CHAPTER 4. GOVERNMENT’S ROLE IN THE ELECTRICITY SECTOR

a. GOVERNMENT’S LEGISLATIVE ROLE
b. GOVERNMENT’S REGULATORY ROLE
c. GOVERNMENT’S ROLE IN THE RESOURCE CONCESSION PROCESS
d. GOVERNMENT’S ROLE IN THE MARKET
e. TECHNOLOGY SPECIFIC POLICY STRATEGIES

Risk reduction is one of government’s most important roles in promoting private investment in the electricity sector. Reducing the number of potential unknowns is especially important where there is little or no experience with renewable technologies at the national or local level.

How can Government take a leadership role in risk reduction?

Government leadership in risk reduction can take many forms. Areas where it may be appropriate for the government to play a role include:

· national energy planning;
· resource evaluation;
· market evaluation;
· least-cost-planning;
· providing access to expertise;
· eliminating obstacles to equitable markets;
· project oversight and evaluation; and
· assistance in providing access to capital and financing.

The essence of public-private partnership is the arrangement for private capital to finance goods and services which traditionally have been provided by public entities.

Public-private infrastructure partnerships require government participation in both these roles. As purchasers of public goods and/or services, governments act in a quasi-commercial capacity. When policy strategists serve as legislators and regulators in matters concerning commercial enterprise, the challenge is to establish an environment in which government puts aside its commercial interests in favor of even-handed implementation of its political and policy objectives.

a. GOVERNMENT’S LEGISLATIVE ROLE

Legislation and regulation are two primary tools used for achieving public interest goals. A legal regime provides the underpinnings for commercial transactions to take place. Legislation can help to remove legal, economic and social barriers to investments in new technologies and investments in specific market sectors. It can provide a framework for the ownership and financing of infrastructure improvements and can provide incentives to encourage greater investment and use of goods with public interest benefits. Clear legal and regulatory guidelines contribute to a stable and predictable market within which the financial community - both domestic international - feels comfortable in investing.

What legislative features promote private-sector investment in the energy sector?

Statutory and legal standards which dearly define and assign the authority and role of the government and its various ministries, departments or agencies regarding the electricity sector will enhance the attractiveness of the electricity market for potential investors.

Ensuring transparency of government decision-making treatment of all developers maximizes competition. “Transparency” refers to procedures in which all factors and values are known ahead of time, allowing all the participants in a project to understand the criteria upon which discussions will be based. The potential participants in a project may include a combination of private-sector, public-sector and quasi-public-sector entities - such as private developers, a national or local government entity, non-governmental organizations (“NGO’s”) and private or quasi-public lenders.

The following eight-step process may be useful for legislative strategists establishing renewable energy policy: Step 1. Articulate the hierarchy of broad national economic, infrastructure and energy goals, clearly differentiating between the desired ends and the means devised to reach those ends. Use this statement as a touchstone in evaluating, establishing and defending a national renewable energy policy. Step 2. Determine objectives in the electricity sector. Step 3. Establish the role of renewable resources in the energy mix. Identify the available or potential renewable resources. Determine whether such a supply and demand analysis supports a goal of attracting new capital investment into new renewable resource generating capacity. Define the term “Renewable Resources”. Clarify that definition by setting forth the specific resources and defining each separate renewable resource. Incorporate technical, political and legal concepts. Step 4. Articulate renewable energy objectives. Establish objectives for each renewable resource. Consult with each renewable energy industry. Identify the developer’s needs, the legal rights the government must grant to fulfill that need, and the accompanying legal duties the government should impose. Step 5. Identify existing and potential impediments. Step 6. Identify the available mechanisms to remove the barriers to achieving renewable energy policy objectives. Identify incentives which may apply broadly to all private investors in any infrastructure project. Identify incentives which bridge hurdles to private-sector investment in renewable energy power generation and which may apply to unique situations of a specific renewable resource. Step 7. Design a legal vehicle. Strive for expedited implementation of the policy objective, but ensure that government undertakings may be relied on without frequent ministerial, judicial, or arbitral interpretation. Step 8. Design a regulatory vehicle. Implement the policy objectives established in the law.

Test proposed laws and regulations in the affected community before finalizing.

A useful strategy is to test proposed laws within the community which the law will govern before the law is finalized. This test may simply involve distributing a proposed piece of legislation to the affected community for comment, and it may involve executive-branch or legislative-branch hearings before a law is enacted. Under either approach, potential misunderstandings may be resolved. Strive to overcome impediments at the outset of putting a legal regime into motion before course correction becomes difficult if not impossible. In this process, the strategist may find three drafting issues critical:

· the guidelines for government decision making,
· the treatment of similarly situated parties, and
· the protection for investors.

Predictability in government decision-making is critical to investment. In every step in which the government must establish a statutory or regulatory process, the investment community will examine the standards that the government will apply in making decisions. Vague or nonexistent standards are viewed with skepticism by an investment community aware of the problems often inherent in laws allowing arbitrary and capricious government decision making. Furthermore, the lack of time-forcing decisions is also often an issue discouraging investment A bureaucracy without time limits creates time delays costly to the private sector.

Encouraging international private-sector investment.

Equal treatment of domestic and foreign parties is essential if foreign investors are to be encouraged. In some legal regimes, it is a valid objective to give statutory preference to nationals over foreign investors. In a resource development regime, in which foreign private-sector investment is a major objective, unequal treatment will have a chilling effect on the accomplishment of that objective.

Provide clear protections for investors and impartial enforcement for all parties.

Protection for investors.

The constitutional and legal investment climate is an essential component in investment allocation decisions. A foreign investor will seldom place its capital in countries unless, when, taken together, the body of laws in a country allow private investors to repatriate their profits and compete fairly with nationals.

National constitutions that respect and protect private property rights and enable laws that provide for private participation in the ownership and control of energy generation facilities are generally a prerequisite to outside investors and the international lending community. This generality does not mean that a country should necessarily have laws which allow for total ownership by the private sector. The investor is concerned primarily with exercising the right to make critical economic decisions free from governmental and political interference. Accordingly, a law that provides for majority (at least a 50.1 percent) ownership by the private sector will generally be acceptable to the international community. There are many additional ways to give the private sector the control it seeks while protecting the public interest in the facility. In the United Kingdom, for example, the government retains a “Golden Share” (which is a limited non-majority ownership interest) which allows it to veto certain fundamental changes.

What legislative features promote private-sector investment in the Renewable resource sector?

A renewable resources law serves three principal functions:

1. A law that focuses on renewable energy resource development allows a country to put together a systematic approach to the development and utilization of these resources. A focused and systematic approach has the best chance of achieving the policy objective of producing electricity from renewable resources.

2. A renewable resources law supports renewable resource investments. It helps establish the predictability necessary for investors to evaluate the risks of investment and to allow investment in a country’s renewable resource sector.

3. Each of the renewables - hydro, geothermal, biomass, wind and solar - are unique resources. Rational exploitation of individual renewable resources requires resource-specific development laws.

For example, geothermal energy may be defined as the “heat of the earth”. It is a unique resource and as such requires a particular set of development laws. There are significant differences between the extraction of minerals, water or hydrocarbon resources and the extraction of geothermal resources. Internationally, attempts to develop geothermal resources pursuant to mineral, water and hydrocarbon laws have proven difficult or impractical. Of equal importance - assuming that the objective of a country is to encourage the private sector to invest in its renewable resources - renewable resources laws establish economic predictability. Investors and bankers need predictability in order to evaluate risk. They need to evaluate risk before they invest in or lend money to a project.

A private developer must secure two legal rights before financing a project:

· the exclusive right to explore and extract or use the relevant resource in an area that he can access; and

· the right to generate and sell electricity (and other products) from any resource developed.

The only way that a hydro, geothermal, biomass, wind or solar private-sector power developer can make money - pay its debts and earn a profit - from developing a renewable resource, is to convert that resource to electricity.

