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Utilities Regulatory Authority

Commission Order

Case U-0003-14

In the matter of developing regulatory guidelines for Power Purchase Agreements for generation and supply of electricity

June 2015

Contents

Contents.............. 2

Foreword.............. 3

1.               Introduction               4

1.1 Purpose of this document 4

1.2          Background 4

1.3          Legal context 4

2. Regulation of IPPs ...5

2.1          Definitions 5

2.2          Role of the regulator 5

2.3          Regulation of IPPs 6

1. IPP impact on consumer prices... 7

3.1          Conditions for tariff adjustment 7

1. Application process... 8

4.1          Tariff Adjustment Application 8

4.2          Draft PPA 9

4.2. PPA Term 10

4.3          Supplementary information 11

4.3.l Transmission Arrange1nents 11

4.4          Decision process 11

4.4.1 Preliminary Decision 12

4.4.2 Consultation 12

4.4.3       Final Order.... 12

4.4.4      Affirmation  by the URA      12

1. Submissions 13

5.1          Assura nces to IPPs 13

5.2          Powers of the URA 13

5.3           Forecasts of diesel price 14

5.4          Government policy incorporated into tariff setting 14

1. Commission order 15
2. Execution Page 16

Foreword

The Utilities Regulatory Authority (URA) Commission is pleased to issue regulatory guidelines applicable to independent power producers (IPP) entering into power purchase agreements (PPA) for the generation and supply of electricity (case U-0003-14). These guidelines describe the regulatory framework as it pertains to third-party independent power producers generating and selling electricity to utilities. 

The URA Commission supports any projects that improve the cost-effective provision of electricity in Vanuatu, either by increasing access where it is currently unavailable, or by improving  efficiency and achieving the Commission's goals of least cost generation and promoting renewable energy. Over the longer term, independent electricity generation offers the potential for competition in the market, providing long- term benefits for consumers. The Electricity Supply Act has been amended in recent years to promote competition in generation. The URA encourages and shall facilitate such projects, provide appropriate support to the Government, utilities and investors, and  protect  the long term-interests of consumers.

There are several ongoing projects that may result in IPPs building generation facilities in Vanuatu for sale of electricity, particularly in the Efate network. One key factor in all of these projects is the drafting and negotiation of the PPA. The current legislative and regulatory framework does not specify the basic parameters of such an agreement. This document describes the parameters and a process that will provide a level  of certainty to  IPPs and  utilities, while also  protecting the interests  of customers.

By establishing these guidelines, the URA Commission hopes to provide a clear regulatory framework that enables investment in efficient electricity generation capacity throughout Vanuatu.

Johnson  Naviti, Chairman 

Hasso Bhatia, PhD, CEO and Commissioner 

John Alilee, Executive Commissioner

1. Introduction

1.1     1 Purpose of this document

These regulatory guidelines are provided to interested persons in the matter of Power Purchase Agreements (PPA) for the generation and supply of electricity. They explain how independent power producers (IPP) and PPAs will be regulated in the existing electricity networks in Efate, Luganville, Tanna, and Malakula. Included in this document are:

• Clarification of the legal status of IPPs and  the regulatory framework
• Description  of how IPPs impact consumer prices, and how the price impact will be estimated
• Description of the process for a tariff adjustment due to an IPP arrangement

1.2   Background

All four of the existing electricity networks in Vanuatu (Efate, Luganville, Tanna, and Malakula) are currently vertically integrated, meaning that in each network the generation, transmission, distribution and supply of electricity are all performed by the same company pursuant to an exclusive concession. In 2010 the Electricity Supply Act was amended to, amongst others, specifically allow for electricity to be generated by other parties for sale to the utility concessionaire. To date, no major projects have resulted in  such an arrangement. However two significant IPP projects are currently under serious consideration:

• 4MW (expandable to 8MW geothermal power station at Takara in North Efate
  • 500-730kW photovoltaic army on  Parliament House and Meteo Building, donated by UAE.

