International Restructuring Newswire
This issue looks at restructuring changes across The Netherlands, Canada, Australia and the UK, and an article on revisions to India’s bankruptcy laws.
In the fight against climate change, and further to the 2015 Paris Agreement, (where 195 Governments agreed to take concrete measures aimed at reducing greenhouse gas emissions globally and to set Sustainable Development Goals), in 2017 the Italian Government ratified the Italian National Energy Strategy (INES)1.
The main objectives of INES are to
Given this background, corporates in Italy, and around the world, have set goals to limit their greenhouse gas emissions, to reduce their environmental footprint and energy costs, and to contribute to the renewable energy targets set by their Governments. One way to reach these goals is through the use of corporate renewable power purchase agreements (Corporate PPAs), which are contracts between the buyer (off-taker) and the power producer (developer, independent power producer or investor) to purchase electricity at a pre-agreed price for a pre-agreed period of time.
INES highlights that Corporate PPAs may facilitate the development and bankability of new, large-scale renewable energy plants. Corporate PPAs are also mentioned in the draft of a new Decree (the Draft New Decree)2, which provides incentives for producing renewable energy over the next three years. However, this is still to be approved by the European Commission and will then need to be issued by the Italian Ministry for Economic Development.
The Draft New Decree considers Corporate PPAs as an alternative to public incentives and proposes to create a market platform to be managed by Gestore dei Mercati Energetici S.p.a. to facilitate long-term contracts for renewable energy. It also proposes that the Italian Regulatory Authority for Electricity and Gas prepare a standard term sheet for long-term Corporate PPAs.
Going forward, the next steps are to
The main drivers for corporate buyers to commit to a long-term Corporate PPA can be broadly described as economic, sustainability and reputational.
From an economics perspective, a long-term fixed-price Corporate PPA is a hedge against power price volatility and may also avoid long-term carbon and environmental penalties by complying with current and future regulatory requirements. Sustainability is also an important driver insofar as corporates are keen to reduce carbon emissions and to contribute towards national renewable energy targets. Committing to Corporate PPAs may also be useful to enhance the corporate buyer’s reputation and brand leadership, as this may help corporate buyer’s to get recognition for renewable electricity achievements and help them to meet their public sustainability commitments.
Moreover, developers and lenders may perceive a long-term Corporate PPA (especially if it is on a price-fixed basis) as a risk mitigation tool to
One type of Corporate PPA is a “sleeved” or “physical” PPA. This is a purchasing contract that may be executed if:
The sleeved or physical Corporate PPA is the most commonly used contractual structure in Italy. Under this scheme, the corporate buyer simultaneously enters into a PPA with the developer and a back-to-back PPA with its incumbent utility.
One characteristic of this type of Corporate PPA is that it requires the utility to physically deliver power to the relevant site, for the corporate buyer which is not permitted to offtake the power directly under local electricity supply rules. Instead, the developer transfers the electricity to the utility, which will sleeve it through the grid to the corporate buyer.
The parties may also agree that physical delivery is not required. This is called taking a “virtual”, “synthetic” or “financial” approach.
Virtual PPAs are financial derivatives (such as Contracts for Difference), where generators and off-takers agree to a strike price that will be paid for each unit of energy generated over an agreed period of time. The project sells the power to the open market, and the off-taker purchases power from the open market. If the market price rises above the strike price, then the developer pays the difference to the off-taker. Conversely, the off-taker compensates the developer in the event that the market price falls below the strike price.
Similar financial structures may be created through the use of call options and put options. For instance, put options would give the developer the opportunity to buy the right to sell the generated energy at a certain strike price. If wholesale power prices fall below the strike price, then the developer can exercise its option to sell the electricity at a higher strike price.
There are numerous risks to consider before entering into a Corporate PPA. Key risks include: market risk, price and project revenue risk, tenor risk, currency (or foreign exchange) risk, credit risk, scheduling risk, basis risk, balancing risk, volume risk, shape or profile risk, construction risk, performance or operational risk, change in law risk, and force majeure risk.
