Commercial Risk Allocation II:

PPA Contracting
Regional Meeting on Economics of Nuclear Power, Funding
of Nuclear Power Programmes and Risk Allocation in Nuclear
Power Projects
Nairobi, 10-13 April 2017

P. Warren (Nuclear Infrastructure Development Section, IAEA)

P.Warren@iaea.org
Power Purchase Agreement (PPA)

An agreement between a Nuclear Power Plant

(NPP) owner-operator (supplier) and a
customer/counterparty (offtaker) to take some/all
of the NPPs electricity output under guaranteed
terms, e.g.
A fixed price (in the UK Contract for Difference framework
the strike price); or
A minimum price (price floor)
Plan of presentation

Part 1: Risk allocation

1. Describe how project risk is allocated to project
stakeholders during the contracting process
2. Describe some principles of risk allocation
3. Differentiate between controllable and uncontrollable
risks

Part 2: Strike price design & PPA development

4. Describe the tariff development process
Financial modelling
5. Describe elements of good design for a PPA

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1. RISK ALLOCATION

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Power Purchase Agreement (PPA)

For countries without easy access to cheap capital a

PPA is a way of leveraging strong expected growth in
electricity demand in order to secure financing
particularly in a BOO framework
The assurance that a stream of revenues will be
available to service debt and pay dividends can be
used to secure financing, if:
Investors and/or lenders can be convinced their claims on
future revenues will be secure, e.g. that they will be:
Ring fenced
Shielded from certain key risks
Risk of low prices and/or lack of demand for MWh

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Key messages

Contracts (EPC, PPA, Fuel Supply, etc) are

designed to allocate risk
Any given risk could in principle be addressed
by any of the contracts drawn up in a project
How do we decide which risks should be dealt with in
the PPA?
How do we decide which of the parties to the PPA
should own each risk?
There is a way to think about this beyond usual
practice!
Taxpayer ratepayer!

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Risk allocation via agreement
Commercial
banks
LDs for poor fuel
performance?
Fuel supplier
Loan
Lending in domestic currency?
agreement

Fuel supply
agreement

EPC EPC JV (Owner/ Government Host

contractor contract Operator) guarantee Government

Fixed price? Direct loan guarantee or PPA

guarantee?

PPA

Take or pay?

Electricity
Utility

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Contracting: efficient risk allocation

Often said that efficient contracting consists

in allocating the risk to the stakeholder best
placed to manage it
Two caveats
1. Sometimes outcomes are jointly determined
Both constructor and operator will determine post-
completion operational performance
It may be important that both have skin in the game
2. Risk appetites differ

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Controllable vs uncontrollable
risks
Regulatory Equipment
delay failure during
SWU price Design
operation
escalation performance
not achieved
Exchange
convertibility
risk Interest rate
Construction
volatility
cost overrun Inadequate Connection
demand risk
Schedule
delay
Change in
Temperature taxation
Exchange of tertiary regime Project Fuel supply
rate volatility intake water becomes interruption
uneconomic

Escalation in
price of
Design
U3O8 price materials
capacity not
escalation
achieved

Controllable Uncontrollable

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Allocating uncontrollable risks

The larger and more uncontrollable the risk

(e.g. prices set in global markets) the more
likely that only parties with very high financial
capacity will be willing to bear it at a price which
allows the project to remain economic
Host government tax base (i.e. taxpayers)
Host government electricity customer base (i.e.
ratepayers)
Vendors with strong national support
Financial markets (via hedging instruments)

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2. POWER PURCHASE
AGREEMENTS

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Power Purchase Agreement
(PPA)
Contrast investor/lender assurance from
a PPA with that from a direct loan
guarantee
Direct loan guarantees are about reassuring
lenders about the prospect of the project
becoming uneconomic before loans are
repaid
1. Construction cost overruns
2. Post commissioning economics

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Power Purchase Agreement
(PPA)
Host government guaranteed Power
Purchase Agreement (PPA) is typically
about host assuming market demand risk
Inadequate demand, low prices
Guaranteeing a price (per MWh), quantity, or
both
2. Post commissioning economics

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Redpoint Energy Study

Will have benefits in terms of lower cost of capital

In 2010 Redpoint Energy carried

out a study for the UK Department
of Energy & Climate Change
(DECC)
Study suggested that a Contracts-
for-Differences (CfD) PPA
framework would reduce financing
costs for new nuclear power plants
by up to 2%.

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Host Government Backed PPA

Policy objective: offer the developer just

enough price support to make the NPP
investment happen!
Key steps in setting fixed price or price floor:
1. Benchmarking risk/return
e.g. Oxera (2011): 9% -13% (pre-tax, real)
2. Obtaining accurate cost estimates
Source?
3. Financial modelling
Solve for the (fixed) price that delivers a return in excess of
e.g. 9% (pre-tax, real)
Price floor likely below fixed price
Developer gets the upside!

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Financial modelling

Assumptions
Financial modelling is essential to
any NPP procurement process
A financial model consists of a
set of technical and financial
relationships typically a set of
equations in an Excel
spreadsheet Financial
Model
Model takes a set of assumptions
Deterministic or stochastic; typically
includes a price or tariff profile
Produces a set of outputs
Outputs are typically figures
of merit for valuing a project
Outputs
(e.g., IRR on equity)

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Identifying a strike price

Strike price
Financial modelling is key to
identifying the strike price to
be included in a PPA
Identification of a strike price
(more generally a tariff
structure) is effectively - an
exercise in reverse Financial
engineering Model
1. Specify an IRR that is
appropriate for investors
2. Solve for the price (tariff
or strike price) which
delivers that IRR
IRR

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A well designed PPA>

Offers assurance to investors and lenders...

Mitigates price and/or quantity risk (take or pay)
Avoids default risk (credible counterparty)

Is politically credibleN
Compare strike price to existing wholesale prices

Avoids windfallsN
Gain sharing mechanisms

Is flexibleN
Reopeners

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A well designed PPA>

Offers the owner/operator assurance, but

maintains pressure for efficient behaviourN
PPA should attempt to build acceptable performance into
the financial model assumptions
Availability factors (and/or unplanned outages)
O&M costs below 25th percentile
PPA should be careful to avoid perverse incentives
This can be difficult e.g. simply guaranteeing a fixed
price for all output could lead to indifference on
planned outage/refuelling timing

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Takeaways

Generic features Rationale

1. A guaranteed price not a 1. Maintains pressure to
guaranteed return minimize costs
2. Take-or-pay - but subject 2. Maintains pressure to
to plant availability maximise availability
3. Model based strike price 3. Minimize cost of
inducement to build
4. Contingent price 4. Impossible to hard-wire
adjustment mechanism future tariff escalation
5. Host government backed 5. Guarantee only as good
counterparty as the guarantors credit

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Thank you!