In order to inform these potential projects and other future projects, the URA wishes to set out the regulatory framework  for IPP and PPA arrangements.

1.3    Legal context

The legal framework of the energy industry in Vanuatu is primarily based on the following legislation and contracts1:

• Utilities Regulatory Authority Act (URA Act)
• Electricity  Supply Act
• Geothermal Energy Act
• Concession for the Generation and  Public Supply of Electric Power in Port  Vila
• Concession contract for the Generation and Public Supply of Electric Power in Tanna island
• Concession contract for the Generation and Public Supply of Electric Power in Malakula island

1 The contractual situation in Luganville is subject to a new tender process. However  any  new  arrangement  will  be subject to existing legislation. 

1. Regulation of IPPs

2.1     1  Definitions

For the purpose of these guidelines, an IPP is defined as a generation facility that is built  for the sole purpose  of selling wholesale power to a utility. This definition does not include small-scale generation by customers, such as with home solar systems as defined in U-0002- 14 Final Order July 2014. Power sold by an IPP is referred to as wholesale power, and the price at which it is sold as the wholesale price.

A PPA is a contract between two parties, one who generates electricity in order to sell (the IPP) and one who purchases the electricity (the utility) for distribution and sale to end-use  customers. The PPA  sets out all of the commercial and technical terms for the sale of electricity between the two parties including the schedule  for delivery, wholesale pricing and the term of the agreement. The PPA is a key  instrument  for  project financing as it defines the revenue stream, project parameters, and credit quality of the buyer and seller.

2.2     2  Role of the regulator

The purpose of the URA is to regulate utilities  to:

• Ensure  the provision of safe, reliable and affordable electricity services
• Maximize access to electricity throughout Vanuatu
  • Promote the long-term interests of consumers
  • Ensure Least Cost Generation  (LCG)

In the case of IPP projects, the aim of the URA is to:

• Encourage IPP projects that will contribute  to least cost generation  (LCG) in the long term;
• Ensure that customers  benefit  from IPP projects  through lower prices and/ or improved reliability;
• Ensure that consumer electricity prices are timely adjusted to pass the benefits of IPP projects on to consumers; and
• Ensure that IPPs, investors, utilities and consumers are treated equitably and fairly.

In order to achieve its purpose, the URA has the general power to do anything necessary  and  convenient  in  the exercise of its functions. Additionally,  the URA has the following powers defined by the URA Act:

• Establish and monitor·safety and reliability standards for utilities and IPPs
• Set the maximum price that can be charged by a   utility
• Set the maximum price that can be charged by an IPP (although the URA does not expect to use this power in most cases, as discussed later in this   document)
  • Request any specified information or documents from a utility or    IPP
  • Investigate anti-competitive behaviour
  • Require a utility or an IPP to confer with the URA as to the manner in which it carries on  any  specified activity in relation to electricity services

2.3     Regulation of IPPs

The URA Act defines a regulated service as "the supply of electricity or water to a consumer (for a fee) and includes all processes leading up to that supply". The generation of electricity by an IPP is therefore a regulated service, subjecting IPPs to the URA Act. This means that IPPs are subject to the same safety and reliability standards and reporting requirements as utility companies, as well as to the same anti-competitive protections laid out in the URA Act.

The URA determines the maximum price charged by utilities to customers. Purchasing power from an IPP is likely to have an impact on the overall power costs of the utility, and as such will impact consumer prices.  It is therefore important for a utility to know the tariff impact of a potential IPP project and how the URA will adjust the consumer price, before signing a PPA.

The pricing powers of the URA also extend to wholesale pricing; however it is not preferred to preset by an order of the URA a maximum price to be charged by an IPP. It would be useful for the developer IPP to know how the URA will determine the pass-through of wholesale price to consumer prices in order  to facilitate financing and assess the bankability and economic viability of the proposed project.

