Renewable energy is synonymous with strong statements about social responsibility, and the ability to drive real bottom line benefits. Organizations are increasingly procuring energy from renewable generation sources as part of their sustainability strategies and to reduce their energy costs. It is a natural hedge against rising and volatile utility tariffs, resulting in realized energy savings over time. Lining up the interests of organizations, investors and lenders, while providing the right technical and contractual solutions, is the main goal of the solar developer.
A Corporate Power Purchase Agreement (corporate PPA) is a financial tool that aligns the competing interests of corporate organizations, solar developers and investors: corporate PPAs allow organizations to build solar energy projects on-site with no capital expenditures incurred. The corporate PPA is signed between an off-taker (customer) and a power producer (solar developer), whereby the off-taker agrees to purchase electricity at a pre-determined price and term.
Building a portfolio of solar PPAs presents significant challenges to solar developers: it’s their responsibility to address the conflicting requirements of customers, investors and lenders in a fair and balanced contract, and to reconcile the differing priorities with pricing and creditworthiness matters. Though, there are emerging strategies and solutions to achieve a favorable PPA to all stakeholders, and partnering with a strategic solar developer is an assured welcome into the benefits of the 21st century.
Understanding the bankability of corporate PPAs
A bankable corporate PPA is essentially a long-term offtake agreement executed with a creditworthy customer and having sufficient tenor to enable repayment of long-term debt, by providing an adequate and predictable revenue stream. Most on-site solar projects are initially fully financed on an equity basis: corporate PPA’s lenders are typically mobilized 2-3 years upon commercial operation date (COD), providing long-term loans, with the cash flows generated by the projects serving as the primary means for repayment of that debt. Thus, the solar projects structures and its key agreements must be designed to mitigate any default risks to those cash flows.
What makes a bankable corporate PPA
Although the structure of a corporate PPA may vary by geography, subject to their respective laws and regulations, a bankable corporate PPA should include some features that are standardized across jurisdictions. Those features should address and mitigate any risks to the cash flow generation that supports the repayment of debt.
Here are nine of the most important characteristics.
1. Electricity offtake obligation and deemed generation
The customer must take and pay all electricity delivered by the developer to the facility, based on a pre-agreed tariff. Should the customer fail to receive generation capacity, a fair list of ‘trigger events’ should be identified and agreed on, which providing the solar developer with equitable compensation. That compensation should be calculated pro rata based on the estimated annual generation, and paid for on a “deemed” delivered basis.
2. Change in law and responsibility for taxes
The agreement should highlight the management of risk concerning a change in law or tax regime that impact the agreement during its tenure. While none of the parties actually evoke such changes, appropriate mechanisms should be in place to seek to remedy, or at the very least minimize, the impacts on the agreement and its cash flows. The economic value of the agreement should be preserved despite of any significant impact to it due to a change in law or tax regime.
The solar developer is likely to procure long-term loans with lenders at some point during the initial years of commercial operations. The agreement should allow for collateral assignment to the solar developer’s lenders with the right to receive notice of any default and to cure such default. Additional step-in rights are generally set forth in a separate direct agreement between the lenders and the customer.
4. Change in customer control
A customer controlling party is an entity that owns more than half of the voting rights in the share capital of a customer, or is able to direct the affairs and the board of directors of that customer. A change in control event is triggered when occurs a change in the customer controlling party. Since thorough due diligence on the customer is made prior to entering into a corporate PPA (which includes the reputation and creditworthiness of its controlling party), the customer should inform the solar developer if a change in control occurs, in order to prepare the solar developer to conduct a similar due diligence on the new controlling entity.
5. Force Majeure
A force majeure event is an extraordinary event beyond the control of the parties and could not be anticipated, such as a war, strike, riot, crime, or an act of God (hurricane, flood, earthquake, volcanic eruption, etc.), that prevents any of the parties from fulfilling their obligations under the agreement. The corporate PPA should allow for time relief if any of such events prevents either the solar developer or the customer to perform its obligations. The costs and risks of loss associated with a force majeure event can be mitigated by adopting appropriate insurances.
6. Termination and payments
The agreement should clearly set out the basis on which either party may rightfully trigger the termination of the agreement. A customer’s unilateral termination may leave the project with no access to the market and thus should be limited to the solar developer’s inability to perform its obligations. However, most on-site corporate PPAs also allows an early acquisition of the solar system by the customer through a pre-agreed exit payment. While in the former case the customer shall provide a termination payment of at least equal to the full amount of the solar developer’s estimated outstanding lenders’ debt, in the latter case the payment should also cover the expected return on equity.
7. Customer payment security
Variables such as the size of the project and the creditworthiness of the customer and its controlling party determine the developer’s rigidity in requiring a form of payment security, of which a variety of options exist. These may be a payment deposit, a letter of credit, or a parent company guaranty, that may be required to support the customer’s payment obligations throughout the agreement.
8. Dispute resolution and governing law
The agreement should provide for arbitration in a neutral and reliable location, under rules generally acceptable to the international community. Historically in the GCC, the English common law-based Dubai International Financial Center (DIFC) courts encourage investors and lenders to engage with project financing opportunities.
9. Foreign exchange
To minimize the currency risk of the solar projects portfolio, the agreement should be either denominated in or linked to the exchange rate of the future debt source’s currency, typically, US dollars. However, most of the currencies in GCC are pegged to USD (except Kuwaiti dinar), which decreases such risk and allows the transaction in national currency.