This post originally appeared on the United Kingdom-based PV Insider website. It is reprinted here with permission.

By Ritesh Gupta

Photos Courtesy of SolarReserve and Lesedi Power Co.

How should electricity producers go about signing emerging market power purchase agreements (PPAs)? We assess what needs to be done in markets, such as India, to combat challenges and carve a niche.

Entities like electricity producers have to carefully plan their revenue-generation model whenever they foray into emerging markets. One of the options is to go for long-term PPAs. One alternative is to go ahead without PPAs where the electricity is sold directly into the grid and then gradually complemented with PPA revenues.

An entity like Santa Monica, Calif.-based SolarReserve, a developer of large-scale solar energy projects, that has been focusing on developing projects in markets such as South Africa, Chile and Australia over the last 15 months or so, believes that electricity producers should treat emerging market power purchase agreements just like they would any other established market while addressing any sovereign or political risk issues.

What To Consider

According to Tom Georgis, senior vice president of development, SolarReserve, an entity needs to consider following aspects:

Finance: To be financeable, any PPA must provide secure revenues that support the up-front project investment cost, annual operations and maintenance, and a fair, market-based return on equity to shareholders.

Risk: Regulatory risk and change-in-law provisions must provide protection for the project owner, especially if they impact project revenues or expenses.

Coping with delays: Georgis points that construction delays and energy production shortfall damages need to be balanced.  In the case of construction delays, the EPC contractor should assume construction risk and provide delay damage amounts sufficient to backstop any delay damage amounts in the PPA.  An EPC contract will typically be fixed-price, date certain with delay damages and performance guarantees.

Credit-worthy: Finally, and most importantly, the PPA off-taker must be credit-worthy to lenders and equity investors with an investment grade rating.

“One advantage of emerging market PPAs is that development banks and export credit agencies tend be active lenders, and in many cases, have specific country mandates to lend to projects,” Georgis says.

Peculiar Aspects

One also needs to be spot on with the peculiar aspects and requirements of a market. As Jasmeet Khurana, head of market intelligence for Bridge To India Energy, explains, in India, developers started using the renewable energy certificate (REC) mechanism to transition between FiT-based projects and wholesale merchant power. Thanks to the shortcomings of the regulatory mechanism, the market is slowly shifting towards PPAs with private industrial and commercial consumers.

He adds that developers sign PPAs with one or more private power consumers at a pre-defined tariff for a period as long at 15 years. As these are retail customers, they pay significantly better tariffs than the wholesale rate of power.

Best Possible Route

The key considerations for the new business models in India are the bankability of the off-taker and the regulatory mechanism surrounding such sale of power.

“The bankability of the off-taker can be managed by the project developer on a one-to-one basis. However, regulations around this third-party sale of power are very complex in India,” Khurana says. “As the regulations are older than solar as a prominent source of power in India, there is little clarity of what duties and charges will be applicable on such projects. Moreover, the charges can change every year, making the investment decisions extremely difficult.

“The good news in this scenario is that some of the states have clarified their positions on how the existing electricity regulations will be applicable on the sale of solar power,” he adds. “As more and more states bring such clarity, either for or against solar, at least the investors will be in a much better position to make their decisions.”

For his part, Georgis says in almost all cases long-term PPAs with credit worthy off-takers will always be the most attractive option to lenders and project sponsors.

“Long-term PPAs provide a contracted source of revenue to lend against,” Georgis says. “But if a market is large enough and has sufficient liquidity with attractive spot market prices, a merchant project could be financeable provided long-term spot-market pricing is forecast to remain high enough to support the project debt service and equity returns.”

“There are instances of projects being financed where a portion of the project is contracted under a long-term PPA and a portion under a merchant. By and large, though, long term PPAs are the more viable and preferred option,” he adds.

As for the challenges, Khurana says regulations are not clear as to how the state-owned utilities want to deal with solar power. As a result, the power producers are not clear how they will be able to use the existing regulations for a new and different source of power.

He also says lenders have been particularly wary of providing any non-recourse finance to merchant solar power projects in India. The only way for a power producer to validate their business case is by signing a long term PPA with a bankable third-party customer and by raising regulatory petitions to get a case-to-case based clarity on how the existing regulations will be applicable on a particular project. This will change over the course of a couple of years, and the first few projects and the precedent set by regulators will pave the way forward for other project developers.

Overall, solar power is in a transition phase globally, as Khurana points out. Unsubsidised solar power has started to become viable for micro-markets at the consumption end.

In the wholesale merchant market, however, where it is competing with other conventional sources of power, some incentives are still needed. This transition period is bound to spur up a lot of business models that make sense depending on the conditions in the local markets.

Project developers want to keep their business models viable by opting for some incentives, but also structuring it in such a way that it is scalable for the future.