The power purchase agreement or "PPA" is a key agreement in the development of a wind power project. While there are wind farms that are "merchant" projects subject to a PPA are far more numerous. For such projects, the PPA represents the sole, or most significant, source of revenue. What I have tried to do in this paper is identify some of the typical issues that arise in the course of negotiating a PPA, both in the United States and Canada, from the perspective of a project lender. This perspective is a most important one because lenders will typically have a lower risk tolerance compared to developers and equity investors. The latter have a different risk/reward profile and are generally willing to take certain risks that lenders are not. Accordingly, the developer, who often negotiates and settles a PPA before the project lenders are selected, must attempt to anticipate and be sensitive to lender requirements in the course of negotiating a PPA. Failure to do so can result in the need to renegotiate terms of the PPA as a condition of lender financing, which is, clearly, something best avoided.
- Term and Fixed Price: Lenders will want to see a PPA that has a term that exceeds the term of the loan provided. The developer will want to see a PPA term that is consistent with the design life of the wind turbines of the wind farm, typically, on the order of 20 years or more.
- Minimum and Maximum Delivery Obligations: Many PPAs have a minimum annual delivery obligation or output guarantee, as well as a maximum purchase obligation, effectively creating a "collar" for power delivered under the PPA. Power output for each year of the life of the wind farm should be projected to fall within the collar, that is, between the ceiling and the floor. Ideally, the collar should be structured to accommodate expected volatility in annual production. The consequences of output falling below the floor or rising above the ceiling are as follows:
- Construction Related Issues: From a buyer’s perspective there are consequences to the late delivery/construction of a wind farm because buyer wants the power and renewable energy credits/green credits associated with such power available on a timely basis. Commonly, a buyer will impose a liquidated damages regime (an obligation of seller to pay buyer a fixed dollar amount for each day of delay) to deal with the consequences of a wind farm not being built in accordance with the project milestone timetable. The PPA itself could be at risk if an absolute deadline is missed. Force measure provisions, which excuse a party’s performance for reasons beyond its reasonable control, and will extend milestone deadlines, must be prepared with care to mitigate this risk. Ultimately, a sufficiently long lead time for construction must be factored into any milestones identified in the PPA to address permitting and regulatory delays and expected timing of procurement of wind turbines (a particular concern in the current market). In some PPAs, developers have been able to have permitting risk specifically included as force majeure in order to extend applicable milestones.
- Credit Issues and Performance Security: Credit concerns of one party regarding its counterparty apply to all project agreements, not just the PPA. Credit enhancement/performance security may be required if the credit strength of the counterparty is an issue. This could be provided by way of guarantees, letters of credit or cash collateral. These are frequently required by buyers from sellers under a PPA. Even though one would assume that, as a payee, most of the credit exposure lies with seller, not buyer, buyer is concerned that non-performance by seller will leave it in the position of scrambling to find replacement power and renewable energy credits in the marketplace at a cost that will be at a premium to the PPA price and that seller may be unable to pay the consequent damages owed under the PPA.
- Buyers Right to Curtail: A buyer’s obligation should be to take and pay for all power generated. The right to curtail should be limited to force majeure type events, system emergencies, and the like, where typically seller receives no compensation. A right to curtail "at will" is a matter that will concern lenders. If buyer is to have a right to curtail or de-rate power output of the wind farm at will, appropriate compensation should be paid (inclusive of PTCs) based on an agreed formula. If no compensation is provided, there should be, at the least, a cap on the amount of generation that can be curtailed.
- Ancillary Revenue: Ownership of ancillary products and revenues related to the generation of power, such as green credits, renewable energy credits, capacity payments and direct support payments, can often be allocated in the PPA between the parties. It does not automatically follow that these belong to seller, particularly where buyer is a utility that requires, for example, renewable energy credits to comply with a renewable portfolio standard. Such allocation will be reflected in the cash flow projections for the project and will not concern lenders if the requisite debt coverage ratios are otherwise provided for.
- Lender Consent Rights: Project lenders are potential owners of the wind farm project, contingent on an uncured default by seller under its loan agreement with them. The PPA is, as has already been pointed out, a key component of the project. Lenders will be concerned to ensure that their step-in rights to take over the project assets, including PPA, are explicitly recognized by buyer via an agreement between lenders and buyer ( often referred to as a "lender consent agreement"). While a PPA will often have text addressing this issue in some respect, such text is usually inadequate from a lender perspective and will not, in any event, provide the direct contractual connection with buyer ("privity of contract") required by lenders. Developers should note that settlement of lender consent agreements can be contentious and time consuming.
