Power purchase agreements: Creating trusting relationships in the Pacific
Power purchase agreements are crucial for financing electricity infrastructure in the Pacific. Developing them with greater transparency will help make the power supply more reliable and affordable.
When we talk about a happy marriage, it is often based on trust in the relationship. It is hard to build a meaningful bond with your partner if you’re hiding part of yourself or not honest.
Not surprisingly, transparency and trust are equally paramount for successful businesses. Economic theory suggests higher market transparency generally results in lower prices and better customer value.
Transparency is more than a buzzword - it is a critical component to most complex business affairs, such as public-private transactions.
For example, in many emerging markets, a standard contract for financing electricity infrastructure a power purchase agreement – is often negotiated and signed to cover a period of 20-25 years. The common understanding is that these agreements bring certainty for independent power producers, which enables them to generate and supply energy over a long period at a contractually determined price.
However, a lack of transparency is common when it comes to unsolicited proposals and bilateral power purchase agreements between governments and independent power producers. With complex terminology and definitions, power purchase agreements are generally considered confidential, and are non-transparent contracts with unclear cost escalation mechanisms.
Nondisclosure of power purchase agreements can have financial costs for state-owned enterprises in the energy sector in Pacific states and other developing countries, beyond the public perception of better-quality supply and tariff expectations, as result of unrevealed cost escalation factors and complex tariff formulas leading to tariff increases in future. Hidden or undisclosed terms mean there is limited information and opportunity to compare with similar transactions in the region.
Regulators are often concerned about potential cost escalation and tariff increases over the life of the agreement. Managing such unpredictable tariffs impose the risk of contingent liabilities on the public sector and diminishes a government’s borrowing capacity.
Furthermore, lack of transparency leads to perceptions of overpayment and public discontent. Without disclosure of power purchase agreements’ key terms to the public, any future tariff increase can be subject to widespread public criticism and political speculation. Under special circumstances, this is likely to create the risk of renegotiation, damaging the reputation of the utility and making future power purchase agreements more difficult, as well as damaging the reputation of the private sector partner by suggesting they purposefully hid important elements of the agreement possibly even from government.
Transparency is an essential foundation for any enduring relationship like signed power purchase agreements.
How do we protect the sector from these risks? There are at least two key actions that will help create a healthy and transparent environment for public-private partnerships in the energy sector.
Setting minimum disclosure requirements for power purchase agreements. Power purchase agreements are commercial legal documents with strong confidentiality terms preventing parties from disclosing and discussing the key terms publicly. It may become even more difficult with unsolicited proposals negotiated bilaterally between independent power producers and governments.
The development and approval of basic disclosure requirements for power purchase agreements will put signing parties under a greater deal of scrutiny and bring more public accountability for proposed transaction negotiations by publishing all key terms and conditions. The stakeholders, including consumers, then have the opportunity to understand and compare proposed power purchase agreement terms with the country’s policy objectives and overall cost of electricity to end-users.
Also, it would help to understand key cost drivers, potential for escalation, and expected increase in end-user tariffs. Lastly, power purchase agreements’ disclosure may have significant impact on the state-owned utilities by creating market incentives to reduce the cost of generation and improve the quality of asset management.
While there are different disclosure standards introduced by international financial institutions and non-governmental organizations, it is important to harmonize these standards with the country’s primary legislation, ensuring consistency with national reporting and disclosure standards and systems. Palau is a good example –it is piloting the first of its kind power purchase agreement transparency procedure that was developed for all public-private partnership transactions in the country.
Transparency as an industry benchmark. Creating power purchase agreement transparency involves state-owned utilities, governments, regulators, international financial institutions, investors, and civil society groups. With few exceptions, it is going to be difficult to create a broad consensus on the ways and means of power purchase agreements disclosure even if disclosure requirements are legally enacted. Launching power purchase agreements benchmark studies and a database of signed power purchase agreements by regional industry associations can help regulators and governments in achieving their transparency objectives.
Recently, the Office of the Pacific Energy Regulators Alliance (OPERA), assisted by the National Association of Regulatory Utility Commissioners and Energy-for-Growth, piloted a transparency initiative on power purchase agreements for the region that was warmly welcomed by all Pacific regulators and power utilities. It was intended to compare terms of negotiated power supply agreements with similar transactions in the region. Furthermore, by adopting regional benchmarking, the alliance and its members agreed that it would become not only a source of transactional data, but also a source of expertise championing high transparency values and targets not only among regulators but developers, financiers, and technology providers as well.
Public disclosure makes transparency possible. Transparency is an essential foundation for any enduring relationship like signed power purchase agreements. Good relationships allow independent power producers to maximize financial returns under terms and conditions available to end-users.
In the long run, it is unlikely that consumers would tolerate those that suppress or misrepresent the true and fair terms of electricity supply through complicated cost escalation terms and conditions hidden at a bidding stage. There is an increasing role for international financiers acknowledging power purchase agreement transparency as one of key financing requirements for the independent power producers.
After all, transparency creates trust and that is the foundation of a strong relationship, like in every happy marriage.