Therefore, in order for an entrepreneur to finance a renewable energy project, it must first secure the legal right to enter the land, the right to explore for, extract, or use its renewable resource, and the right to convert that resource to electricity and sell electricity to a customer. Furthermore, these legal rights must be firmly in place before a developer can obtain financing.

A legal regime consists of laws, regulations (and subordinate procedural documents) and contracts. The following discussions review the elements of those four elements of a legal regime.

How does the legislator identify the requisite legal rights and duties?

It is essential that legal draftsmen understand the nature of the resource and the nature of the renewable resource development process. Form must follow function. To be effective, laws must be consistent with real world situations.

For each step of the renewable resource development process identify the developer’s need, the corresponding legal right required to fulfill that need, and the accompanying legal duty imposed as a reciprocal responsibility.

The policy-maker should endeavor to identify the developer’s need, the corresponding legal right required to fulfill that need, and the accompanying legal duty imposed as a reciprocal responsibility. For each step of the development process, a law that is designed to foster renewable resource development sets forth legal rights which address the needs of the developer. Each right has a concomitant or accompanying duty.

As previously discussed in Chapter 1b (Renewable Energy Overview: Cost-Effectiveness of Renewable Energy), one can identify three distinct stages in renewable energy development. From these three discrete development stages: “reconnaissance”, “exploration” and “exploitation” flow three related areas of legal rights and duties.

Reconnaissance. Developers of geothermal, hydropower, biomass, wind and solar technologies in grid applications may need access to relatively large areas in which resources may exist. Reconnaissance activities have minimal impact on the environment of the land. It is in the mutual interest of the government, the owner of the surface rights, and the developer that a reconnaissance team is not seen as a trespasser. Therefore, some notice mechanism is useful.

Exploration. Exploration involves expenditure of money. The developer needs to be certain that, if it discovers a commercial-scale resource, it has the exclusive and unqualified right to develop that resource. The government, in turn, needs to ensure that a speculator does not claim a vast track of land, then sit on it without any intention to develop it - thus establishing a “use or lose” policy is prudent. Exploration activities often require building roads to haul heavy equipment. They may also require temporary surface rights to the land on which to set resource measuring equipment (such as wind anemometers or stream flow gages), excavation equipment or drilling rigs. Therefore, during the exploration phase, developers need rights of way and the use of a relatively small amount of surface land. The government, in turn, is concerned that compensation to the owner of the surface rights is equitable for both the developer and the surface land owner. With the absence of an easement or other surface right acquisition mechanism, some surface-right owners may attempt to extract an excessive fee from the developer. Furthermore, some private-sector developers may be less experienced than others. Therefore, it is in the interest of the public that the government impose duties - standards of safety - on the less competent developers and ensure environmental protection compliance on all parties.

Reconcile currently existing or projected laws to integrate renewable resource development policy objectives into a comprehensive and comprehensible whole.

Exploitation. Installation of a generating facility requires the use of a definite land area for a long time period - perhaps indefinitely. Rational resource use often requires the government to legislate safeguards. In the case of hydropower, the government may want to ensure that the volume of water flow in the river is not impacted to such a degree that other uses for the resource, such as agricultural irrigation are impeded. Likewise, in the case of geothermal development, the government may want to ensure that the fluids carrying the geothermal energy are not depleted but are re-injected. The government may also need to protect the geothermal field developer from competitors drilling into adjacent areas and “dipping their straws” into the resource it has developed - thereby reducing field pressure. All renewable resource developers in grid-connected areas need to be certain that the electricity from developed resources has the right to be carried over transmission lines, to supply the national grid, and to be distributed to customers.

What legal tools may be used to establish a renewable energy legal regime?

Develop a clear set of renewable resource laws.

A country may elect among a package of legislative and regulatory tools in the drafting of a renewable resource law: laws, presidential decrees, ministerial resolutions, regulations, or amendments to existing laws. Mechanisms must be balanced both for the political ease of execution and the legal security of a potential developer. The clarity, reliability, specificity and predictability of the legal and regulatory framework surrounding the electric sector in a country strongly influences the commitment of private investment to that sector. A legal framework is not the only factor necessary to attract private investment, but it is among the most important factors. Investors naturally seek to minimize their risk. Vague or contradictory laws and regulations may discourage investors from even the most attractive projects.

When determining whether to legislate, regulate or use alternative tools in crafting renewable resource regime, consider both the legal security of a potential developer and the political ease of execution.

Select a legal vehicle that allows expedited implementation of the policy objective.

The policy strategist may consider a number of approaches designed to overcome these hurdles:

Ease of drafting and implementing, however, should not be at the sacrifice of a high degree of certainty that government undertakings may be relied on without frequent ministerial, judicial, or arbitrary interpretation. Resource laws are but one element in a legal regime governing the electricity sector. In most countries separate legislation establishes the electricity system, privatization, mechanisms, and fiscal policies (to cite three of many pieces of legislation which impact renewable resource development). Currently existing or projected laws will need to be reviewed, integrated and reconciled to ensure that renewable resource development policy objectives are integrated into a comprehensive and comprehensible whole.

Develop a clear mechanism for applying renewable resource laws.

It is useful to establish a single government entity with the responsibility and authority for all aspects of resource development and interagency coordination.

Provide procedures for dispute resolution between project proponents and State agencies.

Defining a clear and uncomplicated path for the renewable resource developer to follow is a key to expeditious, cost-effective project development. Ideally, the country will establish a single government entity with the responsibility and authority for all aspects of resource development. If that objective proves politically impossible in a given country, responsibility and authority for interagency coordination ought to be an achievable objective.

In many jurisdictions, the responsibility of agencies is overlapping, and the lines of authority and jurisdiction are confusing. For example, many countries distribute oversight functions for power projects among agencies, with no one ministry authorized to make final derisions relating to a specific project. In such an uncoordinated system, the ministry of finance, for example, may impose requirements on a project developer in terms of its relationship to a lender or in the form of reserve requirements for purposes of an unrelated law, which completely frustrates achievement of the objectives of a resource development law. This irrational interaction of laws in which the objectives of one law negate the objectives of another robs project development of the predictability necessary to attract capital. Furthermore, project development is often slowed or even stopped because of political fighting among state bureaucracies. Accordingly, laws and regulations which provide clear procedures for dispute resolution between project proponents and State agencies (and among State agencies themselves) will assure investors that projects will not be unreasonably delayed.

Government resources may be invested in prefeasibility or feasibility investigations.

The extent of government involvement in pre-feasibility, feasibility, and development, determines the point at which the regulatory regime actually regulates private-sector activities. A fundamental question for the policy strategist is whether, and to what extent, government resources ought to be invested in pre-feasibility or feasibility investigations and, indeed, whether the government itself ought be an active participant in development. If a resource concession is to be offered, significant feasibility assessment must be completed prior to issuing a request for bids in order to have data sufficient to convince developers that sufficient potential exists to justify development in the proposed concession. In an open bid situation, the host country generally can be well-served by doing significant resource measurement and evaluation designed to provide baseline data for the developer who will often be required to do additional, more extensive feasibility investigations on its own. Government-funded exploration can be a positive factor from the private-sector perspective in the development of such resources as geothermal, in which exploratory drilling is not easily financeable and requires private-sector equity investment.

Government-funded exploration in such circumstances, may speed resource development. The government, of course, may seek reimbursement for these efforts. The amount of, and mechanisms for, such reimbursement is a policy issue to be considered.

Governments may require security to assure long term productivity.

Every country is concerned with the long-term viability of resource development. In those situations where the developer will build and operate the project only for a certain period of time and then transfer the project to a governmental authority (a process known as “BOT” - build-own-transfer), the country is justified in requiring security to assure long-term productivity.

