Process for Review of PPAs – Lessons From Nigeria

Legal Authority

Full Credits:   John Besant Jones,  Bernard Tenenbaum, Prasad Tallapragada of Energy Sector Management Assistance Program (ESMAP)
For Educational Purposes only 
Abbreviations and Acronym
  1. NERC  - Nigeria Electricity Regulatory Commission
  2. NOPR -  Notice of Proposed Rulemaking

NERC is required to perform regulatory reviews of PPAs under the Electricity Power Sector Reform Act of 2005 (EPSR Act). Under this Act, NERC is obliged “to ensure that the prices charged by licensees are fair to consumers and are sufficient to allow the licensees to finance and to allow for reasonable earnings for efficient operation.” In addition, NERC has authority under the EPSR Act to specify terms and conditions in a license to ensure that a licensee will “purchase power and other resources in an economical and transparent manner.” NERC also has authority under the EPSR Act (Section 71) to vary its regulatory requirements by imposing appropriate terms and conditions depending on the type of entity that is being regulated. These provisions form the legal basis for the proposals contained in NERC’s Notice of Proposed Rulemaking (NOPR) that it published for public consultation in December 2006.

The NOPR proposes that a regulatory review will be required only for PPAs for which the purchaser will be purchasing power that will resold either directly (e.g., a distribution company) or indirectly (e.g., a bulk reseller) to captive customers. This requirement applies whether the PPAs for the sale of such power are contracts between affiliated or unaffiliated parties. NERC interprets its legal obligation to ensure that a purchase is “economical” in three ways:

  1. The right plant in the right place. The general characteristics of the proposed generation facility must be reasonable. Specifically, NERC must see evidence at a general level that the entity seeking the license is proposing an appropriate technology, an appropriate fuel and will locate the plant at a reasonable location. In addition, the application for a license must be consistent with any formally enunciated energy policies of the federal government of Nigeria.
  2. A reasonable combination of price and risk. NERC must see evidence that the proposed combination of price and risk allocation in the PPA is both fair and efficient.
  3. Affordable to the buyer. NERC must see evidence that the purchaser will be able to afford to purchase the electricity with the revenues that it is likely to receive from its customers and, if available, government provided subsidies or guarantees. In particular, NERC will require an assurance from the purchaser that it will be able to afford its payment obligations under the PPA under existing or expected retail tariffs with the support of subsidies or guarantees.

Overall, NERC considers that the regulatory process proposed in the NOPR will produce four major benefits:

  1. It will allow NERC to fulfill its legal obligation to ensure that its regulatory actions are “fair and balanced” and that long-term power purchases made on behalf of captive customers are economical.
  2. It will provide a checklist of terms and provisions and risks that must be considered in developing PPAs. This should ensure better-quality PPAs in the future and avoid unnecessary and costly disputes.
  3. It will provide NERC with better information that can be used to develop projections of the generation costs that constitute a major component of future end-use tariffs.
  4. It will ensure that the general public will have better knowledge of the basis for NERC’s decisions and will have the opportunity to provide NERC with informed comments based on facts rather than hearsay.

As a general rule, NERC considers that the two parties to a contract should have substantial discretion in writing the terms and conditions of the contract, subject to any general guidance that NERC decides to give in the future and any overall caps on retail tariffs that may be established as part of a future multiyear tariff (MYT) setting system.

However, NERC’s fundamental regulatory concern is that such contracts can also have a major impact on the prices paid by consumers of electricity who are not direct parties to the contract. Therefore, NERC considers that it has a clear regulatory responsibility to ensure that the terms and conditions of such contracts are fair and efficient in order to protect those Nigerian consumers who will ultimately pay for the electricity but who are not signatories to the PPA.

 The Proposed Regulatory Review Process

NERC Will Review a PPA, rather than Approve.  It NERC will not approve or disapprove of a PPA. Instead, NERC’s review will be limited to providing comments and observations on the submitted PPA. The ultimate and binding control on the prices to consumers of electricity that result from a PPA will be exercised through NERC’s system of setting retail tariffs for end users.

NERC intends to establish end-user tariffs through a multiyear tariff setting system that is the subject of a separate NOPR. The seller and purchaser will have the flexibility to decide how they incorporate NERC’s comments into their PPA when they negotiate a final signed version of the PPA.

However, they do so at their own risk. If the parties choose to ignore NERC’s comments and observations, they are more likely to run the risk of failing to satisfy the implicit annually adjusted cap on the power purchase costs that distribution entities will be allowed to pass through to their captive customers under NERC’s planned multiyear tariff setting system.

