The Long-Term PPA Conundrum in India ��� A Commercial Way Forward Part II

Part II of this article explores the various non-power purchase agreements (“PPA”) related options that can be considered in India as an alternative/supplement to long-term PPA’s, along with the likely trends in the Indian power market in the medium-to-long term future.

Non-PPA Related Options

• Wholesale Power Markets (“WPM”):

Development of WPM is critical for a matured and effective electricity market to exist. WPM lead to multi-pronged benefits for all stakeholders, such as providing: (a) market signal for further investments, (b) flexibility to sellers and buyers with regard to procurement/sale of power, and (c) efficient price discovery.

Further, effective WPM allow power generation companies (“Genco(s)”) with expiring PPA’s or Gencos with more risk-appetite (especially those financed by higher equity) to seek longer period of uncontracted time period wherein energy can be sold on WPM i.e. longer merchant tails.

In a recent positive development, a real-time power market has recently been launched in India[1]. However, more steps should be taken to actively develop and promote the WPM.

• Gencos can supply power as a consortium to a consortium of buyers. Both parties can guarantee the minimum supply and offtake collectively. Such arrangement can provide certainty to parties without possessing the rigidity of long-term PPA’s and exploring consequent flexibilities. For e.g., Gencos can ensure enough capacity for power supply to buyers while trading surplus power in wholesale market.
• For equity investment backed power projects with more risk-taking ability, an efficiently run power project can capture the high-priced periods of wholesale markets which PPA’s do not permit. For example, identifying power distribution companies (“Discom(s)”) that are regularly sourcing their seasonal variations and peak demand from the WPM can be targeted.
• Development of a Power Derivatives Market

In the long-term, a developed power derivatives market that allows use of instruments such as forward and option contracts to provide price certainty and different trading strategies, as well as hedge downward price risks, is critical for improving market efficiencies. For India, a power derivatives market will provide the additional benefit of reducing reliance on long-term PPA’s.

In this regard, the in-principal approval of the Central Government to allow the functioning of derivatives market in power, following an apparent understanding between Central Electricity Regulatory Commission and Securities Exchange Board of India regarding its jurisdictional aspects, is a welcome development for the Indian power market[2].

• Synthetic PPA’s and Proxy revenue swaps

Post-development of a well-functioning power derivatives market, the following instruments can be gradually introduced in the Indian market: -

1. Synthetic PPA’s

These are essentially financial instruments that do not lead to actual power exchange between parties, but rather sale/purchase through the WPM wherein buyers and sellers pay each other based on a strike price (swaps) or via options.

2. Proxy Revenue Swaps

These are a powerful alternative to supplement/ replace long-term PPA’s and simultaneously attract investments (including investors seeking risk diversification and green investments) to the power sector. Using these instruments, power producers can outsource certain portions of risk to a third party (such as investors and insurance companies) and receive fixed revenue from their project, while allowing investors to take the risk (i.e. the profit/loss from the project).

For e.g., investors can invest in the expected power generation by renewable energy (“RE”) sources. This is an indirect bet on expected power generation by the particular RE source (and therefore, an indirect bet on the weather). Based on the performance of project due to purely exogenous factors, parties will settle the contract. The power generator will obtain a fixed revenue whereas the investor will receive the upside/downside of the project’s performance.

Conclusion

The Indian power market is an attractive and exciting place for further investments and structural developments. It is apparent that there exist a variety of contractual, commercial and financial ways other than long-term PPA’s wherein the Indian power markets can reward all stakeholders.

Though PPA’s and existing long-term PPA’s will continue to remain relevant, especially for meeting the base demand of Discoms, the above possibilities demonstrate that long-term PPA’s need not form the only basis for driving investments in the Indian market. Further, expiring long-term PPA’s in India are unlikely to get renewed by further long-term PPA’s, especially in the medium to long-term.

Therefore, all stakeholders should mutually work forward to encourage, develop and utilize the various alternatives to long-term PPA’s that will ensure sustained growth of the Indian power sector, achievement of its planned capacity additions, and ultimately enable the development of a mature and high-growth Indian power market.

Part I of this Article can be read at: https://tlhblogs.com/the-long-term-ppa-conundrum-in-india-a-commercial-way-forward/

The views and opinions expressed in this article belong solely to the author and do not reflect the position of Tatva Legal, Hyderabad.

[1] India Energy Exchange, IEX Launches Real-Time Electricity Market, June 1st 2020, available at, https://www.iexindia.com/Uploads/NewsUpdate/01_06_2020Press%20Release%20-%20RTM%20Launch_29%20May%202020.pdf

[2] PTI, Power Min gives nod for forward, derivative contracts in electricity, 15th July 2020, available at, https://www.outlookindia.com/newsscroll/power-min-gives-nod-for-forward-derivative-contracts-in-electricity/1896199.