Regulating for Diverse Rights Rights to various resources on the same land may be licensed or let by concessions. This multiple-license situation is known as “juxtaposed diverse rights”. To the extent that a resource concession may interfere with other surface or subsurface uses, the regulatory regime may make specific provisions for juxtaposed diverse rights. In some jurisdictions, the problem may require resolution in the organic law. In the event that an application for renewable resource rights is presented for a resource area in which there are previously registered rights of a different legal origin and judicial nature (such as rights derived from legislation pertaining to hydrocarbons, or mining or electricity), the bearer of a renewable resource right should exercise its rights in a manner to avoid creating material damage to the holder of the other rights. In the event that the holders of different renewable concessions of the same nature determine that these concessions, for example, may overlie the same interconnected geothermal resource, or may interfere with the same hydro resource, or may affect each others’ wind source, it is essential that mechanisms be established to reconcile such competing interests as well as to ensure rational resource development

Consider requiring security to assure long-term productivity for BOT-type projects.

However, in situations in which the developer will build, own and operate and (perhaps) transfer the facility - processes known as “BOO” or “BOOT” - such security may not be needed or justified. Typical security devices include warranties, letters of credit, reserve accounts to secure operations and maintenance obligations and reserve accounts to secure capital improvement obligations. Penalties for failure to deliver on guaranteed energy performance may be an appropriate method of enhancing performance.

The question of whether and how much to charge for resource use is a key issue for the policy maker.

Certain national resources, such as geothermal and hydro, are held in trust for the benefit of the populace. To allow their development without receiving payment from the developer may prove a political impossibility in some jurisdictions yet it is the energy users in the populace who, in fact, are paying for the resource use, although indirectly. Moreover, the government will have expenses in establishing a resource regulatory regime. By establishing a payment requirement on the developer the government may be able to fund these regulatory costs - again at the price of imposing an indirect tax on the electricity user. The policy maker should be mindful, however, that any solution which imposes different costs on different classes of energy generators will change the competitive cost of delivered power.

What fiscal incentives to promote renewable resource development are available to the legislative drafter?

The following are some of the legislative mechanisms that can be promoted depending upon the structure of the electricity system and the goals and objectives within a country.

Impose a tax on sales of electricity generated from carbon-based fuels with resulting tax revenues dedicated to development of renewable resources.

Carbon-based tax.

One option may be to tax sales of electricity generated by polluting fossil fuels and use the revenue to pay a premium to generators utilizing non-polluting renewable energy sources. While this option may not provide the maximum amount of security desired by lenders, it will provide additional enhancement to the projected revenues received by a “merchant plant,” thereby improving the financeability of the project.

Collaborative financing approaches.

The government may also elect to step up efforts to assist private developers in securing financing or credit support from the multilateral development agencies. These agencies recognize the need to encourage the development of non-polluting and indigenous sources of electricity in emerging nations. With the participation of the large multilaterals, governments may be able to induce local lending institutions and capital markets to participate in financing. The more participants in a project, the more risks are shared. In market regimes which do not enable long-term power contracts, the lending community sees significant risk. If that risk can be shared among a greater number of parties, it enhances the likelihood of a project’s being financed. One can envision a renewable energy, merchant plant project finance scheme in which venture capital provides 30 percent equity and 70 percent debt is shared among a consortium of local banks (thus significantly reducing local currency exchange issues) and more traditional lending sources. This approach could include guarantees by a partnership between the national government and one or more multilateral development agencies. Guarantees by the development agencies, which are, in fact, created to provide funding for risk situations others will not finance, will go a long way towards making such financing of merchant plants possible.

Increase the role of the government in convincing multilateral development agencies to play a more active role in the financing of renewable energy projects.

Credit mechanisms.

Other possibilities would include the creation of a “guarantee fund”, sponsored by the national government and the multilaterals, which, although not project specific, would be available to lenders of failed projects which had qualified to be covered by the fund. Revolving funds consist of a dedicated pool of monies contributed by the government for the purpose of providing debt or equity capital for investment in renewable resources projects. As funds are invested and repaid (including a rate of return which approximates market conditions) the fund grows, thereby facilitating financing of more projects.

Create a national guarantee fund or revolving fund which is available as credit support to all qualified developers of renewable energy facilities.

Feebates or environmental dispatch.

“Feebates” are a revenue-neutral strategy (for the wholesale market) that places a pollution fee on electricity generated by more polluting technologies and gives rebates to electricity supplied by cleaner technologies. “Environmental dispatch” uses a pollution index to adjust the resource cost and dispatch power. The difference between the pollution index and the feebate is that the pollution index is not necessarily revenue neutral.

Both the feebate and environmental dispatch mechanisms can be instituted at either the state or national (federal) level and both are compatible with either a monopoly or market-based utility model. Both mechanisms affect all generation resources sold in the wholesale market, and internalize environmental costs in the short-term as well as the long-term market. The challenge in establishing either of these mechanisms is the difficulty of agreeing on a set of specific pollution indices (environmental externality values).

Provide fiscal incentives that will allow renewables to compete in an open-market system.

Fiscal incentives.

Fiscal incentives will always serve to attract private investors. They make renewable energy projects more financeable by reducing the capital costs and thereby providing greater comfort to the lenders that there will be sufficient revenues to pay the debt. Examples of fiscal incentives are: accelerated tax depreciation, removal or reduction of trade barriers on renewable energy equipment and investment-tax credits for capital costs.

Government purchase.

One of the strongest forms of influence is by example. If government entities such as schools, hospitals, government buildings and water districts, use electricity from renewable sources, this usage sets an important example for others. It also allows people to gain direct experience in working with various types of renewable energy facilities.

Require government agencies and institutions to purchase some or all of their power from renewable resources.

Mandate that distribution companies have a minimum amount of their load met by renewable resources.

Portfolio standard.

The government may mandate that all distribution companies have a certain amount of renewable energy capacity in their portfolio by requiring them to enter into long-term power purchase agreements with renewable energy project sponsors. These contracts could be for a term of years, renewable at the option of the distribution company. The distribution companies would be able to enjoy the economic benefits of a renewable project after its capital costs have been retired, a potentially valuable hedge in the event of an increase in the wholesale market price for electricity. New renewable energy facilities brought on line through a portfolio mandate may result in higher energy prices in the short-term, but the impact of the mandate will diminish, and the economics of these projects will “turn around” as the debt-service costs of these facilities are retired.

Appendix D contains a more detailed explanation of the renewables portfolio standard approach.

b. GOVERNMENT’S REGULATORY ROLE

The private sector will not invest money into electricity generation (or any other aspect of the electricity sector) unless and until there is regulatory stability. Since regulators implement the law, regulatory actions become the framework within which electricity sector investments are made. The business community looks for a constant set of regulations and guidelines upon which investment decisions depend for their viability.

This section deals specifically with economic regulation and the regulation of natural resource use. Environmental regulation can also affect the electricity sector, but is outside the scope of this paper.

When is Government regulation necessary in a competitive environment?

Economic regulation.

The goal of regulation is the promulgation and preservation of the public interest

When a sector of government owns and operates the electricity industry, it is assumed that the public’s interests will be expressed and protected through existing government processes. This assumption, however, is not always valid - as evidenced by the numerous examples in which the political process, particularly the influence of special interest groups, has subverted the public’s interest in the policies that govern operation of the electric sector. When some or all of the electric industry functions are privatized or capitalized, or where competition is otherwise introduced into one or more of the electricity functions, the need for independent regulation emerges. In these situations, independent regulation is necessary because it is believed that the electricity sector is imbued with the public’s interest - in other words, there are broad-based public services that are not likely to be realized through a private monopoly or a competitive market without governmental oversight and intervention. The goal of regulation is the promulgation and preservation of the public interest. The objectives of traditional regulation of the electric utility industry have been to:

· ensure reliable power at the lowest price;

· establish processes that result in sufficient revenues to attract additional investment in electricity infrastructure as required to ensure reliable power at a reasonable price; and

· design rate structures (tariffs) and incentives (price signals) to encourage the wide use of electricity.

