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.
Monday, September 13, 2010
Solar Energy – Legal Structure Issues
Thursday, October 1, 2009
IWPP Finance in Oman and the GCC
After years of remarkable expansion followed by a precipitous decline in the wake of the global financial crisis, the credit market for international water and power projects (IWPPs) in Oman and the GCC appears poised for a recovery.
While 2008 saw a project volume in the Middle East of about US$50 billion, nearly six months passed before the GCC saw its first IWPP financing of 2009. Bahrain’s Addur IWPP closed on 29 June, raising US$2.1 billion and bringing the overall project volume for the region to US$6.7 billion for the year.
The financial crisis forced project lenders to write down the value of project debt, driving up the cost of borrowing. Further, it wiped out the secondary market for project loans as banks shunned the formerly popular practice of packaging debt in off-balance sheet vehicles.
The capital that commercial banks were willing to lend came at a higher cost and decreased tenor. Whereas tenors running from 15 to 20 years at 100 bps over Libor were once common, the Addur project received debt at a tenor of eight years at 350 bps over Libor. Today, the cost of capital averages at 250 bps over Libor.
The revival of IWPPs in the region has been driven by loosening credit conditions linked to new trends in IWPP finance. Specifically, banks are making increasing use of hard or soft mini-perm structures. In a hard mini-perm, debt is offered at a short tenor, in the range of seven years, requiring early refinancing. In a soft mini-perm, a longer tenor is used, but incentives are used to encourage the lender to refinance well before maturity.
Another key trend has been the rising profile of export credit agencies and international development banks. Export credit bodies provide access to large amounts of relatively inexpensive capital and offer added confidence to commercial banks. Development banks have also played a key role by providing an additional source of capital and a backstop for project debt.
Finally, banks have been favoring government supported projects. For instance, an IWPP with a concession or off-take agreement is a stronger candidate for financing given its relatively secure future cash flows. Additionally, governments may guarantee the obligations of state-owned parties entering into such agreements.
Increasing electricity and water demand has led the government of Saudi Arabia to tender projects in form of engineering, procurement, construction (EPC) contracts, rather than build, own, operate (BOO) or build, own, transfer (BOT) contracts.
Oman aims to avoid such a measure. Continuing on its program of privatization, Oman expects to see the close of a club financing of an IWPP in Salalah this year. RFPs have been released for projects at Barka, Sohar, Duqum, and Ghubrah, with another for an IWPP in Mirbat on the way. Additional projects are being studied, including a solar plant in the south of the country.
In past projects, the Oman Power & Water Procurement Company (OPWP) has entered into off-take agreements. In the case of the Barka and Sohar IPPs, the OPWC will purchase the output under a 15-year agreement.
IWPP finance and execution in Oman implicates a range of complex legal issues, including:
In addition, it is often necessary to put in place all the project agreements in order to obtain IWPP finance. Depending on the project, these agreements may include:
As the credit market revives -- and as the oil prices rebound -- Oman grows increasingly likely to meet its goal of increasing output through an ambitious program of privatization.
