Monday, September 13, 2010

Solar Energy – Legal Structure Issues

As discussed in a previous post (Hot Topic: Solar Energy), solar power is poised to play a key role in meeting the Sultanate’s future energy needs. With the Omani Authority for Electricity Regulation having published a comprehensive report on renewable energy in 2008, and the Omani Public Authority for Electricity and Water anticipated to soon release a feasibility study for the Sultanate’s first large-scale solar plant, there are clear indications of growing support at the policy level for solar energy projects in Oman. Once policymakers decide to undertake specific solar energy projects, the implementation framework for these projects will come to fore.

As the Sultanate crafts its implementation framework for solar energy projects, it is likely that economic and strategic issues will lead, and the legal issues will follow their cue. However, it is important to choose the legal structure that will best express and accomplish the chosen policy goals. This article explores the economic and strategic context for solar energy in Oman, and outlines some possible legal structures that may meet the Sultanate’s needs.

Economic and Strategic Context

Solar energy has clear advantages over other energy sources, namely that it is renewable, plentiful and non-polluting. Over the long term, investing in solar energy makes solid economic and strategic sense. Solar power provides a secure, stable and sustainable energy source. Solar production costs will likely fall as technology improves, whereas fossil fuel costs have shown a propensity to rise with global supply constraints and demand increases. Further, replacing fossil fuel-based power with solar power also reduces pollution, which lowers health and environmental costs to society as a whole.

However, solar projects do face a short-term disadvantage: at current technology and market prices, the per-unit cost of producing electricity using solar energy is significantly higher than using natural gas or other fossil fuels.

In order to overcome the obstacle of short-term cost and launch solar projects that will yield long-term benefits, governments usually will absorb, over the short and medium term, the production cost difference between solar-based energy and fossil fuel-based energy. In other words, the key step to getting solar energy projects off the ground is for the government to subsidize the project to make it economically viable. Although such a subsidy can be politically difficult to carry out in some countries, it likely could be done in the ordinary course in Oman, where government subsidies to provide affordable electricity to the population have long been a top priority of government policy.

There are a number of possible ways that the Sultanate could structure such subsidies, and these various legal structures contain subtle but important differences.

Possible Legal Structures for Solar Subsidies

The first, most obvious way that Oman could subsidize solar energy production would be for the government to absorb the higher per-unit cost by directly financing and carrying ownership of the solar plant. In this case, the government would typically recruit a third-party operator with the requisite technical expertise, and would build and operate the solar power facility as a public-private partnership (see the June 2010 Client Alert for an overview of the public-private partnership model).

Alternatively, the government could subsidize the purchase of output from a privately owned and operated plant. Under this approach, the government would solicit a private party to build and operate a solar energy plant and cause the Oman Power & Water Procurement Company (“OPWP”), the government-owned, sole wholesaler buyer of electricity in Oman, to enter into a subsidized long-term purchase agreement that would allow the operator to earn a reasonable profit above its cost of producing the solar energy. This power purchase agreement would typically have a term of between 15 and 25 years. It is important to note that private operators seek a long-term power purchase agreement not only for assurances that they will earn a reasonable operating profit, but also to help secure financing to build the plant in the first place, as banks are more likely to lend money for projects that have revenue streams which are guaranteed (and are backstopped by the government).

Finally, as Oman’s solar power sector evolves in future years, OPWP eventually may decide that it would like to tap private-sector capacity even further. One way to do this would be by adopting a “feed-in-tariff” model along the lines of what is used today in Germany and other European countries. Under this model, private businesses and households install solar panels on their property and sell the excess energy that they produce to the relevant electricity authority (in Oman’s case, this would be OPWP). Rather than negotiate power purchase agreements with each business and household that contributes to the electricity grid, the electricity authority establishes a standard rate, commonly called a “feed-in-tariff”, that it pays to all contributors. The government purchases excess solar-produced electricity from businesses and households at feed-in-tariff rates that are high enough to allow the businesses and households to recoup the cost of purchasing and installing their solar panel systems. The feed-in-tariff model both encourages more widespread adoption of solar energy and helps to instill eco-friendly values across society.