In many of the countries that are just introducing competitive markets into the electricity sector there is little regulatory experience. Experience indicates that in virtually every electricity sector that is attempting to move to a fully competitive market type, some independent system of regulation or oversight has been necessary to guide this new market to ensure competition actually develops. Frequently governments determine that separate regulatory agencies are best suited to implement regulation.

In theory, regulatory bodies are quasi-independent of the other branches of government, looking to legislatures for their broad scope of authority and funds, to the governor, minister or the people for appointment or election, and to the courts for support of appeals. In practice, such quasi-independent regulatory bodies, although susceptible to political pressure from a variety of sources, tend to be more independent and better informed about implementation issues than legislative bodies.

Regulatory commissions also serve as arbitrators who settle disputes that necessarily arise from time to time concerning contractual relationships among the key stakeholder groups.

This Manual does not attempt to discuss all the aspects of developing an effective independent regulatory regime. Rather, the guiding principles are highlighted and regulatory activities specifically related to the development of independent investments in the electricity sector (and specifically renewable generating facilities) are noted.

How does the economic regulator design a regulatory regime to promote renewables while protecting other public interest issues?

The policy strategist designs regulations to promote developmental investment in the renewable energy resources, while simultaneously establishing reasonable standards for the protection of the people and the environment of the country.

In developing regulation, the two primary tasks are:

· identifying the public’s interest that is being fostered or protected; and

· identifying the mechanisms and tools that can accomplish this task with the least disruption to the market and the least-cost to the public.

Experience indicates the primary economic regulatory areas specifically associated with the development of renewable resources include:

· calculation of the total value of renewable resources to the electricity system;

· analysis and comparison of various types of power within the resource planning process and how to account for the environmental benefits of renewable resources in the planning process;

· how to design technology-neutral requests for proposals for generation to be developed by independent power producers;

· how to develop standardized contracts for purchasing power from renewable resource facilities;

· how to provide fair and open transmission access for intermittent renewable resources; and

· how to assure quality performance (i.e., good operation and maintenance service) for renewable facilities constructed for rural electrification programs.

The regulatory structure conclusively establishes how a country’s resource policy will be implemented in practice. Every experienced investor understands that the laws of a country are only first-level indications. Sometimes, for example, a development incentive which has been established as a matter of policy - in a law - has never been implemented as a matter of practice - in a regulation.

The following natural resource development policy strategies have proven sound in the drafting of new regulatory regimes in countries which are attempting to lay the groundwork for renewable resource development:

· Regulations while promoting resource development should also be designed to strike a balance between development and protection. Regulations must prevent waste and ensure the environmental integrity of the resources while they are being developed.

· Policy strategists can learn valuable information from countries that have already developed their resources; however, resource development regulations should be tailored to the environment of the country. What works in one country will not necessarily work in another.

· Adhere to the rule “don’t over-regulate what you don’t have”. Regulations should not prematurely attempt to duplicate a regulatory system in place in a country which has extensive renewable resource development.

· Strike a balance between essential monitoring and over burdensome and costly reporting. Inspection and reporting requirements add to the costs of a project and thereby may dilute its economic viability. For the investor “time is money” and every moment spent in a reporting process represents an expenditure of time and money which results in additional project costs as well as delays.

· Both economic and natural resource regulations must be adaptable to tomorrow’s technology. Regulations must be technically sound by today’s standards, but today’s technology must not be locked in.

The following guidelines for developing renewable energy resource regulatory policy provide a reference for the policy strategist.

Guidelines for Developing Renewable Energy Resource Regulatory Policy Step 1. Clarify the policy position of the Government. In drafting regulations, the threshold step for the policy strategist is to articulate the goal of the legislation which underlies all implementing action. Then, in order to ensure that the legislative goal is enabled, it is essential that the policy strategist articulates a conceptual objective for the regulations consistent with the legislative goal. For example, the conceptual regulatory objective may be two-fold: · to avoid micro-management of a resource which is not yet developed; and · to promote a self-regulatory, private-sector environment with the minimum amount of direct government participation, while still ensuring operationally safe and environmentally sound conditions. In other words (using a geothermal example), if it is dear that a safe and sound blowout prevention program is required, and if the conceptual objective is to minimize direct governmental participation, the regulations and norms may be directed to establishing compliance standards, penalties for non compliance, and bonding procedures for restitution in case of an incident rather than to establish on-scene, government oversight Other objectives produce different results. Step 2. Determine the organizational structure within the responsible agency. The renewable resource regime may provide a single ministry with the authority to promulgate regulations and to grant authorizations and concessions. Within this context, it is essential to understand how the designated ministry allocates the promotional and the compliance regulatory functions between itself and its directorates; how the checks and balances - both formal and informal - have been instituted; and how the internal decision-making and appellate apparatuses function. Concomitantly, legislated interfaces among ministries need to be identified. In particular, fine-tuning the relationship between the ministry designated to oversee renewable resource development and other ministries is critical in the drafting of the regulations for the various renewable resources. Step 3. Identify other laws with potential bearing on the renewable resource regulations. It is critical to ensure the integration of regulations into the country’s legal regime. For purposes of standardization, subject matter to be addressed in regulations should be carefully reviewed to ascertain their coverage in other laws and regulations. The renewable energy resources law and the proposed regulations should be scrutinized and a check list made of issues that may be the subject of other laws or regulations. Pertinant laws or regulations can be cross-referenced or pertinant provisions can be inserted into the renewable resources regulations in parallel language. For example, such issues as determination of rights of way, establishment of a record registry, and provision of environmental standards may be the subject of other laws or regulations.

Step 4. Establish a policy of regulatory content in relation to subordinate rules. In most countries, regulatory authorities enjoy broad discretion as to the content of regulations and norms. A threshold understanding of the desired allocation of content among laws, regulations and norms will prevent needless over-drafting of regulations. Step 5. Draft regulations and subordinate rules as a single package. In many countries, a regulatory regime is a time-tiered system and a regulation must be in place before a subordinate rule is finalized. Nevertheless, for reasons of consistency and understanding of the regulatory concept, a total package should be drafted. Once drafted, they can be refined in context of regulatory changes, but without seeing and reading a preliminary detailed package spelling out how a regulatory provision is to operate, the ultimate effectiveness of a regulatory concept is difficult to envision. Step 6. Incorporate a legal/technical translator on the regulatory team. A resources regulatory project designed to attract foreign investment typically includes the drafting of a definitive regulation and an accurate (not definitive) translation into other languages - English, Japanese, German, etc. Translations by a translator without a legal background consistently contain linguistically “accurate” but legally misleading translations - creating text which is misleading to readers. Step 7. Encourage a team approach. The government of the policy strategist should be encouraged to incorporate persons from the private sector, from sister agencies, and from the legislative branch to participate in an advisory capacity on a regulatory drafting task force. There are potential risks with this approach - e.g., perceived violations of the rule of separation of the executive and legislative branches, turf issues between sister agencies, etc. Nevertheless, the value of incorporating possible “opponents” early-on in the decision-making process outweighs the potential down-side. Step 8. Solicit input from industry. In the case of a law designed to promote private-sector development of a resource, the advice of the potential developers whom the law is designed to attract and whom the regulations are designed to regulate is invaluable to the policy maker. Step 9. Allocate sufficient time for the political process. Laws and regulations are not drafted in a vacuum. Political consensus and will to proceed is based on confidence, and confidence-building is a time-consuming exercise. Sufficient time must be built into the project Step 10. Draw on but do not be a slave to, precedent The understanding of regulatory precedent ‘ from a variety of jurisdictions is essential; however, regulations in one jurisdiction can seldom be transposed directly into another. For example, the governments of two countries may concur mat blowout prevention in a geothermal site is an essential regulatory task; nevertheless, the concept of one government (that its role as a protector of people requires a regulator to be on site for every well drilled) may be at odds with the concept of another government (mat the private-sector must be made responsible for self-regulation).

c. GOVERNMENT’S ROLE IN THE RESOURCE CONCESSION PROCESS

One of the more important regulatory elements is the resource concession process - that process which allows private sector involvement in most countries’ energy sectors.

