A Review of the Power Purchase Agreement

By: 
Wayne C. White, Ph.D.
Date: 
Monday, May 1, 2000

Between the Republic of the Philippines National Power Corporation and a consortium constituting the San Roque Power Corporation concerning the construction and operation of the San Roque Multipurpose Project

Table of Contents

Executive Summary
I. Introduction
II. Overview
III. Is private sector project development proof of the San Roque dam’s economic viability?
IV. Will the project be a low cost provider of electricity?
V. What is the assignment of risks and responsibilities between the developer and the Philippine government?
VI. What are the agreement’s implications for social and environmental impacts?
VII. Is the Republic of the Philippines assured of project completion?
VIII. Is the Republic assured of responsible and productive long term operation?
Appendix A
Appendix B

Executive Summary

The San Roque Power Purchase Agreement (PPA) is the primary document for assigning a concession to a consortium formed by three international companies, granting it specific duties and privileges concerning construction and operation of a dam and related structures on the Agno River, and promising it payments for construction, and throughout 25 years of concession life.

Private sector involvement in the San Roque Project’s development is not proof of economic viability. The BOT contract does not subject the project’s developers to market disciplines. Rather than earnings being from fees set by competitive markets, the earnings to the developers will come from a $400 million transfer from the National Power Corporation to the San Roque Power Corporation, and later fees that are set by contract, and include payment under scenarios wherein no power is produced.

The project is not a low cost provider of electricity. Sample calculations of monthly billings included in the PPA are equivalent to 13 to 21 Pesos per kWh (US$.32 to .51 per kWh). A competitive project should provide electricity at approximately 2 Pesos (US$.05) per kWh or less.

The Philippine government carries a large proportion of the project risk. It carries a far larger financial risk than the SRPC for successful completion of construction, and carries all of the hydrological risk.

The PPA does not ensure mitigation of social and environmental effects. Social and environmental mitigation are detached from the mechanisms for project construction and operation, thus creating a situation where the project will go forward regardless of how affected persons or the environmental endowment are treated.

The Philippines is not assured of project completion, as the PPA provides opportunities for the developer to abandon the project should it threaten to be unprofitable for them.

The PPA does not, and can not, ensure productive long term power production, but it does create an obligation under which the National Power Corporation may be liable for payments of $10 million a month although no power is generated.

The PPA has provisions which come into effect if the NPC is ever privatized or sells any assets, and if these actions can be construed to impinge on the SRPC’s privileges under the PPA in any way. Under these provisions, the SRPC can demand that NPC buy the project from them at a price dictated by a formula given in the PPA. This applies even before project completion, in which case the NPC would be compelled to pay for and take ownership of the unfinished project.

I. Introduction

This report seeks to contribute to a better understanding of the San Roque Multipurpose Project and its implications for the Philippine government and people through an analysis of the Power Purchase Agreement (PPA) that governs the project’s development. The project is currently under construction on the Agno River in Pangasinan Province, Republic of the Philippines.

The PPA does not tell the whole story of the project’s viability and impacts, which would require in-depth consideration of the economics, social and environmental impacts, etc. It is however a formative document, all the more so since it was used as a vehicle for more than the expected power purchase arrangements. The San Roque PPA is the primary document for assigning a concession to the San Roque Power Corporation (SRPC), the private consortium developing the project. The SRPC consortium has been formed by three international companies: Marubeni Corporation of Japan, Sithe Philippines Holdings, a division of Sithe Energies of the US, and Italian-Thai Development. The PPA grants the SRPC specific duties and privileges, payments for construction, and outlines a schedule of fees and tariffs to be paid to SRPC over a twenty five year period.

This report analyzes the PPA with respect to the following questions:

  • Is private sector project development proof of its economic viability?
  • Will the project be a low cost provider of electricity?
  • What is the assignment of risks and responsibilities between the developer and the Philippine government?
  • What are the agreement’s implications for social and environmental impacts?
  • Is the Republic of the Philippines assured of project completion?
  • Is the Republic assured of responsible and productive long term operation?

