Power purchase agreements in Norway – legal pitfalls and future potential
Background: Historical increase in PPA signings – adjusted PPA contract format
According to the report, announced new PPA signings in Europe have increased from around 127 MW in 2013 to 2.330 MW in 2018. Of these, Norway and Sweden have contributed with more than half of the signings in the last five years. This represents a significant increase in the use of PPAs in Norway, largely driven by the combined hedging need of energy intensive industry purchasers and wind power sellers.
A less discussed fact is that the content and drafting of a standard PPA has also developed. Up until 2015/16, PPAs in Norway were typically signed between industrial purchasers and the largest hydropower producers. But with the increasing number of wind power projects maturing for completion since 2016, the standard PPA has been adapted to better suit the purposes of sellers that do not have a large portfolio of power plants to supply from, and purchasers that do not necessarily rely on a steady sourcing of power. The development illustrates that the same PPA template will not necessarily be suitable in all circumstances, and tailor-made adjustments and careful consideration is always recommended.
Fixed volume PPAs: Beware the volume risk and consider tailored force majeure clause
The typical corporate PPA in the Norwegian market up until around five years ago was for delivery of a fixed volume of power between an industrial consumer and a producer of hydropower. These contracts are generally straight-forward agreements, defining the agreed delivery period, point and price, and the agreed contract quantity as a fixed volume. The supply of power is not linked to the production in any specific plant, and both seller and buyer have a corresponding obligation to sell and deliver, and purchase and accept, the agreed contract quantity regardless of actual production or consumption of power.
Due to the organization of the Norwegian power market and grid, it is (almost) always possible for both seller and buyer to deliver and accept power at the delivery point. Unless the contract states differently, the assumption under Norwegian law is that a fixed volume PPA means an obligation for seller to deliver power regardless of the production in the facility, including to purchase power in the market for delivery to buyer if the seller’s own production does not cover the delivery obligation. The force majeure clause has limited practical use, and the seller can only be excused from his obligation to deliver the contract quantity in highly extraordinary situations, for instance lack of capacity or severe outages in the grid. This implies a significant volume risk from the seller’s perspective.
For sellers that own a large portfolio of hydropower plants, this risk is usually acceptable. The total production in seller’s own plants will normally be enough to ensure delivery to buyer. In wind power projects, however, the seller typically only owns one or a few wind parks. Because of the variable nature of wind power production and the increased risk of a force majeure event affecting the entire production capacity of the seller, the risk relating to the delivery obligation in a fixed volume PPA can be significant for a wind plant owner.
To alleviate this risk, one option is to negotiate a specific clause in the PPA that governs in which situations the seller’s delivery obligation may be reduced or suspended, should the facility not produce as expected due to force majeure events – often called “facility force majeure”. In practice, this clause extends the traditional force majeure clause to also have effect in situations where it is possible for the seller to fulfil the delivery obligation (by purchasing power in the market) but this can be economically burdensome if the market price is higher than the agreed contract price.
As produced PPAs: Different risk allocation but more tailoring required
The traditional fixed volume PPA has served well for sellers that can take on the full volume risk for delivery to the buyer. For wind power sellers, the “as produced” PPA can be a more suitable format. An as produced PPA typically implies that seller undertakes to deliver to buyer the entire, or a fixed part, of the actual production at a specific facility. In such PPAs the delivery obligation is not to deliver power “in general”, but to produce and deliver power from one or several specific sources. This feature fundamentally changes the risk allocation in the contract per se, and the buyer accepts to share the volume risk with seller. No or reduced production in the facility means no or reduced delivery to buyer – and a corresponding reduction in buyer’s payment obligation.
The as produced PPA is less attractive for buyers with steady offtake of power that rely on the PPA for sourcing and hedging purposes. Such buyers risk having to source significant parts of their consumption in the market, in periods where the seller’s facilities are not producing enough to cover the buyer’s consumption. For buyers that are less exposed to power market prices, for instance if they have a flexible offtake or use the as produced PPA as one of many tools in a compound sourcing portfolio, this risk can be acceptable. Another possibility is to combine the PPA with a shorter-term agreement for supply of power in situations when the PPA volumes are not enough to cover the buyer’s consumption.
The as produced PPA is generally a contract format that requires more tailoring than a fixed volume PPA. This increases the negotiation risk and cost. Combined with lower attractivity for potential buyers, this probably explains part of why the as produced PPA is less common even for wind projects, and has to our knowledge not been used for hydropower assets in the Norwegian market. If the commercial logic is in place, there is however no reason why an as produced PPA could not represent an attractive hedging alternative also for owners of hydropower plants. As illustrated, the as produced PPA implies a risk allocation that could be more attractive for example for run-of-river plants with limited control over fluctuations in the production. With the right buyer, this could be an option to explore.
The role of PPAs in the future zero-emission energy system: Still relevant?
The increase in PPA signings in Norway the last five years has been significant. With the current regulatory uncertainty relating to onshore wind power concessions, the likelihood of an equally steep curve the next few years seems low. In addition, the cost of onshore wind power has come down to a level that implies financing may be easier to obtain with (more) merchant exposure. This seems to indicate that the future of PPAs – at least related to onshore wind power – in the Norwegian market is uncertain.
So far, the number of PPAs linked to hydropower in the Norwegian market has been limited. One reason is presumably that while PPAs have been a necessity for securing the income level and obtaining project financing for wind facilities, the same has not been the case for hydropower. Also, traditional hydro power sellers have historically been more prone to choosing shorter term financial hedging solutions or fixed volume PPAs with selected industrial consumers as described above (due i.a. to the possibility for resource rent taxation based on the contract price).
In a world with significant uncertainty, low power prices and a growing need for upgrades and investments in existing assets, the need for longer term hedging and the general appetite for PPAs among hydropower owners could increase. In addition, new consumers such as battery factories and hydrogen producers could represent increased PPA demand. One potential arena for future PPAs could also be supply of power from offshore wind installations directly to installations on the Norwegian continental shelf.
History shows that the PPA is a multi-purpose tool that can be adapted to suit the needs of new market players, or new needs of existing market players. This will surely be the case also in the future. The green shift brings plenty of opportunities for new renewable energy production and consumption – and we anticipate that PPAs will have a role to play in the future zero-emission energy system.
See also our webinar about this subject: "Det nordiske markedet for PPAer: Hvor går veien videre?"