What are resource concessions, and how are they granted through the regulatory process?

Viewed in its broadest context, a concession is any right or privilege which a private developer must secure from a government before engaging in a business activity. More technically, a “concession” is a grant of special privileges by a government allowing a private party to exploit government land or resources.

Most nations proceed on the principle that since the country’s natural resources belong to the nation as a whole, exploitation of the resources must be controlled by the government through a rational process of issuing concessions to qualified parties.

Governments consistently issue concessions to generate electricity, operate and maintain transmission or distribution systems or operate utility systems in discrete sectors of their country. In many countries governments grant concessions for the right to utilize a water resource or extract geothermal energy. Some countries may require several concessions to construct, own and operate a generation project. For example, one may need a concession to explore a geothermal resource, and then another concession to utilize the resource for the generation of electricity. In the context of rural electrification, concessions may be offered to private investors allowing them to develop vertically integrated, privately owned electricity systems for geographic areas defined in the concession.

Establish objective criteria upon which the selection of the resource concession award will be based.

In attracting private investment for renewable energy development, the structure of the concession is extremely important. For example, concessions may be structured so as to attract private investors, while at the same time the terms of the concession may be structured to assure that the entity holding the concession completes the proposed objectives (e.g., timely completion of development).

The following sections describe regulatory principles which are important from both the private investor’s and the country’s perspective in any concession structure.

Regulations need to state objective criteria upon which the selection of the resource concession award will be based.

The private investor looks for assurances that the process for granting concessions is fair. From the private investor’s perspective this means that in the event of competition for a concession, the government will award the concession to the most qualified applicant, through a transparent and standardized process. What determines the most qualified applicant depends on the nature of the concession and government objectives in granting the concession.

In a competitive award process, an objective, qualified panel should apply the criteria.

A panel or committee comprised of people who are qualified to evaluate the proposals from technical, developmental, and financial perspectives - as well as to evaluate the proposal’s responsiveness to the other objectives expressed in the concession offering - will give the investor greater confidence that its proposal will be fairly evaluated.

Establish objective, qualified panels or committees to oversee competitive awards.

Temporary resource concessions allow candidates for permanent concessions to evaluate project commercial feasibility.

Where concessions are granted for the development of energy projects and include the right to construct, own and operate an electricity generating project, the process typically provides for granting a temporary concession prior to granting a permanent concession. It is in the interest of all parties to allow developers the time and support to conduct thorough project feasibility studies. The purpose of the temporary concession is to give the selected developer sufficient time to undertake more extensive feasibility studies so the developer can assure itself and its investors that the proposed project makes sense in the final analysis. By linking a temporary resource concession with a pre-emptive right for the developer to obtain the permanent resource concession, the government may increase the developer’s confidence that the money spent on expensive feasibility studies will not be spent in vain. Temporary concessions, although time limited, are exclusive. For a given project, no more than one temporary concession should be outstanding at any one time. The holder of the temporary concession needs to be assured that it will be entitled to a permanent resource concession for the site, so long as it complies with the terms of the temporary concession. These measures are necessary to ensure that the concessionaire has the proper motivation to expend the funds necessary for a feasibility analysis which is sufficient to satisfy a project lender.

Utilize temporary concessions linked to a permanent concession to allow candidates for permanent concessions to evaluate project commercial feasibility.

A concessionaire needs to know what its rights are and what it must do to maintain them throughout the period of the concession.

A concessionaire needs complete access to the project site and to all information in the possession of the government regarding the site, so that it can adequately evaluate the project. An investor will need confidence that if it obtains a permanent concession it will have the legal right to acquire, for fair market value, all land and other property (such as riparian rights) needed for attaining the objective of the concession. An investor will also look closely at the regulations to see if they provide for a quick and equitable way to resolve disputes between the land owners and the concessionaires regarding the determination of fair market values. For example, a dispute resolution process may be put into place which allows the concessionaire to proceed onto the property if it places a bond or other security instrument as collateral for the ultimate determination of value. Failure to provide for eminent domain rights leads to situations where an isolated local landowner can unreasonably delay project development. In the case where a law requires more than one concession to complete a project, the investor will want to know exactly what the process is for obtaining the subsequent necessary concession.

Minimize the number of secondary permissions required in concessionary grants.

Grants of concessions should minimize the number of secondary permissions required.

Concessions are often supplemented by secondary instruments (known variously as permits, licenses, warrants, etc.) empowering the guarantee to do some act, not forbidden by law, but not allowable without such authority. Many jurisdictions require the holders of concession rights to obtain secondary permits from various governmental agencies at the local, provincial and/or federal level. The project developer would like to be assured that, if its proposal conforms to the requirements of the concession offer, it will be able to obtain the necessary permits at all levels in a timely and cost effective manner. Investors prefer laws which empower a single agency with comprehensive authority over all matters, including permits that are needed to proceed with the proposed project. In many countries multiple agencies require multiple permits and the rules for the issuance of such permits are random - without reference to government objectives in the energy sector. Such situations have a chilling effect on investment. Non-exclusive reconnaissance permits can effectively attract developers to known resource areas. In unknown (or “wildcat”) areas or in areas in which there is insufficient data, such permits can be even more effective in encouraging reconnaissance if developers are given an exclusive or preferential right to convert a reconnaissance permit to a non-competitive concession, or a right to match the highest bid if the concessions are awarded through competitive bidding.

In resource concessions, establish both the best use of the resource and standards for determining which concession applicant will meet those needs.

Governments are usually concerned that development make the best use of the available natural resources. In some instances, equipment efficiency is the paramount issue, as in the case of hydro and geothermal generation. In other instances, there is a specific task to be performed, such as pumping water or running certain equipment, and (so long as the task is accomplished at an acceptable price) efficiencies may be a less important factor. The best use of the resource may also involve multiple uses. Country objectives for hydroelectric development may include energy production, flood prevention, irrigation and recreation. Development of solar and wind projects may need to be consistent with the agricultural uses of the land on which they are located. It is incumbent upon the regulatory strategist to define in each concession what the government considers to be the best use of the resource and to develop standards for determining which concession applicant will best satisfy those defined uses.

A “use or lose” policy requires balancing several considerations.

While the concessionaire may be motivated by a date-specific commitment to provide electricity under a power sales agreement, the government may establish and monitor timelines. To assure that the concessionaire is working diligently towards construction of the project, the government may require that certain milestones be met by the concessionaire in order to retain its concession rights. This “use or lose” policy assures that developers will not “bank” projects to prevent other developers from competing for a limited resource or limited market place. By balancing a “use or lose” policy with government flexibility on excusing unintentional developer delays (e.g., time consumed by the government, third parties or natural forces), realization of final project completion may be better assured. It is generally acceptable to the international lending community that the government require security in the form of bonds or letters of credit to assure that the concessionaire is motivated to perform in a timely fashion.

Although viewed from different perspectives, the private investor objectives of a resource concession be met. While the private investor’s main concern is to obtain a reasonable rate of return on its investment, the country’s concerns, while not necessarily in conflict with the private investor’s, may be broader in scope.

d. GOVERNMENT’S ROLE IN THE MARKET

In countries in which vertically integrated utilities under state ownership or control predominate, long-term planning is relatively easy. Resource planning allows design of a capacity expansion program that includes renewables in the country’s generation mix. The primary challenge under this model is designing a solicitation system that attracts private investors, fulfills the desired quota of renewables, obtains the utilities’ expected output at competitive prices and yields projects that are creditworthy. A second critical element of any resource acquisition process is the power purchase agreement.