The table below includes a brief description of the risks noted above and ways in which those risks may be mitigated.
|Type of risk||Details||Ways to mitigate risk|
|Market risk||Agreeing to a purchase price for power over a long period of time could be risky if electricity prices decrease. Although unlikely, this could happen because of new technologies, regulatory changes, better transmission capabilities, a combination of these factors, or for other reasons.||To mitigate market risk, corporate buyers should consult a market expert and consider power price forecasts.|
|Price and project revenue risk||
Corporate PPA pricing structures may be fixed (an agreed price per MWh with no escalation over time) or flexible. For example, the parties may agree to a price increase over time linked to inflation or wholesale power prices.
The parties may also agree to set the price at a fixed discount to the fluctuating wholesale power price, perhaps with a cap and floor, so that if the wholesale price drops below the floor, the corporate buyer pays the floor and if the wholesale price increases above the cap, the corporate buyer pays only the cap.
To mitigate price risk, if the price of power is expected to decrease, a corporate buyer should opt for a flexible pricing mechanism.
Generally speaking, developers will almost always benefit from a long-term, highly predictable pricing mechanism, whereas lenders will want a fixed price in order to ensure that the projects revenues are certain and will be sufficient to repay any loans.
Lenders traditionally manage project revenue risk using a range of tools, including: debt sizing, creation of ad hoc reserves, increase of interest rates and shorter-term loans. Flexible and innovative solutions exist to balance the requirements of the various parties to a Corporate PPA, including
Tenor risk relates to the period over which the corporate buyer is obliged to pay for power contracted for under the Corporate PPA. It can be a fixed duration period, or a period that is subject to extensions triggered by certain conditions.
For power produced by an existing renewable energy plant, in Italy the term of the Corporate PPA is usually short (1-5 years). By contrast, for power produced by a renewable energy plant that is under construction, the term of the Corporate PPA is usually longer (10-15 years).
With a fixed price comes the possibility of significant savings (if power prices increase) and the risk of being locked into a higher than market price (if power prices decrease).
The corporate buyer’s position on tenor risk will depend on two things: its sensitivity to the fluctuation of power prices and its estimated future demand for power.
Developers will be guided both by lenders’ minimum term requirements and by power price forecasts.
Lenders will expect that Corporate PPAs cover at least the term of the loan being contemplated, and preferably also include a tail period after the maturity date, especially when the lender is providing a high proportion of the capital to finance a new project.
Put and call mechanisms may be implemented to balance the expectations of the various parties to the Corporate PPA. For instance, if the wholesale power price goes up, the corporate buyer may be granted the option to extend the term at a higher price. If the wholesale power price goes down, the developer may be granted the option to extend the term at a lower price. In these scenarios, the put and call prices are fixed in advance, applying acceptable caps and floors.
|Currency (or foreign exchange) risk||The risk arises because of the mismatch in the currency of debt obligations and currency of revenue which exposes the project to the risk of devaluation over time. This can result in reduced investments in the country due to currency risk.||To mitigate currency or foreign exchange risk, a currency swap with a third-party provider to protect against devaluations may be used.|
Since Corporate PPAs are crucial revenue contracts, the creditworthiness of the corporate buyer is also crucial.
In fact, the attractiveness and bankability of long-term Corporate PPA agreements depend significantly on the creditworthiness of the corporate buyer.
Credit risk covers the likelihood that the off-taker will be unable to pay amounts owed under a Corporate PPA.
Even where a corporate buyer has a good reputation and global brand, the creditworthiness of the particular contracting entity will be carefully scrutinised by both the developer and the lenders.
To mitigate credit risk, lenders might require letters of credit, parent company guarantees, or another appropriately sized bank guarantee from an A-rated bank.
Multiple buyer structures (where there is a single corporate buyer representing the aggregated demand of a group of buyers) can also help spread credit risk (so-called club structures).
With club structures, a lender may develop an internal bespoke credit rating for the blended buyer vehicle, rather than rely solely or partially on third-party credit support.
Multiple buyer structures involving multiple corporates, or a combination of corporates and utilities, could also be interesting for a seller, as a way to increase appetite for large projects, where a single, large interested buyer does not exist.
|Scheduling risk||Scheduling risk relates to the deviations between forecasts of expected power production by generators to network operators and the actual outturn production.||Typically, scheduling risk is borne by the network operators who charge a fee for their services.|
Where a project is located can have a major impact on the risk of that project. This is commonly referred to as location risk.
Numerous factors relating to location, including: transmission line congestion, wind and solar intermittency and variability, market saturation, and state-based or regional regulations can influence the value of a Corporate PPA.
