United States: Colombia To Award Long Term Power Purchase Agreements

The Colombian Government is expected to award long-term renewable power purchase agreements (PPAs) by October 22, 2019. The Mining and Energy Planning Unit (UPME) announced that a total of 26 traders and 27 generators with 56 generation projects submitted their interest to participate in the auction and on October 2, 2019 UPME shortlisted 23 traders.

This auction is part of the Government’s strategy to tackle current uncertainties about a potential power deficit in 2021 and 2022 in a sustainable manner and follows an earlier auction carried out in early 2019 that concluded without making any award as a result of the limited number of participants (14 offers by potential off-takers and nine offers by potential project developers). In July 2019, the Colombian Ministry of Mining and Energy ordered that a second auction be launched for long-term PPAs, which only allows for participation of agents of wholesale power market, as power purchasers, and owners of power generation projects from non-conventional renewable sources, as sellers. The Ministry of Mining and Energy expects that by January 2022 at least 10 percent of power distributed by companies in the wholesale market should come from renewable sources.

Among the main changes between the first auction and the new auction that is expected to be awarded on October 22, are the following:

  • Power Sources. The draft PPA for the first auction required the generation companies to generate certain median power from its own renewable power project. In contrast, the new PPA requires the generation companies to supply energy, which may be obtained from other sources. This change provides the developers with the flexibility to outsource the energy required under the PPAs from third parties in case of potential delays related to the construction of the new projects.
  • Contract Term. Under the new auction, the term of the PPAs will be 15 years from January 1, 2022. This is a longer period than the 12-year term set forth in the previous auction. All suppliers are required to start supplying power from this date, even if the new projects are expected to achieve commercial operation on a later date.
  • Scheduled Commercial Operation Date. Under the first auction, the projects were required to achieve commercial operation by a scheduled date no later than December 1, 2021. Under the new auction, the developers should achieve commercial operation by a scheduled date no later than December 31, 2023. According to the new auction, the bond provided to ensure completion of the projects would be gradually increased from 10 percent of the annual value of the energy awarded, if the project does not achieve commercial operation by the scheduled date, to (i) 20 percent, if the delay is less than six months, (ii) 30 percent, if the delay exceeds six months, (iii) 40 percent, if the delay exceeds 12 months, and (iv) 50 percent, if the delay exceeds 18 months.
  • Power Generation Projects’ Minimum Capacity. The first auction required projects with a minimum capacity of 10 MW, and in the new auction, the minimum capacity required from new projects is only 5 MW.
  • Power Blocks. Under the first auction, power was to be offered at a single price. In the new auction, power suppliers are allowed to submit offers in power blocks for periods ranging between 00:00 and 7:00, 7:00 and 17:00, and 17:00 and 24:00 and buyers shall present purchase offers in terms of maximum daily MW per hour. It is worth highlighting that the use of power block approach was one of the key features that helped Chile to launch a successful bidding process, which attracted many new developers and that ultimately culminated with the award of substantial power contracts to non-conventional renewable projects and a significant reduction to the price of energy in the Chilean market.

The improvements introduce in this second long-term power auction certainly helped to diversify the base of participant developers and allowed smaller projects to qualify for the auction (as a fact, the number of bidding developers tripled, from 9 to 27) and to maximize diversification even further, in this auction the Commission for Regulation of Energy and Gas (CREG) mandated that no seller should provide 50 percent or more of average daily power output.

The draft PPA for this second auction also preserves other key features from the first auction, such as the “take or pay” approach for the energy supply (which is a compelling feature that was not available in the successful auctions conducted in Chile), certain step-in-rights in favor of the lenders financing the construction of the new projects, the exchange of blank promissory notes (which is customary in the Colombian market), the delivery of a performance guaranty by seller (which under the new draft, will be equal to 20 percent of the annual price of the contracted energy)1and the delivery of a payment guaranty by the off taker (which for this second auction, will be equal to 30 percent of the annual price of the contracted energy)2.

However, this second long-term power auction also faces several challenges that will be tested after the award date.  Among the most notable hurdles that developers, off takers and financiers will need to overcome are the following:

  • Contract Price in Pesos. Despite criticism raised by foreign interested parties in the previous auction, the PPA still sets the energy price in Colombian pesos (a price that would be adjusted on a monthly basis by the producers’ price index determined by Colombia’s National Statistics Department (DANE)). As it may be recalled by other examples, such as the 4G Toll Road program in Colombia or Argentina’s renewable program “Renovar”, the use of local currency has been an important challenge to attract foreign developers and/or lenders.
  • Financial Strengths of the Off-Takers. The fact that this auction is limited to participants in wholesale power market does not necessarily mean that all of power purchasers will meet the credit worthiness that may be desired from the off takers, especially in the context of a project finance transaction where the certainty of expected cash flow is a paramount concern. In this regard, it should not be a surprise that the financial analysis of the off takers to whom the PPAs are awarded will be cautiously scrutinized by the lenders willing to provide the financing for the new projects.
  • Change of Control. In case of an indirect assignment or change of control, the seller may only object to any such assignment or change of control under very limited scenarios, and any potential concern regarding the credit worthiness of the new controlling entity is not an excuse to reject any such change of control.
  • Penalty in Case of a Termination Default. In the event of a default by a party that may cause the early termination of the PPA, the non-defaulting party is entitled to request a penalty equal to 20 percent of the PPA’s contract value (that is, a value equal to the contracted energy multiplied by the energy price and the supply period). This penalty may be accumulated with other damage claims, including loss of profit claims. In the context of a project finance transaction, the expected amount of the penalty to be collected should be a natural ceiling to the loan amount that may be assigned to such PPA.
  • No Direct Agreements. As noted above, the PPAs do provide for some basic step-in rights in favor of lenders, but the off-takers are not required to negotiate direct agreements with lenders that may wish to clarify (or improve) certain provisions of the PPAs.
  • Dispute Resolution. The PPA provides that any dispute would be resolved by arbitration according to the rules of the Arbitration and Conciliation Center of the Bogota Chamber of Commerce. In light of the recent Landmark Decision in the Ruta del Sol II Arbitration, the use of domestic arbitration may be a concern to potential international lenders.

According to a recent S&P’s report, Latin American countries may see major investments in renewable energy, particularly in Chile, Colombia and Brazil3.  In this regard, during the 2019 United Nations General Assembly, President Iván Duque announced that Colombia, along with Chile, Peru, Ecuador, Costa Rica, Honduras, Guatemala, Dominican Republic and Haiti, is taking on a lead role towards accomplishing the collective target of 70 percent renewable energy use by 2030. According to President Duque, this is part of the region’s compromise to tackle climate change. The lower costs and abundance of natural resources is key for the region in implementing wind and solar projects and is attractive for key power players and international lenders.

There is no doubt that Colombia needs to continue improving its energy matrix and is trying to take a leading role in a region that shows a strong appetite for more renewable power sources. However, despite Colombia’s noble intention, the road to success on this endeavor will be challenging and a significant dose of ingenuity, pragmatism and careful consideration of the risks and mitigations will be required during the implementation phase of this undertaking by the relevant market participants, including the Government, developers, off takers, lenders, suppliers and contractors.

Footnotes

1.The performance guaranty in the first auction was equal to 33 percent of the price of the median annual energy. Under the current PPA, it would be for 30 percent of the annual price until the effective date of supply, when it will decrease to 20 percent.

2. The payment guaranty in the first auction was for 33 percent of the price of the median annual energy.

3.  Project Finance International, August 2, 2019, Americas: LatAm – S&P bullish on renewables.

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