DLA Piper Update: South Africa's Landmark Renewable Energy Program

DLA Piper Update: South Africa's Landmark Renewable Energy Program

By Damian McNair and Evelyn Chan

South Africa's Renewable Energy Independent Power Producers Procurement Program (REIPPPP) is a landmark project designed not only to secure energy to meet increasing demand, but also to stimulate the country's renewable energy sector as part of the South African Government's goal of generating 42% of all new electricity from renewable energy sources over the next 20 years.

Our involvement
Our Asia Pacific Finance & Projects team, in conjunction with our DLA group firms in Johannesburg and Europe, is advising more than half of the successful bidders and lenders providing project finance for Phase 1 and Phase 2 of REIPPPP. We are also acting on a number of Phase 3 projects for bidders and lenders.

Under the REIPPPP, bidders may submit proposals to construct and operate renewable energy projects and sell power to Eskom, the South African energy utility. Preferred bidders must then enter into a non-negotiable power purchase agreement (PPA) with Eskom, together with number of ancillary agreements with other relevant counter parties, including an implementation agreement, direct agreement and connection agreement (the Project Documents).

With a total capacity target of 3725 MW in the first round to be built by 2016, over 80% of capacity is allocated to onshore wind and solar photovoltaic technologies. However, a range of other renewable energy technologies are involved, including concentrated solar power, biomass, biogas, landfill gas, small hydro and small independent power producer projects.

The key aspects of the REIPPPP are:

  • Value for money outcome driven by competitive bid process based on price competition
  • Off-take is guaranteed under a PPA with Eskom
  • Bidders bid the price payable by the Eskom pursuant to the PPA
  • Bid prices cannot not exceed the cap allocated for each technology in the relevant request for proposal.

Project financing and the REIPPPP
Project finance is being used to finance the REIPPPP projects. Project finance is widely understood to mean the financing of assets with limited or no recourse to the owners of those assets (ie where lenders are repaid solely from the cash flow generated by the project and whose only security is the revenue and the assets of the project). However, often in simple terms it is of a limited recourse nature to the project sponsors during the construction phase and of a non-recourse nature thereafter.

In some cases, project finance has been structured on a basis that minimises the lenders' risks by incorporating a number of back-up or secondary means of credit support provided by the host government, sponsors, purchasers or other counterparties, while also relying primarily on the project company's cash flow to service the debt and security provided over the assets of the project company.

However, credit support by sponsors can effectively operate to defeat the limited recourse nature of the project financing. For that reason, special attention must be paid to the allocation of risk when using sponsor support to create a bankable project.

Managing construction risk
The form of construction contract of choice for entities bidding for projects under the REIPPPP are Engineering, Procurement and Construction (EPC) contracts. This is because EPC contracts are capable of effective construction risk management, which is critical to project success for both sponsor and lenders.

Key lender requirements of EPC contracts include a fixed completion date, a fixed completion price, no or limited technology risk, output guarantees, liquidated damages for both delay and performance, security from the contractor and/or its parent, large caps on liability and restrictions on the ability of the contractor to claim extensions of time and additional costs (in general, by back-to-backing and limiting the contractor's entitlements to what the project company (as seller) receives under the PPA).

It is also necessary to ensure that key issues emanating from the REIPPPP procurement framework and Project Documents are reflected in the EPC contract. Examples of key flow downs include completion timeline, capacity requirements, testing regimes, force majeure, compensation event, system events, unforeseeable conduct, site risk, application of insurance proceeds and economic development obligations. Explicit obligations, risk or potential liability (but no specific obligations) and requirements to take certain action to allow the project and the project company to comply with the requirements of the Project Documents are categories of obligations, risks and liabilities that may be passed though under the PPA. Any risk, obligation or liability that cannot be passed through to the contractor under the EPC contract will need to be mitigated by some other means such as through insurance or by the provision of some additional form of sponsor support.

Where any entitlements of the contractor arise as a result of the owner being entitled to relief under the Project Documents, the contractor's entitlement should be linked to and limited by reference to what the project company (as the seller) receives under the PPA, rather than what the project company is or may be entitled to. The best approach is minimising risk by ensuring that the project company's obligations are back-to-back under the EPC contract (for example, with regards to an extension of time and/or costs) with the PPA. This applies to other issues as well such as those surrounding testing and the dispute resolution process under the EPC contract, which should be aligned with the PPA to mitigate any risk that the project company is exposed to dispute resolution procedures under the Project Documents that it cannot pass through to the contractor.

Interface and operational issues
Of course, the EPC contract is only one of a suite of agreements necessary to document the development of a renewable energy facility. It is critical to ensure that that the EPC contract properly interfaces with those other agreements. In the context of the REIPPPP, this includes addressing the interface between the EPC contract and the Operation and Maintenance (O&M) contract, by ensuring that all pre-operational procedures in that agreement are back-to-back with the EPC contract.

The O&M contract covers matters such as operating procedures, maintenance of the facility (including major overhauls and outages), maintenance of a spare parts inventory, performance levels, reporting requirements to the owner, lenders and perhaps to the government authorities and, in some cases, maintenance of the continuing contractual relationship with the government authorities and utility suppliers on behalf of the owner. Other key clauses included in the O&M contract deal with compliance of operational requirements imposed under the regulatory regime (for example, compliance with environmental controls imposed on the project) and other project documents. In addition to other operational risks during the operation phase, the same risks as discussed above in terms of pass through from the Project Documents also apply to O&M contracts.

Challenges and complexities
A number of bidder participants in the REIPPPP are involved in multiple projects. The volume of projects combined with tight timeframes, in particular moving from preferred bidder status to financial close, has been and continues to present a major challenge. Significant input and collaboration from external advisors has been essential. Lenders with exposure across a number of projects have adopted a conservative approach to risk, particularly in technologies other than wind and solar photovoltaic technologies. Moreover, limitations imposed by the PPA, such as there being no opportunity for the seller to increase the installed capacity after a specified commercial operation date and the fact that the Project Documents are non-negotiable, have added complexity to these challenges.

Other challenges include ensuring that all environmental and planning approvals are in place prior to financial close, and dealing with the complexities of potential grid constraint issues such as delays to projects due to delays in completion of transmission and distribution works required to connect plants into the grid.

This information is intended as a general overview and discussion of the subjects dealt with. The information provided here was accurate as of the day it was posted; however, the law may have changed since that date. This information is not intended to be, and should not be used as, a substitute for taking legal advice in any specific situation. DLA Piper is not responsible for any actions taken or not taken on the basis of this information. Please refer to the full terms and conditions on our website.

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