Further, the URA Act (as amended) defines an electricity producer as "a person who generates electricity for sale to a utility and who is not a related entity to that utility". The role of the URA in dispute resolution  includes assisting to resolve disputes between a utility and an electricity producer, at the request of any party involved.

In summary, the role of the regulator is to ensure fair market practice and that IPPs and PPAs deliver consumer benefits, by doing the following:

• Ensuring the IPP leads to least cost generation for the utility system and meets their requirements
• Timely adjusting prices to pass through benefits to consumers as a result of IPP  generation;
  • Preventing anti-competitive behavior; and
  • Resolving disputes between  the patties having or entering into a  PPA.

1. IPP impact on consumer prices

The viability of an IPP is assessed based on its ability to produce power at a lower cost than existing or alternative generation options available to the utility. By purchasing power at a lower cost than it can generate, a utility reduces its overall costs, which then can be translated into lower prices for customers. In practice this means that a utility needs to have a clear view of the prices it can charge the consumer before it signs a PPA with an IPP. In order to provide this certainty, the URA will issue an order describing the tariff adjustment that will apply upon the commissioning of  the IPP generation unit.

3.1  Conditions for tariff adjustment

In order for the URA to determine the tariff adjustment as a result of a PPA, the negotiating parties should demonstrate the following:

1)   Least cost generation: Thus is defined as the most cost-efficient  means of electricity generation,  over  the longer term. An IPP will contribute to least cost generation if the average total cost of delivered energy when their energy production is added to the generation mix is lower than when compared  to other  feasible options.

2)   Customer benefit: Customers will benefit from improved generation ef ficiency through lower prices. It is possible for customers to benefit from improvements in service quality, reliability or price stability, even if prices are not reduced.

3)   Fair treatment of all parties: There should be a realistic and fair balance of risk and no unreasonable excess profit margins for any party.

The first test of the competitiveness of a proposed IPP arrangement is to compare the estimated levelised cost of energy of the IPP with the variable costs of existing generation it will be replacing. If the IPP's price of delivered electricity (including delivery costs) is lower than the variable cost from the highest priced electricity generator of the utility, then it is likely that IPP purchase will contribute to least cost generation. The optimmn generation mix can be estimated by performing re-dispatch analysis, with and without the IPP, indicating whether or not generation costs can be reduced in the short or long term.

Therefore in order to calculate the impact on the overall cost of electricity, the IPP must first estimate their levelised cost of energy (LCOE), including capital costs, at which it is willing to sell energy to the utility. The utility must then assess how much this will affect their average production costs taking into account the following:

• Avoided cost of fuel and any other operating cost reductions
• Impact on spinning reserves of intermittent power sources
• Distance to load centres and cost of additional transmission network
• Network strengthening and reinforcement
• Impact on system losses
• Assets stranded
• Any subsidies or aid donations included in the IPP arrangement should be reflected in its costs.

1. Application process

Although within its legal authority, at this time the URA does not require that an IPP seek a PPA approval from the URA. It should however inform the URA that an IPP is being pla1med with general profiles of the project, utility need, costs. This Order describes the factors the URA is likely to consider when assessing the impact on the utility's costs and consumer prices resulting from the PPA, and how it may affect system reliability.

In tandem with the PPA negotiations, the utility should make a Tariff Adjustment Application outlining the details of the project and the tariff impact resulting from the proposed purchase of power from the IPP. This should be done in all cases, regardless of whether the utility considers the PPA to be tariff neutral. Ideally it should be a joint application supported by a draft PPA, however separate applications can be made if there is no initial mutual agreement. In such cases, the IPP may file an application with the URA supporting its project and the proposed PPA and indicate points of disagreement with the utility, and the URA can assist with discussions and potentially resolve any disputes. In the event dispute cannot be resolved informally, either party may file a formal complaint with the URA as provided in section 19 of the URA Act.