How are on-grid, renewable projects best solicited in a state-owned or monopolistic utility system?

Although there are almost as many different styles of bidding solicitations as there have been solicitations, most utilities are familiar with all-source bidding procedures: the utility issues a solicitation seeking bids from project sponsors for capacity and energy, with the bid going to the lowest cost supplier without regard to the project’s fuel source. By this method, the utility seeks a specific amount of capacity and purchases the associated energy in accordance with a per-kilowatt-hour formula that normally allows the project sponsor to recover its fuel cost. Renewables are likely to be less successful in “all-source” bidding solicitations in which all technologies compete against each other. The emphasis on fixed cost in all-source solicitations favors the economies of scale of large, stand-alone fossil plants and creates difficulty in comparing resources with dissimilar attributes.

All-source bidding solicitations favor thermal projects because the costs associated with thermal projects can be readily determined and are normally not site specific. Thus, a private-sector bid to supply fossil-fired thermal generation can be prepared with comparatively little time and expense.

By contrast, renewable energy projects are normally very site-specific and can require many months of study before cost information can be developed to the point where a bid can be made.

The criteria established to determine the winning bid in most all-source bidding programs typically fail to take into account the long-term benefits offered by renewable projects and the different cost patterns experienced in conventional thermal versus renewable projects. Moreover, a tendency to take a fairly short-term view in weighing the relative costs and benefits of thermal versus renewable projects also impedes renewables.

In the case of most conventional thermal projects, per-kilowatt capital costs are low when compared to the typical renewable project. On the other hand, a renewable project may have a zero fuel cost and very low variable costs, while thermal projects have comparatively high and often unpredictable variable costs. Despite these differences, utility power solicitations for renewable energy projects often proceed using the thermal model and base comparative evaluations on an imperfect view of the long-term costs and benefits of the various technologies. Utilities tend to make their acquisition decisions on the basis of a project’s capacity and energy costs in the first few years of a multi-year transaction, giving insufficient weight to the long-term implications of the arrangement. The design of a bidding program will influence the ability of particular technology types to compete successfully.

Solicitation and bidding models for renewable energy solicitation.

When a utility has determined what it believes to be a fair price to pay for renewable energy, it can then initiate the process of attracting private investors to develop the available resources. There are generally four solicitation models which have been used: the site-specific bid, the tariff-based solicitation, the site-specific tariff bid, which is a hybrid of the first two, and the negotiated solicitation.

Site-specific bid models. In this model, the utility has a specific site or sites and a specific energy source in mind, and asks potential developers to enter a bid for the rights to develop the site -- the lowest bid wins the right to develop the resource. Unfortunately, experience has shown that this approach is not effective in attracting private developers of renewable projects. The problem with this model is that the project developer’s chances of winning such a highly competitive bid are so low, and the costs of a pre-feasibility study are so high, that a project developer is generally unwilling to undertake a prefeasability effort sufficient to develop a realistic bid. Prefeasability studies performed by the host country are rarely specific enough for the developer to undertake more than a sketchy plan for the project. Those developers willing to participate in this kind of a solicitation are compelled to make assumptions based on worst-case scenarios which result in a very high bid price. In fact, most developers have simply elected not to participate in site-specific bid solicitations. The few that do participate submit bids that are either not creditworthy or so high as to be unacceptable to the host country. This model has created many problems in the Philippines, which has been attempting to solicit firm bids for the development of several hydro sites.

Tariff-based models

A variation on this model has fueled dramatic increases in the development of renewable energy projects in the United States. In this model the utility undertakes its least-cost planning and determines the rate, or tariff, it is willing to pay for renewable energy resources. It is critical that least-cost planning take into consideration all benefits and costs associated with various energy fuel sources. Predictably, the use of this model will establish rates which are different as between renewables and non-renewables as well as among the various types of renewables. Most importantly, the utility determines, on a reasoned basis, and after accounting for all benefits and costs, the value of its resources.

Once this price is established the utility offers to purchase a set amount of capacity for the various energy sources at the tariffed price. Assuming developers respond to the solicitation, they will submit applications to develop specific sites. The utility can then select the proposals which best meet the criteria established by the utility and award temporary concessions giving the developer the exclusive right to further investigate feasibility and commit to developing the resource. See section 4c (Government’s Role in the Concession Process) of the Manual for a discussion of concession issues. If the response to the solicitation fails to meet expectations, the utility must determine if it is willing to offer a higher price for the resource and issue another solicitation. Or, the utility may conclude that the resource does not provide sufficient value in the current marketplace based on the originally established criteria and therefore abandon the particular resource until market conditions change.

Hybrid, site-specific tariff bid models.

Again the utility undertakes least-cost planning and determines the price it is willing to pay for a particular energy source. This price can then be included in a solicitation for site-specific renewable projects, with the understanding that the price included in the solicitation will be the ceiling price. Developers can then submit bids based on a percentage of the ceiling price. This method seeks to ensure that the utility will fulfill the goal included in the Comprehensive Plan regarding the expansion of the nation’s base of renewable resources, while at the same time bringing competitive pressure to bear on project sponsors to constrain bids. However, this method presents similar problems associated with the first model: the feasibility studies supplied to investors may be based on unreliable or incomplete data, making it very difficult to develop firm bids. The effort could ultimately prove futile if no bids are received or may even need to be repeated if the received bids turn out to be impracticable.

Pre-qualification/negotiation models.

This model begins with a pre-qualification process whereby the utility establishes transparent criteria for qualification. These criteria should include not only technical ability and experience, but factors related to financial capability and the ability to obtain necessary financing for the construction of the project.

Once the participants in the process have been pre-qualified, the utility can then prioritize the successful qualifiers according to another set of criteria. That set of criteria should be based partly on the relative merits of the pre-qualification criteria as well as such criteria as the party’s willingness to involve the utility and government in certain aspects of decision-making. the willingness of the party to provide incentives and equity participation to workers and employees and other matters that may be of particular importance to the government. Once the qualified parties are ranked, negotiations can begin with those at the top of the list according to a strict schedule requiring progress on such negotiations. Negotiations must be transparent and arbitrary rankings would need to be prohibited. This model has been used successfully in some counties, but has recently come into disfavor because of perceived or real favoritism in the process. A verifiable means of assuring transparency is critical to the success of this model.

A variation on this approach is to use the pre-qualification process to establish a bidder’s list. The pre-qualified bidders then submit proposals addressing a discrete set of project attributes and requirements. Bids are evaluated on the basis of price and non-price factors and the bidder with the highest score wins the bid.

Certain energy projects are either too small to justify inclusion in a solicitation of utility-grade projects, or are able to deliver energy only on an intermittent basis, and special rules should be developed for these resources. Examples would include small wind machines or hydro projects having a capacity under 100 kilowatts, or larger facilities that serve sizable industrial loads. but which occasionally have limited amounts of excess power to sell into the grid. In these cases, the utility should develop and offer an energy-only purchase rate based on the utility’s average energy cost.

Electricity, not the renewable resource, is the product of value.

What is the role of power purchase agreements in private-sector development of renewable resources?

The success of a country in attracting private capital is directly related to its sensitivity to the way in which private investors generate investment capital in the world markets. In particular, the renewable resource industry uses project financing for grid-connected systems.

“Project financing” is a mechanism whereby a developer borrows money and repays it from the revenues generated by the project.

The single most important key to project financing is a power purchase agreement. A “power purchase agreement” is the contract between the owner of a power-generating facility and its customers. In this agreement, the customer promises to pay a pre-negotiated rate for power and capacity over a period of years, assuming that the generation facility performs as promised.