One type of location risk is basis risk, which is the possibility of a mismatch between the market price at a project’s delivery point and the prevailing price at the agreed upon trading point that is specified in the Corporate PPA.
If the buyer and developer are located in different markets and the Corporate PPA payments are linked to the wholesale price in the market that is local to the developer (not the buyer), then the buyer is exposed to the ‘basis risk’ in wholesale price movements.
This risk is usually more relevant to virtual Corporate PPAs, but can also be relevant in physical Corporate PPAs (in markets with zonal pricings).
If the retail price in the buyer’s market(s) and the wholesale price in the developer’s market are not correlated, then the buyer becomes exposed to volatility in retail power purchasing.
In order to share basis risk and structure a bankable project, some virtual Corporate PPAs provide for pricing adjustments (on a fixed or floating basis) or caps.
Alternatively, some project owners enter into ancillary agreements with third-parties to hedge the basis risk, either by their own initiative or by request of the lenders.
Balancing risk relates to the need to provide a continuous supply of power to the corporate buyer.
It is the risk of exposure to power system costs that arise when an asset’s forecast generation is less than its actual generation.
The more an asset contributes to the power system’s imbalance, the higher the imbalance cost is. The more the generation profile of an asset correlates with the market-wide generation profile of its technology, the more the asset’s imbalance correlates with the overall power system imbalance, resulting in higher imbalance costs.
One way to mitigate the seller’s balancing risk is through outsourcing, i.e. entering into an agreement with a third-party (or a party belonging to the same group as the corporate buyer), which agrees to supplement for any shortfall in power production in order to meet the obligation of providing a continuous supply of power to the corporate buyer.
As an alternative, the corporate buyer may execute a back-to-back electricity supply contract with a third-party provider or with the electricity utility, whereby the renewable supply is topped up with other electricity to provide the required power supply.
Third-parties or utilities will typically charge a fee to compensate for managing the balancing risk.
Volume risk captures the variability of power generation of a plant over a period of time, which may be a season or a full year.
The risk may derive from climatic variations, such as wind that is higher than expected one year or lower solar irradiation levels due to a cloudy summer.
Corporate buyers will insist that the developer commits to a minimum volume over a reasonable period of time.
Developers may agree to the extent that the minimum output requirements are achievable and aggregated over time.
Failure to comply with a volume guarantee could lead to contractual damages being payable to compensate the corporate buyer for the actual cost of buying additional power.
In some jurisdictions, so-called weather derivatives have been implemented.
|Shape or profile risk||
Shape or profile risk is connected to volume risk but it captures the fact that hourly generation will be variable depending on wind speed or solar irradiation, irrespective of whether the overall volume over a given period is equal to the estimated volume.
The intermittent actual generation of power from a renewable energy plant may be different from the generation forecast and also, inconsistent with the baseload demand of a corporate buyer (which is likely to be flatter, with a pronounced variation between business and non-business days).
Developers may be willing to guarantee the mechanical availability of their plants but not actual output, as that is influenced by weather conditions and operational strategy over which they have no control.
As a result, shape or profile risk has so far been considered as a risk to be managed by the corporate buyer.
The corporate buyer may traditionally use its utility supplier as a sleeving agent to manage the variable volumes from the Corporate PPA as part of the wider management of the corporate buyer’s electricity demand.
However, thanks to smart digital telemetry and process control, innovative buy-side mitigation tools are emerging which may allow the buyer to adapt its load on the grid to correspond to the generation profile of the renewable energy plant or to imbalances on the grid. These technologies can respond to an imbalance by switching off equipment that does not immediately require power until the price spike has passed.
Although there are few cases where the seller offers to manage shape or profile risk, the fact is that the seller may (i) seek to absorb the risk by setting firm deliveries at a conservative level; or (ii) outsource this risk by entering into a parallel financial hedge with a third-party (such as a trader) to manage the commitment of financially settling against a firm volume.
Proxy revenue swaps are hedging solutions where the hedge provider or the insurance company pays the seller a pre-agreed fixed-price per annum (rather than providing a fixed unit price per MWh generated or sold).
The project swaps the uncertain annual volume of power that would be generated by an efficient project with a more certain payment at a fixed long-term price.