In case of an application  filed  by a utility seeking approval of  a  tariff adjustment to cover PPA  costs, a

detailed analysis of the options, costs and quantities must be provided to justify the PPA. The URA believes it  is prin1arily the responsibility of the utility to establish that the PPA is the least cost generation option for its incremental power.

At a minimum, the following documents should be provided, described further below:

1. Tariff Adjustment Application
2. Draft PPA
3. Supplementary information

4.1     1       Tariff Adjustment Application

In order to fully assess the impact that the IPP will have on consumer tariff, the application for a tariff adjustment should include:

• Demonstration of the need for the purchased quantity, based on demand/ capacity balance, adequate reserves, etc.
• Cost assumptions IPP build costs; Running costs; Useful lives of generation equipment and amortization schedule
• Avoided costs over the project life
  • Calculation of cost of production per kW/h  (PPA tariff)

• Short term costs  (e.g. fuel saved)
• Long term costs (e.g. incremental capital cost, disposition of stranded assets)

• Changes to tariff adjustment  formula  (if applicable)

The Tariff Adjustment Application document should demonstrate how the tariff is calculated, and provide supporting information for assumptions (i.e. quotations, cost estimates, benchmark data). If there are factors that are either highly variable or unpredictable (e.g. build costs), the application should include any conditions that could vary the tariff adjustment. For example, the tariff application should include a description of how the benefits of any major cost savings during the facility construction will be shared with   customers.

4.2    2   Draft PPA

Supporting the Tariff Adjustment Application, a draft PPA should be provided to the URA. The draft PPA is a document that will set out the legal agreement between the utility and the   IPP.

The draft PPA should include the following  information:

4.2.1       PPA Term

The Term of the PPA is an  important  factor  for project  viability  assessment.  Lenders and  investors  will  look for a long term PPA that will ensure capital  recovery.  It may also be beneficial  for  the  buyer  to  enter into  a  long term agreement as this would provide price stability, adequate capacity  and  reliability.  The URA will  take  both of these factors into account when considering  a  proposed  term  of  the  PPA.  However the URA  also has the aim of ensuring least cost generation is achieved and by agreeing to long term PPA's with  fixed  prices,  the URA is limiting its options to seek cheaper energy  for  the  consumer  in the  future,  therefore  it  is  the  URA's belief  that  there  must be  a balance  between  the two  conflicting  goals.

The URA believes that the length of the loan period and debt service is the important element in the IPP and PPA terms. Typically lenders extend debt for a period of 10-12 years. This is critical factor in a PPA structuring, cash  flows, etc. Therefore, a reasonable  approach would  be  to set the PPA term matching the term of the loan. This encourages the developer to seek and garner longer term loans and thereby lower debt service and cash flow requirements. For depreciation/ amortization purposes a straight line method over the life of the project shall still be used.

Another factor regarding the PPA  term is in relation to  the length  of concession  contract  held by the utility. In a case where a proposed PPA extends beyond the end of a utility's concession contract, the Government should co-sign the contract to guarantee that the PPA terms will be included in any re-tender of the utility concession. Additionally, the URA Tariff Adjustment Order will continue to apply after the end of the concession contract, meaning that the consumer price pass-through mechanisms will be maintained  for  the new utility. This provides the IPP with the required assurance that the PPA terms will be included in any subsequent  utility contractual arrangements.

4.3     3 Supplementary information

In addition to the tariff adjustment and the draft PPA, some supplementary information should be included.  The type  of information  depends on the IPP  but  may include:

1. Funding sources and length of the loan and terms of the loan (especially donor funds)
2. Analysis of the risk factors involved, both construction and operation and who bears the risk
3. Demand  forecasts to demonstrate the need  and consumption potential for electricity  produced
4. Environmental and social impact assessment
5. Transmission agreement and connection point

4. 3.1   Transmission Arrangements

Central to a PPA is the agreement between parties as to the point of delivery of the IPP off-take, and responsibility for bringing power to that delivery point.