The importance of the power purchase agreement to a developer may be more dearly understood by looking at these agreements from a developer’s perspective. A geothermal energy investor, for example, has to spend money to explore for geothermal resources much the same way one does in prospecting for gold or oil - however, the geothermal prospector cannot export hot steam abroad. Similarly, the hydropower energy investor has to spend money to create a reservoir and the biomass, wind and solar developers have to invest in technology that converts a source of potential natural energy into electricity. Electricity. not the resource, is the product of value. Therefore bankers must be assured that someone in the producing country will buy electricity at a price that will generate sufficient revenues to repay borrowed monies - or that the electricity will be exported and bought by a customer in a neighboring country. For example, during the 1990’s Mexico has been exporting approximately 500 megawatts of geothermal-generated electricity to Southern California.

Electricity, not the renewable resource, is the product of value.

Streamline and standardize the legal and regulatory procedures for power purchase agreements between the utility and private power producers to minimize costly delays and complications in contract negotiations.

A power purchase agreement is a means to an end. If the policy objective is to enable private-sector entrepreneurs to develop renewable energy, grid-connected facilities to sell power in a country, a power purchase agreement is the most effective mechanism presently in use to allow financing of private-sector generation facilities. Power purchase agreements are effective tools only in countries in which national legislation or practice allows entities other than the national utility to generate electricity.

What is the role of power purchase agreements in the renewable energy context?

Ideally, any purchaser of generating capacity and electricity which is soliciting power for addition to its grid - be that a utility. a distributor or other entity - will have prepared a well-thought-out standard power purchase agreement to be included as part of the solicitation. The preparation of standard power purchase agreements will not only speed the post-award contract negotiation process, but will also place bidders on notice regarding the terms and conditions of the contract. Since, from the developer’s perspective, contract terms translate directly into costs and benefits, communicating the terms sought by the utility to prospective bidders permits the bidders to embody a complete assessment of the economics of the transaction in their bids. Without a firm understanding of these factors, bidders will be forced to rely on guesswork in formulating their bids, undermining the entire bidding process.

A power purchase agreement for renewables that has substantial monthly capacity payments can have fairly modest payments for delivered energy.

What policy issues need to be considered by the government in the context of power purchase agreements for renewables?

In general, the legal and regulatory procedures for power purchase agreements between the utility and private power producers need to be streamlined and standardized to minimize costly delays and complications in contract negotiations.

When preparing a standard power purchase agreement, utilities and other power purchasers should be aware that renewable facilities differ from conventional hydrocarbon-fueled projects in several ways. Failure to reflect these differences in the power contract will complicate, if not preclude. the renewable project’s ability to attract financing. Fortunately, these differences can be accommodated without compromising the power purchaser’s position.

Renewable projects tend to be far more capital-intensive than conventionally fired facilities. The typical renewable project will have a very high proportion of fixed cost - chiefly in the form of debt service - and a low proportion of costs that vary with the output of the plant. Given this cost structure, renewable projects seeking financing need to be able to demonstrate that the power contract will produce a very steady cash flow over the life of the financing. This demonstration of commercial viability can best be achieved by negotiating a power contract with some customer - be it a utility. a distributor or a commercial facility - that has substantial monthly capacity payments (payments per kilowatt of deliverable capacity). If the capacity payments are sufficient, then the payments for delivered energy (payments per kilowatt hour of delivered energy) can be fairly modest. This kind of payment structure presents a relatively low risk profile to investors, and the resulting lower debt service costs can be reflected in the prices paid by the utility under the power contract.

Pricing for power purchased from an independent power producer needs to reflect its value to the purchaser in terms of the power producer’s ability to meet on-peak, off-peak, baseload and peaking capacity requirements. Given the higher value of electricity generated during peak demand, the cost difference between peak and off-peak electricity prices needs to be dearly defined. Alternative capacity payment and dispatching language can be developed and included for subsequent negotiation.

What are the major source-specific considerations in developing a power purchase agreement?

The source-specific considerations and suggestions below are relatively simplistic guidelines, and legal counsel should be sought before adopting them.

Geothermal Projects. Projects driven by geothermal energy are normally designed to run at a fixed output level around the clock. The power contract should include substantial capacity payments and very low energy payments, reflecting the typical cost structure of these projects. Capacity testing provisions can be based on the adequacy and regularity of deliveries during on-peak hours. Dispatching provisions should be limited to a requirement that the unit go to maximum output if required in the case of emergencies.

As a practical matter, dispatching provisions that allow the utility to reduce the unit’s output below its normal operating level will result in a waste of the available geothermal energy and can engender additional operations and maintenance costs, and therefore should not be included.

Hydroelectric Projects. Hydroelectric projects come in two varieties, peaking (or storage) projects, and run-of-the-river projects. In drafting power contracts this distinction must be kept in mind.

In the case of run-of-the-river projects, the operator of the project normally has very limited control over the output of the project: the project’s deliveries vary with the water level in the river. In these cases, capacity payments can be tied to the results of regular capacity audits of the facility, or to actual on-peak deliveries. The power contract should not, however, contain dispatching provisions given the operator’s limited control over the facility’s output.

Power purchase agreement for the renewables should reflect the value to the purchaser in terms of the power producer’s ability to meet on-peak, off-peak, baseload and peaking capacity requirements.

By contrast, peaking hydro facilities offer substantial capacity and dispatching benefits. A true peaking hydro unit will normally have a large reservoir behind its impoundment. Water flowing into the reservoir can be stored during low load periods such as weekends or evenings. At times of high demand, the water can be released through the unit’s generators to support the increased load. Stored water can also be held behind the dam as an emergency reserve to provide immediate system support in the event of emergencies such as a sudden loss of generation elsewhere on the system. Contracts covering the output of peaking hydro units should include substantial capacity payments and relatively low energy payments. These units should be completely subject to utility dispatch.

Wind and Solar Projects. Deliveries from wind and solar projects depend entirely on the availability of wind or sun at the site, although in many cases generation patterns from these sources consistently conform to utility load - patterns. Accordingly, contract provisions should allow for capacity payments in the event that the project demonstrates consistent deliveries of energy during on-peak (high demand) periods. Dispatching provisions should not be included, since the operator has very limited control over the instantaneous output of the project.

Biomass Projects. Many biomass projects are operated as cogenerators; they support production or manufacturing in a nearby industrial facility, such as a sugar or paper mill. In a typical application, the biomass unit will be both generating electricity (either for the grid, for the industrial host’s electric load, or for both) and providing process steam to the host facility during all hours of the day and night. In this kind of operation, the typical biomass facility should be regarded in the same light as a geothermal plant: it should be expected to run in a base load pattern (around the dock) and should not be expected to respond to dispatching orders except in emergency situations, and then only if their design permits.

Power contracts for these facilities should include substantial monthly capacity payments tied to reasonable testing procedures. Biomass projects that are not operated in conjunction with an industrial host are often referred to as “stand-alone” projects. From the project developer’s standpoint, these projects can be built and operated most economically in the base load approach followed by cogenerators.

Utilities requiring generating sources that have the capability to follow load fluctuations can negotiate with stand-alone biomass projects to obtain such capacity, but should expect to pay somewhat higher prices than for base load output, given the higher capital and operational costs encountered in building and operating these types of stand alone biomass projects.

Power purchase agreements are difficult to formulate in the abstract. Each country, each utility, each generating source is sufficiently unique in that, when coupled with the issue of renewable resource objectives, a model power purchase agreement, prepared in the abstract, without reference to concrete issues, can be an irrelevant document. With this very strong caveat, the agreement outline contained in Appendix C is designed to provide a very basic overview. The drafters of a country specific power purchase agreement are urged to seek expert technical, legal and financial counsel.

e. TECHNOLOGY SPECIFIC POLICY STRATEGIES

Depending upon the renewable resources that have been identified as factoring into the national energy mix, the policy strategist may determine that a resource-specific legal regime may need to be enacted and that resource-specific incentives may need to be put in place in order to encourage resource development - especially if a domestic industry is non-existent.

