77970 NOTE NUMBER 337 viewpoint PUBLIC POLICY FOR THE PRIVATE SECTOR FINANCIAL AND PRIVATE SECTOR DEVELOPMENT VICE PRESIDENCY MARCH 2013 Small-Scale Generation Steven Ferrey and Issues in Standardizing Power Purchase Agreements Alejandro Moreno P rograms to att r a c t inv e s t m e nt in s m a ll- s c a le e le c t r ic it y g e n e r a t i o n , Steven Ferrey (sferrey@suffolk.edu) is a of te n p owe red by r e ne wa b le e ne r g y s o ur c e s , ha v e b e c o m e in c r e a s i n g l y professor of law at Suffolk common in the d e v e lo p ing wo r ld a s g o v e r nm e nt s s e e k t o b ot h e x p a n d University Law School and access to e lectr ic it y a nd im p r o v e s us t a ina b ilit y . A v a lua b le t o o l f o r an international energy attorney. Alejandro such p rograms is a we ll- c r a f t e d , s t a nd a r d iz e d p o we r p ur c ha s e Moreno (amoreno2@ifc agree me nt, whic h c a n r e d uc e t r a ns a c t io n c o s t s f o r g e ne r a t or s a n d .org) is a consultant with the World Bank Group’s government agencies alike and substantially improve the economics of Investment Climate small generation facilities. This Note discusses key considerations in Advisory Services. designing a standardized agreement for a small power producer program. Nearly 20 percent of the world’s people have option for providing power to remote sites or in little or no access to modern energy services, areas with low or diffuse demand, but they are a share that rises to 40 percent in South Asia often more expensive than larger projects (per and to more than 70 percent in Sub-Saharan unit of energy generated) and are not neces- Africa (World Bank 2010, p. 8). Almost half rely sarily the most effective use of resources for a on coal, wood, or waste for cooking and heat- national utility company. Government-backed ing.1 Led by a booming electricity sector,2 global small power producer programs can provide the energy demand is expected to increase by 80 opportunities and incentives for private power percent by 2050. But energy is still distributed producers to fill this gap. THE WORLD BANK GROUP unequally, and the lack of access to affordable, In addition, small projects are often devel- reliable power today remains an important bar- oped using renewable resources, which eliminate rier to economic development in many parts of the need to transport and store fuel in remote the world. locations. As governments around the world Addressing the lack of access to energy is a recognize the effects of climate change, small key policy priority, and many developing coun- power producer programs are often combined tries have begun to implement policies and pro- with renewable energy programs and incentives. grams to expand the development of their energy The power sector of every country operates resources, including by attracting investment under a legal framework usually implemented to small-scale or renewable power generation through a number of core legal documents, but projects. Small-scale projects are often the only the cornerstone of any long-term power sales S mall - S cale G eneration I ss u es in S tandardi z in g P o w er P u rc h ase A g reements agreement with a private power generator is the Key clauses and considerations power purchase agreement (PPA). A PPA is the For standardized PPAs, the key issues addressed primary legal contract between the seller and by traditional project-specific PPAs must be deter- buyer of power, specifying prices, obligations, mined up front and apply to the entire targeted and all associated terms and conditions of the sector. Such considerations include the term of transaction. the PPA, control of generation and operations, Designing a standardized PPA is a particu- the structure of the tariff, and the allocation of larly critical (and complex) element of a small risks between the buyer and seller of power. Table power producer program. This Note discusses 1 shows how five small power producer programs 2 the options and considerations that go into the in East and South Asia addressed such issues. development of a PPA between a small power producer and the national grid, including the Length of the term benefits of standardization. Because the devel- The length of the PPA term is a critical element opment of PPAs requires legal and regulatory in realizing project leverage and financing. In assistance, multilateral and regional develop- the capital-intensive power generation industry, ment banks have often played a pivotal role and lenders often will provide loans only to project are likely to continue to do so. developers that have already signed a long-term PPA providing a sufficient revenue stream to Why standardize? repay the loan amount plus a debt coverage A standardized PPA treats all small power pro- contingency. Entry into standardized PPAs can ducers and the utility similarly through its legal be managed through either controlled