Colombia’s 1st Renewable Energy Auction Faces Peculiar Challenges
Colombia’s First Renewable Energy Auction has been set for October 22, 2019. The government has published the PPA (Power Purchase Agreement) contract and its terms of reference. There have been several relevant modifications to the auction’s design intended to incorporate February’s lessons and many important changes regarding the contract draft that was published last June.
Since February’s auction failure was blamed on insufficient demand-side participation, there will not be competitiveness criteria requirements on the buy-side for the auction to take place. There will be a demand target to be auctioned and a ceiling price, which will remain unknown until the auction. Likewise, the methodology to match sell and buy offers, aimed at maximizing the benefit to consumers for each hourly block, will not be publish until after the auction.
Participation in the auction will be voluntary. Nonetheless, it will be interesting to see how energy traders respond to the mandatory energy purchases set in the National Development Plan, which states that traders must obtain between 8% and 10% of their energy purchases from non-conventional renewable long-term contracts.
The PPA contract term will be extended to 15 years beginning on January 1st, 2022, which should help projects to reach 70%-80% debt structures, up from the 40%-50% that would have been achievable otherwise. Moreover, there are contractual provisions for delays due to force majeure events, where if mutually agreed by buyer and seller, the contractual period will be extended by the duration of the event up to 18 months, at which point the contract would be terminated without penalties. If there is no mutual agreement, provisions are made for arbitration between the parties.
For traders, participation is conditioned mainly on being registered as a public service company in Colombia. For sellers, only non-conventional renewable energy projects above 5 MW can participate (i.e., biomass, small hydroelectric generation under 20 MW, wind, geothermal, solar and wave generation). Moreover, generators must be registered in UPME’s (Colombia’s Unidad de Planeación Minero-Energética) phase 2 and have a favorable connection concept by UPME with an expected connection before December 31st, 2023.
The favorable connection concept requirement highly impacts the participation of wind projects being developed in La Guajira. That is, of the 52 projects (8.0 GW) being developed, only 12 (1.6 GW) have a favorable concept and are eligible to participate in the auction, while 8 (1.8 GW) are under UPME’s analysis, another 16 (2.7 GW) require system expansions and 16 have been either denied or have action pending by the developer. Ironically, as the auction stands today, Renovatio and EDP’s Project Alpha, the only wind project having achieved the milestone of obtaining an environmental license in La Guajira, cannot participate in the auction.
One of the most important introductions to the auction is the hourly block system with 3 clearly defined blocks (from 00:01 to 07:00 hours, from 07:01 to 17:00 hours and from 17:01 to 00:00 hours) aimed at considering the inherent daily volatility in the generation profile of renewable energy sources.
Qualified sellers can submit one, or several offers specifying which ones are mutually inclusive, mutually exclusive or simultaneous. Sellers’ offers will state the minimum number of packs of energy, each pack consisting of 0.5 MWh, to be sold at each hourly block and a COP/MWh price without the regulatory CERE (cost charged to market participants to pay for the Reliability Charge: remuneration offered to tender awarded generators that commit to deliver energy upon request). The quantity of packs and their price will be the same for each hour of the block for each offer.
This opens a dilemma, especially for solar generators. Liquidations are executed on an hourly basis and the amount of energy committed is the same for every hour of the block. Since the generation potential of a plant, say solar, is very different at 7.00 am than it would be at midday, the generator must decide whether 1) it offers the low-end quantity of energy it can generate (7 am) for all of the hours in the block, selling the remainder in the spot market during hours of higher generation, or 2) if it opts to offer a higher level of energy for all the hours in the block, with the risk of having to purchase shortages during low generation hours at an unknown spot price, or through a back-up contract.
Buyers can submit one, or several offers, stating the maximum number of packs of energy to be purchased and a COP/MWh price without CERE. The energy packs assigned could all fall within the same or different hourly blocks. Thus, traders do not know within which hourly blocks their offers would fall. This introduces planning difficulties for traders.
Buyers cannot offer to buy more energy than their average daily commercial demand for 2018, as published by UPME for each trader. Similarly, sellers cannot offer more energy than the daily energy generation supported by the project, measured with the capacity factors published by UPME.
Contractual price adjustments will be based solely on changes in the Colombian Producer Price Index, despite the government flirtation with adding a US inflation and exchange rate adjustment components. Thus, the possibility of projects obtaining cheaper USD denominated loans is almost ruled out.
As for guarantees, they must be liquid, unconditional and irrevocable. Admissible guarantees include bank guarantees and SBLCs (Standby Letters of Credit), the latter being the only admissible alternative for banks outside of Colombia. For intervened entities, such as Electricaribe, an Irrevocable Payment Instruction from their trustee is admissible. The auction’s guarantee pack includes:
- A bid guarantee by both buyers and sellers equivalent to 10% of the annual energy offered for sellers and for 5% of the energy to be purchased by the buyer multiplied by COP 135 per kWh.
- A contract execution guarantee (including a timely COD) by the seller equivalent to 30% of the annual energy multiplied by its contract price before the beginning of the energy delivery, and 20% thereafter.
- Guarantee of payment by the buyer equivalent to 30% of the annual energy multiplied by the contractual price.
- Moreover, to facilitate collections on any unsettled obligation following the termination of the contract, each party should subscribe a promissory note to the counterparty.
Should early termination of the contract be attributable to either party, a fine equivalent to 20% contract’s value must be paid to the compliant party. The early termination events include 3 consecutive default payments by the buyer, mutual agreement and a force majeure event lasting over 180 days, the last two being challenging for obtaining financing.
First, there is the risk that one project would provide a disproportionally large offer preventing the auction to go ahead under the competitiveness criteria. Recall that in February’s auction, the Herfindahl-Hirschman Index (HHI), which is the squared sum of the “market” share of all competitors was well above the maximum allowed value, implying that one single participant presented an offer equivalent to between 85% and 90% of all the combined offers. Moreover, the dominance indicator of 88% suggested that one project was able to absorb 88% of the total matching-demand.
Second, there is the risk that buyers will not participate abundantly, as participation is voluntary, and the mandatory energy purchases set in the National Development Plan are neither enforceable nor deviations penalized. Moreover, there are not clear incentives for buyers to participate massively in the auction.
Third, there is the risk that some potential sell-side bidders could be discouraged by the counterparty risk. True, this time around, the seller will provide their bid guarantee knowing which buyers are qualified to participate and their financial statements. However, they do not have a say in which counterparty would be matched with their offers. Moreover, there will be over 2 years between the auction and the beginning of obligations, enough time for a substantial change on the financial position of weaker buyers.
Fourth, since the ceiling price will remain unknown until the auction, there is the risk that offers could go above the maximum allowed, disqualifying offers that could have potentially be eligible if the ceiling price was known in advance. Moreover, we do not know the size of the demand target to be auctioned, which if small could prove disastrous, should everything else work, in terms of opportunity cost.
Finally, the risk of transmission lines or substations not delivered on time has not been addressed. According to UPME, the average delay by the two main transmission companies in Colombia (ISA and Grupo Energía Bogotá) in delivering their infrastructure is close to 1,000 days and counting. It remains to be clarified what would happen to the contract, and how buyers and sellers would be compensated in the likely event, particularly for wind projects in La Guajira, of a project reaching COD on time but having no connection to deliver the energy to the buyer. It is also unclear whether such event would be contemplated as a force majeure event, in which case the contract would be early terminated following a 180-day delay, which would not be looked upon kindly by banks.
Wind turbine Image by Steppinstars from Pixabay