PPA and PWPA extensions – options in a changing market

January 2021  |  SPECIAL REPORT: ENERGY & UTILITIES

Financier Worldwide Magazine

January 2021 Issue

Independent power and water projects first appeared in the Middle East in the mid-1990s and have proved hugely successful. In 2019, the top 10 regional developers controlled a generating capacity of 27.5GW spread over 80 projects.

However, the earliest of these projects are now nearing the end of their terms and regional governments are now wrestling with what can be done with these projects.

Between 2021 and 2022, around 3GW of generating capacity is coming out of contract in the gulf region. These assets will have considerable life left in them and in the absence of any functioning regional merchant markets, other uses for these assets will need to be found.

When these projects were first procured, the assumption was that the plants would revert to the government or that extensions would be offered. The initial wave of projects were designed with a ‘transfer’ component in them, either as build, own, operate, transfer (BOOT) or build, operate, transfer (BOT).

At the time, regional governments were very much of the view that these assets should become state property; they had been paid for over a period of years and so should revert to government control. However, in the intervening years virtually all regional governments have stopped running power and water plants and are now realising that these projects are a liability rather than an asset. Governments around the region no longer want to own assets, and the various procurers are no longer able to run these plants, even if they were to take them on. The privatisation process, which started in Oman with the Manah IPP, has been extremely successful, and the idea of governments owning these assets has fallen out of fashion around the region.

Where there are transfers happening, the assets are being tendered out to be run on an operation and maintenance basis, and it does not seem likely that governments around the region will have the appetite for the residual risk associated with ownership of these assets.

In addition to the strategic reasons as to why governments do not want to take these assets on, without major refurbishment these plants would operate at markedly lower efficiencies than any replacement projects. The technologies and equipment that were used to construct the plants when they were procured haven been superseded by new technologies.

Newer projects in the region are using contractual models that do not require the transfer of assets to the public sector at the end of the term. Most allow flexibility by giving land rights which extend considerably beyond the term of the power purchase agreement (PPA) or power and water purchase agreement (PWPA). For future expiring projects, this will allow developers and procurers time to evaluate what the best approach will be for the asset.

For Oman, where these issues are most pressing, various mechanisms are being used. The first of these is a day ahead spot market which all generators will be required to participate in. This proposed spot market was conceived as a way to increase efficiency of dispatch and to incentivise existing generators to make capacity improvements. When operational, the spot market will also offer an alternative route for generators to sell their power in addition to an offtake agreement with the Oman Power and Water Procurement Company (OPWP). The spot market was slated to start operating in early 2021, following testing during 2020. However, it seems likely that this will be delayed.

Oman has also turned to innovative procurement strategies to allow it to access the generating capacity of existing assets. The first of these is the Power 2022 process, which is ongoing and should offer PPA extensions to existing participants in the market. However, OPWP has not yet announced the results of this tender.

In the UAE, the approach being taken is bilateral negotiations for extensions. However, the commissioning of Abu Dhabi’s nuclear power station and the massive investment in utility scale solar means that the opportunities for extensions may be limited.

In Abu Dhabi, most plants were procured as IWPPs. For the projects coming up for expiry, water production was based on multi-stage flash (MSF) technology which requires power plants to operate whether the load is needed or not, especially in winter months when power demand is down, primarily due to reduced air-conditioning requirements, yet water demand remains high.

For the other regional jurisdictions, there will be interesting discussions to be had as each country starts determining what to do with its power and water assets. In recent years there has been a radical change in the desalination and generation markets. Highly efficient reverse osmosis plants have rendered the older MSF plants hugely uncompetitive, solar photovoltaic (PV) projects are now the default option for many regional procurers and the UAE now has a functioning nuclear power station.

In addition, demand curves are looking very different following the shock of COVID-19, which exacerbated the issues already facing regional economies with the collapse in oil prices.

Procurers will have to evaluate whether they want to offer extensions to these older power and water facilities or allow them to expire and gradually move to more efficient technologies such as reverse osmosis or high-efficiency turbines.

There is also growing pressure to reduce the carbon intensity of regional economies and so renewing a thermal power plant is becoming less attractive. These expiring thermal projects may also be a good way to encourage the gradual move away from conventional generation and into solar PV, particularly as tariffs for utility scale solar are already competing with thermal generation. Recent years have seen an explosive growth in renewable energy in the region and procurers are now comfortable with relying on these assets as a dependable source of generation. The possibility of dispatchable solar-based projects, such as Dubai’s Noor Energy 1, which has a concentrated solar power (CSP) element, will only add to the attractiveness of renewable energy as a replacement for conventional generation.

There are also exciting developments in solar desalination, either by using solar PV to provide the necessary energy, or more sophisticated techniques where solar radiation is used to perform part of the desalination process.

There will not be one solution to this problem; each country will have its own needs and issues which will push it down a different path. However, it is clear that the power and water sector which we are faced with at the expiry of these first-generation plants is almost unrecognisable from the one which these projects were developed for. One lesson which developers, procurers and advisers should take from this is that flexibility in relation to events happening far in the future should be anticipated in the project agreements.

 

Thomas Wigley is a partner at Trowers & Hamlins. He can be contacted on +968 2468 2928 or by email: twigley@trowers.com.

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BY

Thomas Wigley

Trowers & Hamlins

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