How to Reduce Exposure to Project Execution Risks Before and After a PPA is Signed
April 30, 2018
Like any large, complex infrastructure project, renewable energy development is fraught with numerous risks that may not be apparent at first. After all, how hard can building a wind farm or solar project be? Most people are on board with the idea of clean energy, right?
In reality, only 10 to 20 percent of all renewable energy projects that begin development make it to construction because of the myriad of development and execution related risks. Renewable energy assets are not all the same. Each project faces unique circumstances related to permitting, grid interconnection and land acquisition that can impact cost and PPA price.
Yet, despite these challenges, 18 percent of electricity generated in the United States was sourced from renewables (including hydro) in 2017 — an increase of three percent from the year before. And virtual power purchase agreements (VPPAs) have been the largest drivers of offsite C&I projects as they account for 64 percent of offsite renewable energy capacity currently operating and 61 percent of offsite capacity in development.
After spending months searching for a project and/or running an RFP and negotiating a PPA, the last thing you’d expect as the buyer is for the project to underdeliver or never get built. Not having the right protections in place to safeguard against development and execution risks can lead to wasted time and effort.
To avoid allocating time and resources to clean energy projects that go unfinished, it’s important to recognize the most common development and execution risks and what solutions are available. Here we’ll explore the subsets of risks, and related solutions, that can occur prior to and after signing the PPA.
Risks: Before Signing a PPA
As you search for a project and then begin honing in on the perfect match for your sustainability, energy management, and other related goals, there are a few simple ways to minimize execution risks.
Whether conducting a third-party administered RFP or a self-directed project search, one common approach to separating qualified from ineligible bidders is to require a modest bidder deposit, which is a fee bidders pay up-front to move to the next stage of the process. These modest fees can serve as a litmus test to gauge the financial capabilities, experience and commitment of developers. The theory is that serious sellers will put their money where their mouth is.
These bidder deposits can vary based on a project’s size. In some cases, there may be multiple rounds of increasing deposits required to establish a developer’s seriousness. Depending on the type of solicitation, some of these deposits may be refunded.
However, a drawback to bidder fees is they can result in a barrier to entry for lean, yet qualified, developers. By requiring a bidder deposit, you may inadvertently miss out on the diamond in the rough.
If the goal is to mitigate PPA execution risk by pre-qualifying a stable of developers, another successful approach is to comprehensively research and vet each developer upfront to screen for experience and capability. Your organization can conduct this research independently, or work with a trusted advisor with deep development experience and an existing network of qualified developers.
Whether the trusted advisor has former developers on staff or has built relevant experience in other areas of the industry, their expertise is necessary to know what questions to ask both before and after a PPA is signed. The goal is to understand a developer’s reputation and be certain their expertise and capabilities are aligned with the demands of your project.
While the number of experienced developers has grown in lock step with the growth of the renewable energy industry, vetting the developer remains an important step in your procurement process.
Here are just a few of the many questions an advisor would suggest asking when vetting developers:
- How many megawatts (MW), and of what sizes, locations, and types, has the developer successfully completed? Do they match your procurement goals?
- Which parts of the development value chain is the developer responsible for and what aspects will be outsourced to other parties?
- Is the developer also the long-term owner/operator? If not, who will end up owning and operating the project in the long-term?
Getting answers to these questions allows your organization to determine the biggest areas of risk when working with a developer and to plan accordingly.
After you identify the right developers, it’s now time to pick the right project. While there are many factors that go into project selection — size, technology, location, commercial operations date, load correlation, price, value, etc — perhaps most important is picking a project that will actually get built.
If your organization has a conservative risk appetite, and there is a premium placed on ensuring the project reaches commercial operations, the safest bet is to select a project that is far advanced in development.
Selecting a mature development asset means understanding the right questions to ask developers to accurately assess project development maturity and risk. A solar project in Virginia must achieve a completely different set of development milestones than, for example, a wind project in Texas.
There are three primary pillars of project development: land control, permitting, and grid interconnection. Each one of these pillars must be structurally sound to result in a successfully completed project, and any one can cause a project to stall, fail, or increase its PPA price.
Furthermore, it is common for developers to sign a PPA with one or more of these development pillars incomplete — and, this presents execution risk. For instance, after the PPA is signed, it is likely the project still needs one or more land use permits or is awaiting a final grid interconnection study.
A change to required utility interconnection upgrades can result in tens of millions of dollars of additional upfront capital expenditure, which can, and often does, sink the economics of a PPA. Similarly, receiving the necessary discretionary permits from a local zoning board or a state Public Utility Commission can be a time consuming, costly, and uncertain for the developer.
When armed with the right questions, you can properly uncover these development risks to ensure you’ve selected a project that will reach the finish line.
Risks: After Signing a PPA
Once you’ve picked a project and are ready to move forward with PPA negotiations, there are important provisions that should make their way into the PPA to cover execution risk from PPA signature to commercial operations. Below, we touch on several common ones, but there are certainly others.
One important provision is the assignment right, which determines the guidelines for transferring ownership of the contract from the developer to another party. Assignment rights allow the developer to sell the project, and therefore transfer the PPA contract, to another entity that may arrange financing, manage construction, own the asset, and/or handle day-to-day operations.
Negotiate a PPA to ensure that the contract can only be assigned to another party with equal-or-better credit as the original seller, that existing terms and conditions still apply, and that other important elements of the contract remain intact.
Another common approach to reducing execution risk is to require the developer to eliminate, or greatly reduce, conditions precedent to the PPA contact becoming binding. A condition precedent serves as a trigger that, if the condition is not achieved, absolves one of the parties from fulfilling its obligations and/or paying penalties to the other party for failure to perform.
A developer might want a condition precedent if, for instance, the project is still awaiting a key permit that, if denied, would undermine the entire project — a substantial execution risk. Established developers with mature projects should be willing to forgo conditions precedent.
A third solution to minimize execution risk is to require the developer to provide a pre-construction financial security that takes effect when the PPA is signed and can be drawn on — for the buyer’s benefit — to the extent the project fails to reach construction or only completes a portion of the expected size.
The financial security should be set at an amount that’s meaningful enough to the developer that they have a strong incentive not to underperform and risk having the security drawn down. Typical financial security amounts range from $25,000 per megawatt — of expected project size — and go up to several hundred thousand dollars per megawatt, depending on buyer and project-specifics.
Similar to the idea of a bidder deposit, the idea behind a financial security is that serious developers with mature projects will be willing to put capital at risk.
Simply setting the financial security amount higher isn’t necessarily a good thing, though. The financial securities aren’t free for the developer, and these costs are often baked into the PPA price. An experienced advisor can recommend appropriate financial security amounts that balance the need to have a meaningful amount while not unnecessarily ballooning the PPA price.
Once a project reaches commercial operation the financial security can be dissolved or returned if there haven’t been any issues. More often than not, there is a post-commercial operation financial security that takes effect to cover settlement shortfalls. But, that’s a topic for another time.
A final recommendation to ensure everything is running smoothly after signing the PPA is to schedule regular check-ins with the developer. You could include a provision in the PPA to require formal monthly or quarterly updates; however, it’s also good to check in informally after signing the PPA. It shows your commitment to the project and allows you to keep tabs on progress and socialize updates with stakeholders.
Account for these leading execution-related risks to help ensure your project stays on course and starts operating as planned. Remember these are only some of the risks to be aware of pre-construction, stay tuned for more on how to solve the distinct challenges that occur after a project starts operating.
What to do next?
- Discuss these risks further with LevelTen’s wholesale market experts, contact us.
- Credentialed renewable energy buyers and developers can request access to the LevelTen Marketplace to see what projects are available.