A Floor Tariff for Renewables in Least Developed Countries

A Floor Tariff for Renewables in Least Developed Countries

A Floor Tariff for Renewables in Least Developed Countries

by Terje Osmundsen

Terje Osmundsen (Norwegian, born 1957) is a former state secretary to the prime minister of Norway, with a varied career from international business (natural gas, engineering, telecom) to publishing and scenario-based consulting. Since 2009, he has been senior vice president of Scatec Solar AS, a leading developer and supplier of solar power plants. http://energiogklima.no/nyhetsblogg/terje-osmundsen/

 I propose a risk sharing mechanism targeting enhanced bankability of solar and wind projects in Least Developed Countries (LDCs). The floor tariff would be applicable to renewable power projects with Power Purchase Agreements (PPAs), but without a fixed, guaranteed tariff for the PPA period.

Renewable energy developers in LDCs with projects that have more than a 10-year payback period should be eligible for a minimum sales price guarantee. The guaranteed minimum sales price – the floor tariff – could be indexed to the country’s official average wholesale tariff for electricity.

Many more solar and wind projects could be built, if the project finance could include a possible third-party guarantee against a possible – but highly unlikely – fall in the relevant market prices for energy during the 20 year period. If such a mechanism was available, Power Purchase Agreements could become bankable even in cases where off-takers – often government-owned utilities in poor financial health – are unable or unwilling to commit to a fixed tariff for the whole 20-year contract period.

The guarantee could be issued by a pool of industrialised countries as a precursor the announced new UN-initiated Green Fund and could be managed by the International Finance Corporation (IFC) or one of the other multilateral development banks active in LDCs. Should the guarantee be drawn upon to cover a material loss on specific contracts, the loss should be counted for as development aid by the donor countries. Alternatively, it could be covered by proceeds from the Green Fund established as part of a new global Climate Treaty.

One of the conditions for issuing the guarantee should be that the alternative to the project is increased consumption of fossil fuels. In addition, the guarantee should in any case only say 80% of a potential loss due to unforeseen fall in the contract’s reference price, with the remaining 20% to be covered by the developer.

Why is this is an important idea? Utilities and large companies in Africa and parts of Asia and Latin America continue to rely on expensive and polluting diesel and heavy fuel oil to meet the rapidly growing demand for electricity. This happens despite the fact that a substantial share of the demand could be me met by solar or wind power, at a lower cost. In several countries in Africa, wind and solar is now cost-competitive not only against the incremental generation cost but even compared to the average generation costs in the country.

However, except for South Africa, only a handful of utility-scale solar or wind Independent Power Producers (IPP) have been financed and constructed in Sub-Saharan Africa, Latin America and South East Asia. The main hurdle is the challenge of reaching agreement with the off-takers on the key requirements of bankability, most often the take-or-pay commitment and the fixed tariff for the 20-year contract period. Given the high investment costs, such commitments are required to enable private sector financing of solar and wind projects.

However, some potential off-takers, including government-owned utilities are reluctant to sign 20-year Power Purchase Agreements with a locked-in tariff for the whole period. Reasons for this reluctance may vary, but very often it is motivated by a perception that market energy prices will fall in longer term. When discussing the issue with stakeholders, one typically hears statements like ‘When the new hydro or gas-fired power plant is built, energy prices will fall’, or “with equipment prices falling, it’s better to wait’, or “20 years is a very long time; so much can happen’.

There have been a few examples in Europe and the United States where developers have tried to finance utility-scale solar photovoltaic (PV) projects with revenues linked to the wholesale energy price index, but so far unsuccessfully I believe. However, there are examples where the proposed floor price could be applicable:

In Ghana, where the government has announced a feed-in-tariff fixed for 10 years only. After the 10-year period, the tariff will be reviewed every 2 years, partly reflecting the wholesale energy index.

In Senegal, where generation costs are high, but the government and utility company Senelec believe generation costs will fall and therefore hesitates to enter into 20 year fixed tariff contracts

In Namibia, where the official plans are based on the realisation of a 800 MW gas fired power station in 2017, with short term investments in expensive oil-and diesel- powered generators instead of solar.