Utility-scale renewables’ power purchase agreements (PPAs), the LA Times recently wrote, are “confidential agreements between solar developers and utilities” that “lock in power prices two to four times the cost of conventional electricity” which ultimately “line the pockets of banks, insurers and utility companies.”
What such reports miss, said Milbank, Tweed Partner Karen Wong, is how competitive the PPA bidding process has become. Utilities’ requests for proposals and request for offers (RFPs/RFOs), Wong said, “are typically closer to 'take it or leave it' offers.”
In today’s California market, the utility has the leverage, Wong said. “There is a huge market of parties who want to sell power and a virtually monopolistic set of buyers who can name the terms and pick the price.”
Utilities say “this is the power purchase agreement you will be bound by. Name me a price on these terms. If you want to change any of my terms, please red line what you want to change.”
But a bidder doesn’t “want to come across as being difficult,” Wong said. A redlined bid “may not be considered as favorably as one signed on the dotted line without any changes.” Some bidders, she explained, accept the utilities’ standard, just to get a PPA, “without knowing what’s financeable.” This makes it, she added, “difficult for someone who is a real player.”
Wong described six key PPA items: (1) price, (2) certainty of revenues, (3) curtailment, (4) conditions precedent and timing, (5) cure and lender step-in rights, and (6) interconnection.
First, Wong said, a developer “has to get a price that will cover its cost and earn a reasonable return on investment.”
A developer must be certain of payment. “You don’t want to have events of default or triggers that could essentially take the PPA away from you.” Developers must have “adequate cure periods, objectively written, so you don’t find yourself thinking you have a twenty-year PPA, only to find out two days after you sign that the utility can terminate the agreement for default you didn’t even know you triggered.”
PPAs typically allow a project to be curtailed (that is, disconnected from transmission) for reliability or safety reasons. The negotiated term, she said, is about “economic curtailment and what the compensation is.” Aside from some wind developers’ problems with curtailment issues in Texas, she noted, unfair and inadequately compensated curtailment in California does not yet seem to have become widespread.
Because permitting, interconnection, and financing are complex and unpredictable, Wong said, the conditions precedent to, and the timing for, the effectiveness and commencement of the PPA term should be specified in the contract to ensure adequate time to finance and build.
Permitting and interconnection timing are beyond a developer’s complete control, Wong observed. “Usually bankers are willing to commit to provide financing only when they know the PPA is effective. And when they commit to lend, they want to know the developer will not lose the PPA.” Lenders, Wong said, will negotiate covenants in the financing documents to ensure that.
Because of standardized forms in Europe, MEMC (NYSE: WFR) CEO Ahmad Chatila recently said, a PPA there can be as short as two pages. Because it is negotiable in the U.S., a PPA here can require two trees' worth of paper.
“When you add in all the technical exhibits,” Wong agreed, “yes, at least two trees. How many pages are in a tree?”
The relationship between financing parties and developer is crucial, Wong said, because the primary revenue source that returns the investment is defined by it. Cure and step-in provisions protect a financing party from a developer’s failures. “You want to know that if a borrower goes belly-up, or doesn’t perform, the utility will let you step in, give you additional time to cure and take over the contract or find another developer to operate it.”
This is often a three-way negotiation, she explained. “The financing parties want the right to cure on their own, where they can step into the shoes of the borrower.” This can create tension if the utility has already completed PPA negotiations, she noted. Astute developers, she said, “will make sure upfront that they have a long enough cure period.”
A developer should also, if possible, have the interconnection done before the PPA is signed, Wong said, “or at least have a very good idea when it will be done, so you don’t make commitments you can’t satisfy in the PPA.”
One problem, she noted, is that both the PPA and the interconnection agreements are often negotiated with two sides of the same utility and, she added, a utility’s transmission side is typically walled off from the contract negotiating side. Yet if the interconnection facilities are delivered late, the utilities’ transmission side “will not pay liquidated damages while, in the PPA, if the power is not delivered by a specific date, the developer may have to pay liquidated damages to the same utility.”
Because utilities get so many bids, Wong observed, they have something of a "pick-and-choose" mentality. In the past, she said, uninformed developers made low-priced bids and then discovered their proposals weren’t financeable.
“Utilities now ask for more bid security upfront,” Wong said. “Contract viability is increasingly important. The bidder has to be real and serious. If the bid is accepted and the mandate to negotiate with the utility is awarded and isn’t, the bid security may be forfeited.”