II. Overview

Power purchase agreements (PPAs), as commonly understood, constitute a standard component of project finance arrangements for large generating installations. Typically a PPA is a simple assurance from a utility saying, in effect, "If you build the power plant, we will buy the electricity." The PPA usually covers the rate to be paid, which may be at a rate established in an included schedule, or left to be determined by a market, with the PPA language merely citing the agreed upon market indicators. Typically the PPA does not close a project, but rather enables subsequent contracts to be signed. Since lenders want to be assured that the project will have a market for what it produces, signing of a PPA assures them, and allows the developers to then close on their finance. Agreements with a government concerning permits, taxation, and any concession of natural resources may come in a separate round.

The San Roque agreement is more than what is commonly understood to be within the scope of a PPA. It is a de facto BOT agreement, that is, it is the main contractual document governing the agreement between the SRPC, with its consortium owners, and the National Power Corporation, and by specific provisions and side agreements, multiple agencies and officers of the Philippine government.

The PPA establishes the following conditions:

  • insulates the consortium companies, Marubeni Corporation, Sithe Philippines Holdings, and Italian-Thai Development (superceded by Kansai Electric), from liability, establishing non-recourse finance, by defining their wholly owned subsidiary, the San Roque Power Corporation (SRPC) as the responsible party (see Fourth Schedule of the document);
  • grants rights to construct and operate the dam and related facilities to the SRPC;
  • guarantees land and water rights to the SRPC for the term of the agreement at no expense to them;
  • grants the developer (SRPC) a payment of US$400 million during the construction period, in addition to guaranteeing purchase of all electricity produced, and
  • guarantees "Capacity Fee" and "Operating Fee" payments, even if electricity is not generated for lack of water, at a minimum value in the first 12 years equivalent to US$10 million per month.

III. Is private sector project development proof of the San Roque dam’s economic viability?

One of the main motives for private sector involvement in the power sector worldwide is the hope that this will bring about spontaneous and ongoing economic rationality, resulting in least cost power production, and conservative use of resources. These benefits only come to pass, however, when the actors are subject to market disciplines, and are regulated with regard to social and environmental factors.

For San Roque, market discipline would have been the case if all the following conditions applied:

  • the developer takes the financial risk for the project (including internalized incidental effects)
  • earnings accrue from fees earned by the project,
  • those fees are determined by a competitive market, and
  • cost recovery and any profit come as a result of earnings from market determined fees exceeding the costs of production.

The San Roque project, although a type of BOT arrangement, does not meet this description, and therefore is not subject to market forces which would attest to its economic viability. The developer is not taking the financial risk for this project (as will be further detailed later in this report). Earnings are not exclusively from fees earned from project performance, but rather funding for San Roque include the contribution by the government of US $400 million, as well as electrical tariffs and capital recovery payments in amounts set in the contract. The rates established in the contract are not in keeping with competitive market rates, as described in the next section.

Despite private sector participation, the project is a public subsidized construction contract, which will also further compensate the developer during project life even in the event of low generation and/or absence of a market for the produced power. Not only does the private sector participation not demonstrate economic viability, the reliance on subsidy and the above market rates suggest that the project is not economically feasible in its own right.

IV. Will the project be a low cost provider of electricity?

As an example of the market price of electricity, a power plant utilizing combined cycle gas turbines in Southeast Asia can provide electricity at US$.05 per kWh or less. In 1998 the average NPC rate charged to end users was 2.38 Pesos/KwH for the Philippines as a whole, 2.54 P/KwH for Luzon and 1.56 P/KwH for Mindanao.

The PPA establishes a schedule of payments to the SRPC by NPC during the life of the project, that is the 25 year Acooperation period@ following construction. The rates are highest in the first 12 years, then decrease somewhat. The components of the monthly charges include the "Capital Recovery Fee" (comprised of the "Capacity Fee" and the "Energy Fee") and the "Operating Fee." The SRPC can also recover a fee for testing the turbines, and the PPA creates the possibility of other charges.