Transmission planning is an integral part of generation planning when new generation capacity is envisaged­ be it utility-owned or an IPP. Primarily it is the obligation of the power producer to plan for and invest in any line extension to connect from the bus bar to the nearest grid. This investment is an important factor in evaluating the economic viability and LCG. The line extension and connection costs are separately analyzed as it may have broader impact on system stability, losses, and in some cases locational decisions for the IPP.

A Transmission Agreement is a companion to but separate from the PPA. Sometimes the costs of transmission may be rolled into the PPA. In other cases the off-taker may agree to the line and connection investment. A great deal of buyer-seller cooperation is necessary to arrive at a transmission  agreement, connection terms, etc. The URA shall treat the transmission arrangement as an integral element of assessing the IPP viability, consumer price impact and  the PPA  approval  process.

4.4     Decision process

Once an application for a tariff adjustment is received, it will be reviewed by the URA. If additional information is required from any of the parties, this will be requested by the URA in the process of drafting its Preliminary Decision.

4.4.1      Preliminary Decision

The URA will analyse the data provided and will issue a preliminary  decision. The Preliminary Decision will  be subject to public consultation, respecting any relevant confidentiality issues. If the URA believes that the proposed  arrangements  are not optimal,  the URA  may recommend  amended terms.

4.4.2      2   Consultation

As the PPA will have an effect on consumer prices, the suggested tariff adjustment will undergo public consultation. This will be particularly important in the case of a potential increase in  short term tariffs, even   if there is a long term benefit. In the case that there is any disagreement between the parties involved, the consultation period may include discussions between the parties in order to come  to  a  resolution. After a period of time, if this has not happened the URA may recommend  that  there is pause  period  followed by a new draft PPA.

4.4.3      Final Order

Once feedback from all stakeholders has been considered, a Final Order will be made  on the  tariff adjustment. This will be based on  all information  gathered  to  that  point, and will provide a clear description of any tariff  adjustment, the conditions  upon  which it is dependent, and the implementation  process.

4.4.4      Affirmation by the URA

When the URA approves the tariff adjustment (pursuant to the detailed review of the terms of the PPA. and benefits to the constUners) the URA is basically granting a clearance to the IPP and the utility that the PPA  costs shall be allowable expenses in the retail tariffs when the project is complete and commissioned. It would be unfair of the URA to second guess whether the project is cost effective and least cost at the time of its commissioning. Therefore, if the IPP is successfully completed and delivering power as agreed  in  the  PPA, then the URA commission is committed to allow the pass-through of costs incurred according to  the  PPA terms previously approved. 

1. Submissions

Two submissions were received in response to the Preliminary Guidelines document, from UNELCO and Geodynamics. This section describes some specific issues raised in the submissions, and summarises the URA Commission's findings.

5.1  Assurances to IPPs

In UNELC O's submission, three specific questions were raised around specific assurances that the URA could provide to IPPs. These questions are shared and responded to below:

...does the Government of the URA wish to provide…some level of assurance that the generation costs will be fully recovered through customer end-tariffs (Since UNELCO will naturally condition the procurement and continued payment of any IPP generation to the fact that such costs can be fully recovered from the end-consumer) ?

Thrust of this document is to bring a level of certainty to buyer and seller that once approved and found reasonable, URA shall stand behind its commitment to allow cost recove1y. In order for a third party (and a utility) to be assured that the costs associated with an IPP are passed through to customers, these guidelines describe the process through which a Tariff Adjustment will be applied for and processed. A URA Order confirming the impact on consumer tariffs of an  IPP will  provide  the necessary  assurance to both  parties. This is further affirmed  in Section 4.4.4  above.

…does the Government of the URA wish to provide…some level of assurance that it will step in to take over the power purchasing contract after the purchasing term of UNELCO’s concession in 2032 (since the concessionaire can naturally only commit to generation contracts over the term of its concession agreeement) ?