Due to the need to pay up-front structuring fees, annual fees and services fee to put this structure in place, hedging products may be a viable solution, particularly for larger projects.
Another innovative sell-side mitigation tool for shape risk may be the integration of power storage technologies behind the meter, together with renewable energy projects. The seller can use the power storage system to smooth peaks in renewable generation, as well as to assist with imbalance costs and other technical constraints on the grid.
For new projects still to be built, development or construction risk is another factor to be taken into consideration.
Construction risk is the risk that the plant is not completed in a timely basis or at all.
To mitigate construction risk, a corporate buyer may negotiate adequate termination rights, withdrawal rights, as well as damages for any significant delay in the delivery of the power caused by the developer’s delay in completing the project.
Developers will focus on ensuring that all the milestones of a project include an appropriate buffer and will extend any deadlines on the occurrence of a force majeure event and/or a change in law.
Lenders will be aligned with the interests of the developers and will carry out due diligence on both the project and the developer to evaluate the risk that that the Corporate PPA may be terminated before a project is completed.
|Performance or operating risk is||Performance or operating risk is the risk that the project does not perform as expected, in terms of the level of mechanical availability, warranted power curve (wind) or performance ratio (solar PV).||
Corporate buyers may demand withdrawal rights from the Corporate PPA in the event of poor project performance. Developers may try to deny any demand for performance guarantees and argue that these are unnecessary in light of the economic incentive on a generator to maximise production.
If a performance guarantee is agreed, developers and lenders will focus on ensuring that any requirements are reasonably achievable and that the contract also provides for cure rights. Developers will also seek to pass this risk to contractors in the supply chain.
|Change in law risk||
During construction or operation of the project or during the term of the contract, a change in law or a force majeure event may occur.
Change in law risk captures the risk that developments in applicable legislation and regulation may upset the balance of risks and rewards under a Corporate PPA.
Developers will insist on having a mechanism to renegotiate material provisions of a Corporate PPA that may be impacted by a change in law. Such mechanism will seek to restore the agreement to the original economic intent, especially where the Corporate PPA is the primary revenue resource for a project.
A corporate buyer will resist this, especially in case of a fixed-price Corporate PPA, on the basis that the fixed price justifies the project bearing this risk.
Lenders will be focused on one thing – ensuring that any change in law provision does not materially undermine the forecast revenues of the project.
|Force majeure risk||Force majeure risk is the risk that extraneous events may occur over which neither the developer nor the corporate buyer have control (including acts of God or extreme weather conditions), which may delay completion of the project or have an impact upon the project’s power generation capabilities.||
A corporate buyer will focus on ensuring that the seller is required to use its best efforts to remedy any delay or negative impact caused by the force majeure event. The corporate buyer will also demand the right to purchase power from an alternative source, as required.
Corporate buyers may also demand the right to withdraw from the Corporate PPA if the force majeure event extends for a considerable period of time.
Developers, on the other hand, will try to negotiate a long remedy period for any force majeure event before the corporate buyer has the right to terminate the Corporate PPA.
Developers will also want the Corporate PPA to provide that certain types of construction delay and/or facility underperformance are considered force majeure events.
A fair allocation of the force majeure risk between the corporate buyer and the developer is in the best interests of all the parties to the Corporate PPA, including the lenders.
Currently key markets for the development of Corporate PPAs are Latin America, Northern Europe, India and Singapore, which share the following common features
Whether Corporate PPAs will be implemented to the same extent and with the same success in Italy as in the countries listed above is yet to be seen.
However, we are confident that the use of long-term Corporate PPAs in Italy will increase, and that Corporate PPAs will play an important role in the clean energy market and relevant regulation. The decline in the availability of Government-backed fixed feed-in tariffs at a premium to the wholesale market will certainly increase the appetite for Corporate PPAs, although the market demand for Corporate PPAs alone is unlikely to deliver Italy’s INES without other, complimentary regulatory intervention.
As the market for the development of subsidy-free renewable energy projects grows, we expect to see Corporate PPAs become a common part of the energy and sustainability strategies of Italian corporates.
Turkey offers significant potential as well as certain challenges to international investors and developers, in addition to domestic businesses.
On December 31, 2019, the State Council of the People's Republic of China (PRC or China ) released the Regulations on the Implementation of the Foreign Investment Law (Implementation Regulations) which took effect on January 1, 2020.