The Thirteenth Schedule of the PPA provides sample calculations of the monthly billings under three scenarios, all based within the initial 12 year period. This review reduces those charges to a unit basis in Appendix A. To summarize these example rates:

Scenario 1, "Plant operation incurred no outages"
Total example monthly fee in Pesos per kWh

13.17

Total example monthly fee in US$ per kwh

0.32

Scenario 2, "Plant operation incurred outages within the allowable limits"
Total example monthly fee in Pesos per kWh

20.48

Total example monthly fee in US$ per kwh

0.50

Scenario 3, "Plant operation incurred outages outside the allowable limits"
Total example monthly fee in Pesos per kWh

20.93

Total example monthly fee in US$ per kwh

0.51

These unit prices of US$.32, $.50, and $.51 compare very unfavorably with a reference cost of $.05, and from this comparison it is obvious that the project is not a least, or even low, cost provider of electricity.

V. What is the assignment of risks and responsibilities between the developer and the Philippine government?

Under this PPA, a substantial amount of risk is borne by the government, not the developer. The advance payment by the government to the SRPC of $400 million directly pays for a large portion of the construction cost. Overall, the developer does assume some direct responsibility for construction management, albeit at strictly limited liability, and for keeping the turbines operational during service life. Beyond those factors, the contractor has multiple assurances of positive revenue, and it is the Philippine government that is liable for paying the SRPC, even if the project is a high cost generator of electricity, its capacity is not needed, or it fails to produce electricity due to water not being available. Additionally, the Philippine government has direct responsibilities for many features of this project, including obtaining title to and making available all specified land and constructing an access road, many of which will require additional spending from the national treasury.

The provisions of paragraph 15.2.2 deal with the case of the project reaching a state where the NPC concludes that the Completion Date will not be reached, in other words, if the project work progress falls hopelessly behind schedule. In this event, the NPC may terminate the SRPC’s role, and the SRPC will receive payment for all work done, regardless of whether the project ever comes online. The SRPC’s liability is restricted to forfeit of the Construction Performance Bond. The amount of the Construction Performance Bond is US$7.7 million, later increasing to US$39 million; it will be made available until the construction completion date.

The provisions of paragraph 9.8, describe a scenario wherein "buyout" occurs prior to project completion, that is, the NPC is compelled to compensate the SRPC, after which the SRPC holds no rights nor responsibilities for the project. In that case the NPC must pay the SRPC fully for all construction work done, amounts expended, and pay the SRPC interest for any capital invested in the project. In other words, if any of the provisions of paragraph 9.8 apply, the Philippine "buys" all of the project cost in return for an unfinished project, while the developer walks away with a profit.

The developer does not shoulder the hydrological risk, but rather the PPA places it on the NPC. Article 8.5 of the agreement provides that "NPC will be required to pay the full amount of the capacity fees....whether or not any energy is dispatched" if the reason for the downtime is "insufficiency of water." Appendix B of this review calculates the fees due per month even if no power is generated, under the terms and formulas given in the Eight Schedule of the PPA. The result is a payment equivalent to US$10 million, over $400 million Pesos, per month.

The PPA frees the SRPC from responsibility for social and environmental risks and costs. This will be detailed in the next section.

The Philippine government has the following responsibilities:

  • make the Site available to the Operator by the Effective Date (Feb. 23, 1998). It is tasked to obtain registered legal title to all parcels comprising the Site, all necessary governmental permits and rights to use in order that the SRPC shall have peaceful and exclusive possession of the site from Feb. 23, 1998 to the time the project is transferred to NPC or the government. (Art. 2.9.1)
  • the construction, maintenance and repair of the access roads from the Effective Date to the time it is transferred to the government (Transfer Date). (Art. 2.9.2)
  • install, connect and maintain the transmission lines ... (Art. 2.8.2 (ii))
  • obtain and maintain all Water Rights necessary for the construction, testing, commissioning and operation of the Power Station for the period from the Effective Date to the Transfer Date. (Art. 2.8.2 (iii))
  • ensure community livelihood and development activities (Art. 6.8)
  • watershed management


In sum, the developer holds the responsibility for overseeing the construction and some maintenance of a project that is theoretically operational, a position of rather low risk since dam building and turbine supply represent mature technologies, and actual productive operation is not required. The government, meanwhile, is responsible for the above listed works and property transfers, and bears the financial risk for the project. If the river flows are insufficient to produce electricity at projected levels, or if in the dry season no power can be produced, it is the government/NPC that will lose money, as the SRPC will continue to collect monthly payments from them even in the absence of power generation.