The price of power under a PPA is usually fixed, although one often sees an annual inflation factor adjustment apply to at least a part (for example, 15% to 20%) of the unit price of power to address operating and maintenance expenses of the project. Such expenses can be expected to increase over time due to the effects of inflation, unlike capital and financing costs which are, typically, fixed for the life of the project. Accordingly, an appropriate inflation index identified in the PPA is used as a proxy to increase the price of power by an amount commensurate to anticipated increases in operating and maintenance expenses over the life of the project.
Minimum Delivery Obligation: If annual generation is below a stipulated annual minimum, seller could be accountable to buyer for losses suffered in procuring alternative sources of supply. This is doubly painful to the seller as it is not earning revenue and, at the same time, is responsible for make-up payments to buyer based on the cost of replacement power and renewable energy credits/green credits. In some PPAs, a continuing failure to achieve the minimum level of generation could result in early termination of the PPA by buyer.
Lenders will wish to ensure that the predicted power output for the wind farm falls comfortably above the floor. Any concern with the volatility of generation of the wind farm based on a probability analysis could result in lenders imposing a more stringent debt service coverage ratio as a condition to financing (i.e. reducing the leverage of the project) or imposing a greater debt service coverage reserve.
Additional points to note:
Seller should ensure that it is credited with lost power arising from force majeure events, or curtailment of power generation by buyer, for purposes of meeting a minimum obligation.
If seller concludes that it has a systemic problem of under-generation, seller should have an express right to add incremental generation.
Given that teething problems arise early in the life of a project, seller should also consider having an extra allowance for failing to meet the minimum delivery obligation in the first year of operation.
Maximum Delivery Obligation: If an annual maximum amount of generation is stipulated, buyer may be entitled to pay a lower per unit sale price for power generated in excess of the ceiling. A more extreme variation would have the PPA place no obligation on buyer to purchase any surplus power (and seller would have to make alternative arrangements for the sale of such surplus, including sales in the spot market, assuming there is access to same). Ultimately, though, this problem is more of an equity issue than a lender issue as the risk essentially relates to generation in excess of that contemplated in the original cash flow model.
Additional point to note:
In some PPAs a surplus in one year (ie. above the ceiling) can be carried forward, or backward, to redress a deficiency in production in another year (ie. below the floor).
Lenders will be very wary of a tight timetable where there is a risk of liquidated damages which is not adequately secured by construction budget contingency or equity sponsor support by way of cost overrun guaranty. Where the risk is loss of the PPA itself, the concern of lenders will be that much greater.
Additional points to note:
Breach of internal milestones could have the effect of multiplying liquidated damages. Careful drafting should avoid this by crediting liquidated damages for earlier breaches against those accruing in respect of a subsequent breach.
Extensions of milestones for force majeure delay should not necessarily be day for day as a force majeure delay of short duration could cause an extensive delay where, for example, a window of opportunity for construction is lost. This is particularly of concern whenever winter construction risk is concerned.
Consider an allowance in the number of turbines that must be commissioned to declare commercial in-service of the wind farm for the purpose of stopping the clock running on delay liquidated damages sooner. In other words, define commercial in-service by reference to less than 100% of the nameplate capacity being commissioned in order to address "rogue turbine(s)" , i.e. those one or two troublesome turbines which could otherwise severely delay commercial in-service of the entire wind farm.
Ideally, the developer should ensure that it has the right to pass on the cost of delay liquidated damages to the construction contractor where the construction contractor is the cause of delay.
Note too, a seller (and its lenders) will be concerned with any contractual right of assignment of the PPA by buyer to a party that may not have the same "credit strength" as buyer. Making sure that such a right of assignment is conditional on demonstrated credit strength of the assignee commensurate to the original buyer is critical from a lender perspective. A properly drafted seller (and lender) consent is essential to address this risk.
Additional points to note:
Credit strength of an assignee of buyer isn’t necessarily just a function of it having a comparable credit rating to the original buyer. Reputation, volatility of business and size of balance sheet are all relevant. For example, lenders may be concerned with an assignment of a PPA by a regulated utility to an unregulated energy trader, even if such assignee has the same credit rating as the utility.
Some buyers will request performance security in the form of a security interest and mortgage against the project assets. Buyer will typically agree to subordinate such security to the security interest of lenders, as lenders will almost certainly insist on a subordination agreement. Developers should note that negotiation of such an agreement can be complicated and time consuming.
Additional point to note:
Where seller is obligated under the PPA to procure such ancillary revenues for the benefit of buyer, seller should seek to have the costs it incurs (at least direct costs) reimbursed by buyer.
In a paper such as this I can only touch on a few matters of note. Nonetheless, I hope I have given the reader some appreciation of the type of issues bound to arise in connection with negotiating a PPA.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