This issue is discussed in section 4.2.1 above. In cases where an IPP desires a PPA to be longer than the remaining length of a concession contract, the understanding shall be between Government and the concessionaire whether the successor entity is willing to assume the contract; however URA shall honour the PPA under the initial terms, regardless of who the successor buyer is. It would be prudent that URA shall be consulted when a transfer of concessionaire is undertaken.

...does the Government or the URA wish lo determine a base level of expected safety and environmental practices that should be respected by potential IPPs?

As mentioned in section 2.3 above, an IPP is defined to be a utility and is subject to any safety and reliability standards issued by the URA. Furthermore, an IPP would also be subject to any other  relevant  planning, safety, environmental and other regulations issues under Vanuatu  law.

5.2     2   Powers of the URA

In UNELCO's submission, various claims were made regarding the legal power of the URA to regulate IPPs and PPAs, in particular questioning the power of the URA to regulate IPPs.  The  URA  Commission  is satisfied  that everything in these guidelines is within  the power of the URA.

5.3     Forecasts of diesel price

In Geodynamics' submission, they state:

In a diesel dominated production environment the calculation for minimizing long-run incremental (margina1 costs" at a minimum requires a long run forecast of the diesel price. Geodynamics should like to better understand how the URA will make these forecasts.

When making assessments around the future generation mix, some kind  of assumption  of  the diesel price must be made. In cases where long-term forecasts are required, the URA will make use of any publicly available forecasts applicable in the region, such as by SPC, and formulate scenarios to reasonably inform decision  making.

5.4     Government policy incorporated into tariff setting

In Geodynamics' submission, they state:

Given the Governments clear policy direction of meeting aggressive renewable energy targets, Geodynamics would like guidance as lo how Government policy is incorporate into tariff setting.

The URA agrees that there is a clear Government policy to increase the use of renewable energy in Vanuatu. Furthermore there is also a clear mandate to the URA under the URA  Act  to  ensure the affordability and least cost generation. In order to balance these, the URA will seek to ensure that the cost benefits of any renewable energy project are passed on to consumers, making energy more affordable. In a situation where additional renewable energy is possible with an increase in tariffs, the URA will consult with the Government and the public before arriving at a conclusion. Primary driver however would be cost minimization  to  end user, subject to renewable policy considerations. Other factors such as fuel diversity, reliability, local economic impacts may also enter into the equation. For example marginal costs differences would dictate in favour of renewable, other things being equal.

1. Commission order

Findings

Based on the staff analysis and submissions received, the Commission finds that

• Competition in the power generation is important factor for long  term  cost  reductions  and  efficient power supply
• It is important for the URA to support potential IPP projects that can benefit electricity customers in Vanuatu
• Clarifying the impact of an IPP on the consumer is a key role for the URA in the development of an IPP project
• URA must provide assurance to potential parties to a PPA that the approved  terms are honoured
• A Tariff Adjustment Application process, as described in this Order, will provide the URA with  the required  information  to determine the impact of an  IPP on the consumer   price
• The URA has the power to do all things  described  in this Order

The Commission therefore:

1. Establishes that a utility or potential IPP may submit a Tariff Adjustment Application prior to signing a PPA  following the Guidelines described above.
2. Recommends that UNELCO and the Department of Energy submit a Tariff Adjustment Application for the solar generation system to be installed at Parliament House and the .the meteo Building, at an appropriate  time.
3. Recommends that UNELCO and Geodynamics submit a Tariff Adjustment Application for the proposed geothermal  station  at Takara, at an appropriate time.

7. Execution Page[...]

Utilities Regulatory Authority

Vanuatu

You can access the U-0003-14 Commission Order June 2015 on our \Vebsite \V\V\v.ura.gov.vu or  by contacting us by telephone (+678) 23335, email: [email protected] or regular mail at U-0003-14, Utilities Regulatory Authority, PMB 9093, Port Vila, Vanuatu.