Given the increasing focus on renewable energy in the region, KATIE LISZKA* discusses the payment mechanisms involved in such projects.
RENEWABLE power projects are being developed across the Middle East region, for example in the UAE, Kuwait and Saudi Arabia.
Renewable power is likely to be a growth area for the construction sector over the coming years. In terms of natural resources, the region has an abundance of sun and, unsurprisingly, solar power projects are now operational, with further projects being developed, procured and constructed.
Some renewable energy power projects in the region will come to market as independent power producer projects (IPPs). These will be utility-sized plants, where a private sector partner is appointed to both finance, construct and operate the plant. Many conventional thermal power plants in the region have been procured on this basis.
A key difference between a renewable power IPP (depending on the type of renewable energy) and a conventional thermal IPP is the method for calculating the payment for energy produced (or the payment mechanism). What follows is a brief explanation of how the payment mechanism on a solar photovoltaic (PV) IPP may be structured, compared to that for a conventional power plant.
A solar PV plant is non-dispatchable. By dispatchable we mean plants that have the ability to be turned on or off or to adjust their output to meet demand. The principles discussed below apply equally to other non-dispatchable renewable power plants, such as wind.
On a solar PV power project, there are no fuel supply arrangements. Rather than fuel in the conventional sense – for example, coal or gas – electricity is instead generated from a natural resource that is variable and not controllable. There is no need for the generator to purchase fuel. The generator just needs the sun to shine.
In conventional power projects, fuel is supplied by either the offtaker or, alternatively, it is sourced from another third party. The removal of fuel supply arrangements, and related contractual provisions, goes someway to simplifying the payments made in a solar PV power project.
As with conventional power projects, the main agreement between the offtaker and generator is a power purchase agreement (PPA), which sets out the terms and conditions for the sale of electricity generated. On a solar PV project, it is typical for the generator to take the risk of the amount and quality of solar irradiation under the PPA.
In a solar PV project, the offtaker pays for the energy output delivered to the “delivery point”. The amount of the energy payment is determined by reference to a tariff that the offtaker has agreed to pay per unit of energy output delivered. The tariff is commonly expressed as a unit of currency per kWh (kilowatt-hour).
The tariff is normally derived from the levellised cost of electricity (LCOE), which, put simply, is the price that needs to be paid for the electricity in order to cover the cost of its production. The LCOE will account for the capital and operational expenditure of the plant and any cost of financing. In a competitive procurement process, LCOE is a key evaluation criterion.
One factor that increases the LCOE for renewable power projects, which makes them expensive when compared to most conventional power projects, is the capital expenditure. For some technologies, particularly for solar PV, however, the capital cost has decreased rapidly over the past few years.
The payment structure differs from a conventional power plant, where payments are often made up of two elements, one part expressed to relate to energy output and the other part to the available capacity of the plant.
In conventional IPPs, the payment mechanism contains an element linked to capacity being available, in addition to energy output, as there is a value to the offtaker in a plant being available and able to deliver energy as required. Capacity is the maximum electrical output a plant can produce at a point in time. As long as the plant is available, the generator would expect to be paid enough to cover fixed costs (operation, construction and financing) and its return.
Take or pay
Solar IPPs are commonly structured on a “take-or-pay” basis. The general principle is that the offtaker agrees to take and pay for all energy output delivered. In certain circumstances, for example, political force majeure, the generator may be prevented from delivering energy output but it may still be entitled to payment for energy output it would have delivered but for the supervening event. In these situations, payment will be based on energy output that is deemed to have been delivered.
Events allowing the generator to claim for deemed energy payments will be restricted and typically include those that are as a result of default or an action of the offtaker and other agreed non-fault-based events such as political force majeure. Deemed energy payments may, by way of example, be calculated by working out theoretically what energy could have been produced by the available natural resource during the period when the energy output was not delivered.
The generator is incentivised to ensure good performance of the plant because if it does not produce energy then it is not paid. As discussed above, this means that the generator will be concerned under what circumstances outside of its control and which prevent it from producing energy output it will be entitled to compensation. Also, as it is unable to control the natural resource, it will want the offtaker to take all energy output delivered. This can raise interesting questions in relation to the treatment of any excess energy as a result of over-performance of the plant. Offtakers can take different approaches, including capping the amount of energy output or only taking the excess energy output at a reduced tariff rate.
*Katie Liszka is senior associate at Norton Rose Fulbright (Middle East) LLP Dubai office. Norton Rose Fulbright is a leading international legal practice with offices in Europe, the US, Canada, Latin America, Asia, Australia, Africa, the Middle East and Central Asia.
Norton Rose Fulbright has had a presence in the Middle East for more than 30 years and has advised developers, lenders, and contractors in relation to the legal aspects of a wide variety of construction and infrastructure projects in the region. With a combined team located in the Abu Dhabi, Bahrain, Riyadh and Dubai offices, the firm is able to provide both contentious and non-contentious support to financiers, developers, contractors and specialist contractors in the region.
Legal queries related to the construction sector can be addressed to Norton Rose Fulbright (Middle East) LLP through Gulf Construction magazine at firstname.lastname@example.org.