Two-stage Regulatory Process for the Review of Generation Licenses and Associated PPAs

In the first stage, the application for a generation license will be reviewed according to NERC’s standard review of such applications and the license issued if the application meets all of the requirements of its licensing regulations. This involves a review of the legal, technical, and financial elements of the applicant and its proposed generation facility.

NERC issues a generation license to an applicant that has shown the legal, financial, and technical capacity to build and operate the proposed generation facility.
 However, the granting of a license does not imply that NERC has given approval to the terms of any PPA that will be used to sell the power produced from this generation facility.

In the second stage, NERC will review the submitted documents to facilitate compliance with its legal obligation to ensure that the power is purchased economically and with a reasonable allocation of risk.  It will provide written comments to the purchaser and seller. The process for this stage is described in this chapter.

NERC considers that this two-stage process has several advantages. First, it avoids the risk of delay to the process of reviewing an application for a generation license. Such delays are likely to occur if NERC required explicit review of a PPA as a prerequisite for the issuance of a generation license. Second, a PPA is likely to be more accurate and complete if it is reviewed sometime after a license is issued. Third, by conducting the review before a PPA is signed, NERC will be able to give timely feedback to the purchaser and seller of power about price and nonprice provisions in the PPA that could lead to outcomes that are too costly, too risky, or both.

To ensure compliance with this two-stage process, NERC will attach conditions to the licenses of entities that will be buying or selling power on behalf of captive customers (e.g., a bulk supplier, generator, or distributor) requiring that these entities provide NERC with the information needed to conduct its review of the PPA as presented in the questionnaires and tables in the annexes attached to its NOPR (and described later in this paper).

The Seller Files the Application for a PPA Review, Accompanied by a Declaration by the Purchaser.

In the second stage, once the PPA has been fully negotiated (though not executed) between the purchaser and the seller, the seller will be required to submit the proposed PPA to NERC and also complete the questionnaires and tables about prices and risk allocation under the PPA. The seller will be required to vouch by means of a declaration for the accuracy of the information that it submits in the questionnaires and tables.

Separately, the purchaser will be formally required to vouch by means of a declaration that it can afford its purchase obligations under the PPA.

 In addition, the purchaser will be required to state whether it agrees or disagrees with the answers provided by the seller. NERC will encourage early submission of completed questionnaires and tables with the accompanying PPA so that its review can be given in a timely manner. In all instances, NERC’s review will be contingent (i.e., conditional) on the filing of a final and legally binding version of the PPA with NERC.

The Seller and Purchaser Must Use “Plain English” for Their Answers

The answers about prices and risk allocation must be complete, concise, and written in “plain English.” If the answers do not meet this standard, NERC will view the application as being not compliant with these requirements and will not consider the application further. All other things being equal, applicants are more likely to get a faster and positive evaluation from NERC if they provide accurate, clear, and complete answers.

Completion of the questionnaires and tables about prices and risk allocation will not impose an undue burden on sellers because sellers have to provide much of the same information to equity and debt investors in order for these investors to conduct a due diligence review prior to making their investment decisions.

NERC will combine the appraisal of both factual information (e.g., charges, plant specification) and subjective evaluations (e.g. assessments of how risks are allocated between the purchaser and seller) provided about a PPA by the seller according to the proposed methodology set out in the NOPR (and described later in this paper). It reserves the right to seek clarifications from an applicant where it finds evidence of inaccuracies and misrepresentations. It also reserves the right to use its own assessment of a particular provision where it considers that the applicant’s assessment is not accurate. The accuracy and completeness of information supplied about prices and risk allocation must be vouched for by a designated officer of the companies that are filing the application for review.

Independent Party to Analyze the Seller’s Answers, and the Seller and Purchaser Pay for  Service

To ensure that the review is both objective and informed, NERC will hire one or more experts to conduct a written evaluation of the answers given by the purchaser and seller. NERC needs this help to review a PPA comprehensively because a PPA is usually a lengthy document with complicated and subtle relationships among its many parts. The cost of this evaluation will be borne by the seller, or by the purchaser, or shared by the two parties in whatever way they deem appropriate, and NERC will require the application to specify the payment arrangements.

The written expert evaluation will be made public. NERC will establish a roster of experts and will determine which expert will be used to evaluate the answers provided in an application. NERC will also specify the terms of reference for the experts’ evaluations. NERC anticipates that the evaluation will take between 10 to 20 person days, depending on the complexity of the PPA. In selecting the roster of experts, NERC will give preference to individuals or firms who commit to training Nigerian citizens in the relevant evaluation techniques.