There are two principal resource issues with which the policy strategist will have to be familiar: the development of the resource (e.g., the need for a geothermal resource extraction law), and the generation or “dispatchability” characteristics of the resource (e.g., base load, intermittent load, distributed power, etc.). The legal issues regarding resource development are discussed below in this section. Dispatchability is especially worthy of note in the context of “intermittent” resources.

How are intermittent resources built into a generation mix?

Dispatchability is an area of significant interest for policy strategists concerned with the renewables. The term “dispatchability” refers to the degree of control that the utility will have over the output of the project. For example, in the case of a project that is fully dispatchable, the utility will have the right to change the output level of the unit from full output to zero output and back again whenever it chooses to do so.

For some types of units under certain types of power contracts, full dispatchability can be accommodated. For example, a hydroelectric unit that can go from full load to zero load without violating its environmental permits could agree to full dispatchability so long as its power contract or power purchase agreement had the kind of substantial capacity payments described in Chapter 4d (Government’s Role in the Market). In the case of a run-of-the-river hydro project or a wind project, however, dispatchability will be greatly limited due to the fact that the unit is designed to run whenever the circumstances of its energy source permit it to do so. These resources are called “intermittent.” Biomass units can be subject to similar conditions, especially when they are designed to support a thermal load in an adjoining industrial facility. In these conditions, project sponsors will not be able to obtain financing if the only thing they can obtain from the utility is a power contract requiring substantial dispatchability features and with payments solely for energy delivered.

Intermittent renewable energy is cost competitive with energy from fossil-fuel generating stations. It must be recognized, however, that the competitiveness of intermittent renewable fuels is realized over the life-cycle of a generating facility as the low cost of fuel and operations off-sets the front-end capital costs of a renewable facility.

The following list illustrates the types of incentives which may apply to unique situations of a specific renewable resource:

Biomass. Create special biomass resource concession for energy use.

Co-Financing of Exploration. Provide government-financed resource development or identification in whole or part by the government.

Concessional Financing. Allow for pioneer renewable industries with soft loans, or provide soft loans only in remote areas.

Geothermal Drilling. Provide depletion allowance for drilling investment (based on income not on capital investment) and expending of intangible drilling costs to offset exploratory risk factor.

Geothermal Resources. Create a specific law dealing with the unique qualities of geothermal resources. Geothermal resources cannot successfully be managed under existing water, hydrocarbon or mining laws.

Infant Industries. Focus on safety and environmental protection when drafting regulations and avoid micro-management particularly for infant renewable industries. In circumstances in which governmental action is prerequisite to industry action, delay on the part of the government should be construed as government approval.

Mini/Micro/Small Hydro. Support the canal or cluster approach.

Watershed. Initiate joint responsibility between the government and the proponent for the maintenance of watersheds. Especially in rural hydropower projects, water availability is influenced by a project’s watershed.

Windpower. Establish capacity definitions for intermittent resources.

Windpower/Small Hydro. Establish exemption or streamlined procedures for environmental mitigation and forestry clearance.

One critical element in a potential lender’s analysis of project economics is the pricing of goods or services to be provided by the project. Pricing of project outputs presents several complex issues. For example, in countries in which the electric utility is a monopoly, the purchasing power of electric utilities dictates that independent power producers will be “price-takers” not “price-makers.” Thus, in order to ensure the firm, long-term revenue stream that is essential to obtaining financing, independent developers require a mechanism to ensure that electric utilities will pay an economically viable price for their energy.

In the United States, the financeability of electric energy generation projects was enhanced by legislation requiring electric utilities to purchase energy at a price equal to so-called “avoided cost”. The advantage of such an approach is that it establishes a more-or-less objectively determinable level of prices for the project’s output (i.e., a fixed or determinable revenue stream).

On the other hand, much has been written about the various economic models used to calculate “total costs,” much of which supports the conclusion that the value of privately-generated energy is often in the eyes of the beholding economist. Laws may establish a sound framework for investment of private capital, if they take into account the fact that financial markets require certainty of revenues, and if they provide concrete guidance with respect to rates payable for project-financed infrastructure goods and services.

What legislative and regulatory tools are available for Government to take a pro-active role in creating an environment conducive to renewable resource project development?

The following list illustrates the types of tools that have been applied internationally to encourage entrepreneurs to develop new renewable generating sites that can provide an income stream for repayment of principal and interest as well as a - reasonable rate of return on investment. These strategies can be used to encourage greater use of renewable resources and can be implemented through legislative, regulatory or administrative actions depending upon the structure of the government and its relationship to utility activities.

Capital allowances/depreciation. The book value of assets may be depredated for tax purposes at liberal rates.

Clear guidelines. Clear and authoritative guideline information may consolidate and set forth the various laws and regulations for developers to use in developing a private, renewable energy power project.

Establishment of ombudsman. Designate a person or agency to be responsible for the promotion of renewable energy sources. Concomitant authority, responsibility and access to high level decision-makers is essential.

Income tax holiday. Renewable energy firms may be fully or partially exempt from income taxes for a sufficient number of years to allow either accelerated principal and interest payments or a reasonable rate of return on investment.

Investment credit. A percentage of every dollar invested in a renewable energy resource project development may offset future tax owed.

Labor. Renewable energy firms may employ foreign nationals without limitation. Employment of domestic labor may be encouraged by allowing an additional deduction from taxable income. A further deduction may be allowed for labor expenses of domestic workers in designated less-developed areas.

Loss carry-forwards. Renewable energy enterprises which suffer tax losses may carry forward such losses indefinitely to be offset against future taxable profits.

One-stop shopping. Governments may consolidate the oversight of all application and approval processes and the oversight of all rights and penalties consolidated in a single agency. This consolidation is called “one-stop shopping” or “single-window clearance”. To the extent that such consolidation is impractical or impossible (e.g., the functions of the customs agency will typically be separate) such single-source ministry may act as coordinator, ombudsman, or as chairman of an inner-ministry agency.

Performance undertakings. To the extent that a government-owned or controlled entity is the purchaser of electricity, lending institutions have consistently required a “performance undertaking,” i.e., the affirmation that the obligations of the entity involved carry the full faith and credit of the country and a guarantee to ensure that the entity will discharge such obligations at all times as they fall due.

Set-asides. The country may determine that an established percentage of its energy-mix shall be from the renewable resources within a specified time frame. Several incentive approaches may stimulate or mandate this objective:

· Distributors may be required to buy a specified percentage of their energy from renewable energy sources in order to maintain their concession. These distributors need to be protected from unreasonable power purchase rates.

· Distributors may be allowed, and encouraged, to own renewable resource generators.

· Distributors may be provided an additional tax exemption for the purchase of electricity from renewable energy generation sources (similar to the “tax credit” concept, above).

· Generators may be required to generate in accordance with a set energy portfolio mix (see Appendix D).

Standardized power purchase agreements. The government may provide a standard power purchase agreement which is established as the mandatory structural and pricing contract for long-term agreements between distributors and renewable resource generators.

Tax and duty exemption on imported capital equipment. Renewable energy firms may be exempt from customs duties and national internal revenue tax payable for the importation of machinery and equipment and spare parts for a sufficient number of years to allow the establishment of full commercial operations.

Tax credit. For each kilowatt of hour of electricity purchased from a renewable generation facility per year the purchaser or distributor is allowed a percentage tax credit.

Tax credit on domestic capital equipment. Renewable energy firms may be entitled to a tax credit equivalent to a determined percentage of the value of the national internal revenue taxes and customs duties that would have been waived by purchasing the machinery, equipment and spare parts from domestic manufacturers instead of importing such machinery, equipment and spare parts.

Use or lose. Ensure that no speculator may claim and hold a resource for an indefinite period of time without developing it.