Public Power - September/October 2007 - (Page 30)

Alternatives to Financing New Generation: What’s in Your BY BOB TEMPLE WALLET? title of this article is inspired by a television advertisement featuring a person who has just made a major purchase on a credit card, when suddenly a thundering horde of sword-waving Visigoths begins chasing the purchaser. The chase stops when the purchaser announces that the purchase was wisely made on a lowinterest credit card. The increasing cost of new generation motivates utilities to consider alternative transaction structures for meeting electricity supply obligations without being overrun by the Visigoths. Before examining alternative financing arrangements, it is important to understand the terms “take-or-pay” versus “take-and-pay” as applied to power plant contracts. A take-or-pay contract means one party must either take delivery of goods or services or pay a specified amount. This is used in some contracts to ensure that the transaction occurs. For example, a banana farmer might enter into a take-or-pay contract with a fruit retailer so the retailer will buy all the bananas from the farmer or pay a fee for not buying them. The arrangement assumes bananas are available for purchase. Operating under a take-or-pay contract protects the purchaser from price-increase risk. Payments under take-or-pay power plant contracts may be set to cover all fixed costs of the project (fixed operation and maintenance costs, debt service, after-tax equity return) or may cover only part of the project’s available capacity or outputs. Thus, an obligor under a take-or-pay arrangement, such as for a power plant, assumes project risk. That is done normally to provide a guarantee for project financing. In contrast, a take-and-pay contract obligates the purchaser to take any product that is offered (and pay the cash purchase 30 SEPTEMBER-OCTOBER 2007 The price), and to pay a specified amount, even if the product is not taken. This arrangement, however, is contingent on the delivery of the product/service. If no electricity arrives, the purchaser has no obligation to make a payment. Back to our banana farmer: if he and the retailer strike a take-and-pay deal, the retailer’s obligation to perform (pay) is contingent on the farmer’s ability to deliver bananas. There is no payment if there is no delivery. The “project” risk is carried exclusively by the farmer. The retailer still has risk—he has to buy bananas off the market, at the market price, if the farmer fails to deliver. Demand for steel, labor shortages and permitting costs are all escalating to a point where capital costs for most forms of electricity generation start at $2,000 per kilowatt. CPS Energy in San Antonio struck a fixed-price deal for its 750megawatt coal plant in 2005 and, at about $1 billion, it looks like a pretty good deal in the current market. Even utilities contemplating alternative technologies are finding it increasingly more difficult and expensive to site and obtain permits for generation. When I talk to power plant builders and developers, their greatest fears center, first, on escalating costs for critical parts—the steel, the transportation to get parts to a site and logistics; and second, on whether, given the number of large power plants under development worldwide, the labor pool is available at a reasonable price. Developers are increasingly pushing those risks on to the customer by tying price quotes to indices and by limiting guarantees, liquidated damages and their liability. Alternative generation ownership and participation structures Partnering—In considering alternatives to having your utility assume all of the risk in building a new power plant, one alternative could be to spread the risk of permitting, construction and development among two or more partners. The benefits to such an equity partnership include having greater collective political weight behind a project; shared project risk; and a say in project governance. While this arrangement reduces overall risk, the project remains on your balance sheet and your utility has reduced the amount of generation capacity that it can expect from the project. Purchase power agreement—Buying all of your generation needs from a partner will clearly push all of the project development risk onto your project partner. A private partner could use your take-or-pay power purchase agreement (PPA) and obtain financing for building the project. Under that arrangement, a PPA purchaser becomes a project guarantor and the project is “on balance sheet” for the purchaser. If, on the other hand, the PPA is under a take-and-pay arrangement, the PPA still offers a means for the developer to obtain financing; however, the electricity purchaser is not assuming risk for the project. (There are variations on unit contingent or system PPAs that developers can offer.) The power purchaser may be able to funnel the PPA cost through a fuel adjustment clause and obtain new generation without raising customers’ base rates. An alternative to a normal PPA, which may appeal to a project developer, is to pre-pay for a PPA. The cost of the PPA could be lowered to reflect the cost of capital benefit that the purchaser is giving to the buyer. The challenge is maintaining the right balance of risk. With a PPA, you bet your utility’s generation plan on the performance of a third party. That becomes more important when you look at who your counterparty is. While private entities developing power projects used to be fully integrated utilities, today’s project counterparty is likely to be a limited liability corporation or partnership; and you would have limited, if any, recourse if that partner fails to perform. Look at the business history of several merchant operating companies and you will find that when the PPA price goes “under water” (the PPA price is eiPUBLIC POWER

Table of Contents Feed for the Digital Edition of Public Power - September/October 2007

Contents Washington Focus 10 Questions Public Power (Every) Week Training Tomorrow’s Work Force What’s in Your Wallet? U.S. Lags in Broadband Deployment Now What? For Engineers Safety Community Broadband For Governing Boards Human Resources Hometown Connections Customer Service DEED Index to Advertisers Advertisers by Category Parting Shot

Public Power - September/October 2007

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