competi- arrangements. While this inflexibility may be tions or ongoing general offers. viewed by some as a disadvantage, it also provides Most PPAs allow the small power producer to important advantages. If the standardized PPA is elect a term for supplying firm power (a commit- developed by unbiased legal advisers and carefully ment to dedicate and sell power output to the crafted through a consultative process with all rel- utility) of up to 15 years or longer. Long PPA evant stakeholders, it can achieve several things: terms, however, expose both parties to the risk ■■ Because all parties are treated similarly, there of economic change; as discussed below, the PPA is no perception of advantage or unfairness must determine which party will assume each of and all stakeholders can trust and are invested the myriad risks relating to specific changes in in the integrity of the small power producer law and in taxes and fees as well as those relating contract and program. to economic events. Developing countries in the ■■ The up-front transparency and visibility of the process of moving toward retail competition in agreement minimize regulatory risk. the power sector need to work with advisers to ■■ The PPA is internationally acceptable for the adapt long-term PPAs to this changing regulatory financing of small power producer projects, environment. protecting lenders, project owners, the utility, and utility ratepayers. Control of operations ■■ The standardization eliminates the layers of Another key role of a PPA is to allocate control transaction costs that come with negotiating of generation and operations. Common con- a PPA for every small power producer, saving siderations include whether the off-taker utility time and case-by-case regulatory approvals. has the obligation to always purchase the power While standardized PPAs are of particular output, whether the project is dispatchable (that value for small power producer programs where is, whether the project can and must adjust its each project is relatively small and the transaction generation at the request of the utility or grid cost of negotiating each PPA is therefore pro- operator), and whether there is a firm power portionally higher, some countries have begun supply or “capacity” obligation imposed on the to employ versions of standardized PPAs even small power producer. for larger independent power producer (IPP) If the utility controls the dispatch and projects. operation of power, this gives it, as the power Table Practices in power purchase agreements for selected small power producer programs in East and South Asia, 1992–2012 1 Thailand Indonesiaa Sri Lanka Andhra Pradesh, India Tamil Nadu, India Year begun 1992 1993 1998 1995 1995 Maximum size (megawatts) 60 or <90 <30 in Java; <10 <20; <50 <15 in other grids previously <50 Primary fuel Gas Renewable energy Hydro Wind Wind Standard PPA? Yes Yes Yes Not formally, but a standard form In development Long-term firm PPAs? Yes Yes Yes Yes Yes Capacity payment for Yes Yes No No No long-term power? Approach to allocating Alteration of capacity Neutral; originally Neutral; mutual best Nonfirm, but utility must Nonfirm, but utility performance risk between payment; utility can mutual best efforts efforts accept all power can refuse delivery seller and buyer? refuse delivery Capacity payment adjusted if Yes No, capacity payments n.a. n.a. n.a. seller does not deliver? in peak rate Small power producer Yes, if firm capacity No, with original PPA; No No No dispatchable? PPA; 80% minimum freely dispatchable annual output after change purchase obligation n.a. Not applicable. a. After initial success, this small power producer program was abandoned during the 2008–09 financial crisis. Sources: Ferrey 2004; Ferrey with Cabraal 2006, updated to reflect changes since 2006. purchaser, control over when and how much operate or sell power. To address this risk, tariff power it must buy. While having centralized, payments can be “split” into separate payments: coordinated control over power dispatch and a payment for capacity, reflecting the marginal operation is important, some countries have cost of project construction and financing, and found that this creates a visible conflict of inter- a payment for energy actually supplied. Even est, because the utility may be tempted to prefer if the project is not allowed to operate during dispatch from its own plant to that from private certain times of the day or season, the project producers. In such cases this conflict has been is paid the capacity payment (sometimes called addressed by imposing regulated standards “deemed” energy) as compensation for simply and review on the utility; by delegating grid being ready to operate. PPAs for nonfirm power operation to an independent system operator (with no contractual minimum supply obligation different from the utility; or by developing for the small power producer, and payment