NERC Proposes to Make Public the PPA, the Seller’s Answers to the Questionnaires and Tables, and NERC’s Comments on the PPA NERC proposes that the answers to these questionnaires and the PPAs on which these answers are based will be public documents, since it places considerable emphasis on the transparency of its regulatory processes.

Such transparency is important, given the large quantities of money involved in transactions under PPAs.

Such participation will be effective (because it will be informed) when the general public has access to the key documents that affect the prices that they will have to pay over the life of the PPA. In addition, the fundamental legitimacy of NERC’s new regulatory system requires that the general public must have confidence in the fairness and impartiality of both the process that NERC employs and the decisions that it renders. This confidence can be developed when the general public understands the logic of NERC’s decisions and provides informed inputs to its decisions by having access to the necessary information. Purchasers and sellers will also benefit from the greater sustainability of their transactions over the long run when NERC adopts open and transparent processes.

 NERC Does Not Intend to Review All PPAs

NERC will exempt two types of transactions involving PPAs from its proposed requirements for regulatory review. First, NERC will not review PPAs where the purchaser’s customers will have alternative sources of supply and are therefore less vulnerable to the exercise of market power by a seller such as the purchaser under the PPA.

This might occur, for example if a generator proposes to sell to an industrial customer or a group of commercial customers that have alternative sources of supply. NERC will also not require generators with a rated capacity of 100 MW or less to fill out the questionnaire and matrix related to risk allocation, so as to lighten the regulatory burden on smaller generators. However, NERC will require that these smaller generators complete the questionnaire and table about the average purchase price, because it will still need to know the prices at which these generators will sell power to entities that supply captive customers. The purchasers in these transactions will still have to complete the declaration of affordability.

Possible Further Development of the Regulatory Process NERC Will Examine the Scope for a More Limited Regulatory Review NERC intends to match its regulatory methods and standards of review with the process by which the power supply is acquired.

In the future, if NERC is satisfied that the PPA accompanying the generation license application is the outcome of a competitive process such as has been employed successfully in other countries, NERC will employ a “fast track” and more limited form of regulatory review. This is based on the presumption that consumer interests can be best protected by effective competition and, where competition exists, regulation can and should be more light-handed. Therefore, NERC intends to initiate a consultation that will focus on the necessary elements of open and competitive procurements for new generation capacity, as well as possible elements of one or more model PPA that will be fair and efficient for sellers, purchasers and retail customers. Standardized PPAs may be especially beneficial for smaller IPPs.

Database of PPA Terms and Conditions

NERC Will Develop a Database of PPA Terms and Conditions for Benchmarking Future PPAs Consistent with its emphasis on the importance of transparency, NERC intends to use the information provided in the questionnaires and tables to create a reference database of PPA terms and conditions. It will use this database to derive benchmarks for reviewing the terms and conditions in PPAs submitted in association with applications for generation licenses. NERC will periodically update this database and make it publicly available. Since many energy regulatory agencies in Africa and elsewhere appear to have similar legal obligations to review PPAs, NERC also intends to explore how this information can be shared with these agencies to develop better information than would be obtainable on a single country basis.

Governance and Operations

Energy Sector Management Assistance Program (ESMAP)  is a global knowledge and technical assistance partnership administered by the World Bank and sponsored by bilateral official donors since 1983. ESMAP’s mission is to assist clients from low-income, emerging, and transition economies to secure energy requirements for equitable economic growth and poverty reduction in an environmentally sustainable way.

ESMAP follows a three-pronged approach to achieve its mission: think tank/horizon-scanning, operational leveraging, and knowledge clearinghouse (knowledge generation and dissemination, training and learning events, workshops and seminars, conferences and roundtables, website, newsletter, and publications) functions. ESMAP activities are executed by its clients and/or by World Bank staff.

ESMAP’s work focuses on three global thematic energy challenges:

  1. Expanding energy access for poverty reduction;
  2. Enhancing energy efficiency for energy secure economic growth, and
  3. Deploying renewable energy systems for a low carbon global economy

ESMAP is governed and funded by a Consultative Group composed of representatives of Australia, Austria, Denmark, France, Germany, Iceland, the Netherlands, Norway, Sweden, the United Kingdom, the U.N. Foundation, and the World Bank. The ESMAP CG is chaired by a World Bank Vice President and advised by a Technical Advisory Group (TAG) of independent energy experts that reviews the Program’s strategic agenda, work plan, and achievements.

ESMAP relies on a cadre of engineers, energy planners, and economists from the World Bank, and from the energy and development community at large, to conduct its activities

Important Notice

Reference Material:

Regulatory Review of Power Purchase Agreements: A Proposed Benchmarking Methodology Energy Sector Management Assistance Program (ESMAP)– World Bank

Copyright Notice

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