only regulations that designate renewable energy for the “energy” value reflecting the utility sys- small power producers as “must run” facilities tem’s marginal operating costs) do not include that the utility “must take” for purchase, with- capacity payments. out dispatch. Similarly, PPAs should be designed to carefully Allocation of project risks structure grid operation and repair obligations To be effective, a PPA should allocate project and force majeure provisions, which excuse either risks in ways carefully tailored to the country’s the small power producer’s owner or the utility goals and markets. Because small power pro- from its contractual obligations under unantici- ducers are subject to a range of project risks, pated circumstances. how a standardized PPA treats these risks can have a substantial effect on the level of private Tariff structure investment in power generation. Commercial Where the utility controls decisions on the dis- risk is the possibility that project economics will patch and operations of small power producers, not unfold as planned. PPAs typically allocate this creates a risk of projects not being allowed to this risk to the project developer. Sovereign S m a l l - S c a l e G ene r a t i o n I s s u e s i n S t a n d a r d i z i n g P o w e r P u r c h a s e A g r e e m e n t s risk is the risk of the project being national- the associated PPA to its own situation and policy ized or of the country vacating the utility’s PPA objectives. obligations after the PPA is signed. This risk is addressed through change-of-law clauses and waivers of sovereign immunity. Regulatory risk viewpoint is the risk of new laws, new regulations, and new Notes interpretations of the obligations of the utility This Note provides an introduction to the issues sur- is an open forum to or small power producer—a risk that becomes rounding the design of PPAs. For more detail as well as encourage dissemination of particularly salient when the country is restruc- options for implementing both PPAs and small power public policy innovations turing roles and obligations in its electricity producer programs more generally, see Ferrey with for private sector–led and sector. Different countries regulate this risk in Cabraal (2006) and Ferrey (2004). market-based solutions for different ways, but should maintain a balance 1. United Nations, Sustainable Energy for All, “About development. The views between allowing new laws and regulations and Us,” http://www.sustainableenergyforall.org/about-us. published are those of the providing sufficient certainty to attract private 2. The International Energy Agency projects that 45 authors and should not be investment. percent of new investment in energy infrastructure attributed to the World Currency risk includes both the risk of the between now and 2035 will be in electric power, dwarf- Bank or any other affiliated local currency changing in value relative to ing investment in all other energy sectors (IEA 2011, organizations. Nor do any “hard” international currencies and the risk of executive summary, p. 5). of the conclusions represent being unable to repatriate currency to out-of- official policy of the World country international lenders and project own- References Bank or of its Executive ers. To address this risk, some countries index Ferrey, Steven. 2004. “Small Power Purchase Agreement Directors or the countries PPA payments to international currencies to Application for Renewable Energy Development.” they represent. stabilize their value, index the payments to par- Asia Alternative Energy Program, World Bank, ticular inflation indices to maintain their local Washington, DC. http://siteresources.worldbank To order additional copies value over time, or do both. .org/INTEAPREGTOPENERGY/Resources/Power- contact Naoki Ogiwara, Purchase.pdf. managing editor, Conclusion Ferrey, Steven, with Anil Cabraal. 2006. Renewable Power Room F 4P-256B, The World Bank, The technologies exist to mobilize small-scale in Developing Countries. Tulsa, OK: PennWell. 1818 H Street, NW, and renewable power generation in developing IEA (International Energy Agency). 2011. World Energy Washington, DC 20433. countries, where power demand is increasing Outlook 2011. Paris: IEA. most rapidly. Well-designed small power pro- World Bank. 2010. “Addressing the Electricity Access Telephone: ducer programs, with balanced and standardized Gap.” Background paper for the World Bank Group 001 202 473 1871 PPAs, can leverage financing and support effi- Energy Sector Strategy, World Bank, Washington, Email: cient, cost-effective private investment in small- DC. nogiwara@worldbank.org scale power generation. But in every country the government faces a variety of key strategic choices Produced by Carol Siegel to tailor the small power producer program and Printed on recycled paper This Note is available online: http://www.worldbank.org/fpd/publicpolicyjournal