VI. What are the agreement’s implications for social and environmental impacts?

The PPA mentions watershed management, saying "Management and maintenance of the Watershed shall be the sole responsibility of NPC", while project construction and operation is wholly in the hands of the SRPC. Since watershed management is detached from the operational requirements of the project, this contract creates a situation where project construction and operation will proceed regardless of whether the watershed is protected. This, and the lack of any funding for watershed protection from project revenues, are conditions that have led to watershed deterioration in similar projects internationally.

Mitigating measures are not specified in the agreement for environmentally sensitive operations such as deposit or disposal of excavated rock and soil. So apart from environmental impacts inherent in the project’s design which will be manifest through its operation, the contract does not ensure best practices for environmental protection during the construction phase.

The SRPC will have obtained an Environmental Compliance Certificate prior to the contract’s effective date. An Environmental Impact Statement is a prerequisite for obtaining this certificate. Since the effective date has been passed, even this one nominal environmentally related provision to be found in the PPA exerts no meaningful force on activities.

The PPA requires the NPC to obtain a certificate from the Environmental Management Bureau approving plans for a Resettlement Program. Issues such as consultation with, notification of, and, in the event of relocation, proper compensation-in-kind to persons living in the project area, are not mentioned in the contract. The PPA states that it is NPC’s responsibility to "obtain and maintain all Water Rights necessary for the construction...and operation of the power station" and that "NPC, at no cost to the Operator, shall make the entire site available to the Operator.…" This contract, therefore, also creates a situation where the project will proceed regardless of whether affected persons are granted due process, or fair compensation. When this lack of conditionality has been the case in international, particularly SE Asian, experience, due process and fair compensation have not occurred for affected people.

Furthermore, the contract (para 5.4) creates a financial penalty for the NPC if the project does not go forward for reasons of NPC’s failure to obtain the land rights, creating a further incentive for carrying through with the project in spite of unresolved land rights issues.

The PPA grants the SRPC (Article 7) unqualified rights to draw water for operation of the turbines. As such, no meaningful mechanism was preserved for tempering water discharge to avoid environmental damage or preserve downstream aquatic life.

In side agreements, the National Irrigation Administration is tasked to work with the SRPC in shaping its "rule curve" to reflect the discharge priorities for irrigation, and similarly the Department of Public Works and Highways are to help incorporate the imperatives of flood control. There are no firm targets in the PPA, however, for the SRPC to attain these "multipurpose" goals, and the role of the NIA and DPWH seems to be at best an advisory one with respect to discharges.

VII. Is the Republic of the Philippines assured of project completion?

It is reasonable to expect that under conditions foreseen as normal by the parties the SRPC will undertake construction of the physical features of the project as described in the specifications. In the event of the project proving to have substantially less of a financial return than projected by the parties, however, or that construction costs increase significantly, the PPA provides the opportunity for the SRPC to avoid financial loss by abandoning the project. This, in fact, is the essence of the SRPC existing as an independent entity, having entered into an agreement with the NPC that does not allow recourse to the parent companies.

As a function of the San Roque Power Corporation’s being fully owned by Marubeni, Sithe Philippines, and Kansai Electric Corporation (having bought out Italian-Thai Development), money can be transferred out of it to the parent companies. In the event of San Roque Power Corporation being short of funds to meet its obligations, however, the Philippine government, particularly as represented by the National Power Corporation, will have no means of compelling the parent companies to transfer funds into it (Fourth Schedule, Article 2). In such case the San Roque Power Corporation’s obligations would go unmet, whether it formally declared bankruptcy, or merely sat inactive. In this event, the most the Philippine government could recover is the value of the performance bond, although specific circumstances would govern whether they were able to make a successful claim of the bond.

VIII. Is the Republic assured of responsible and productive long term operation?

Under favorable conditions the SRPC has an incentive to maintain the facility and optimize its operation for maximum power production so as to earn the largest possible fee income. This management will largely be at its own discretion as the PPA contains language (5.1.2(ix)) expressly exempting the project from regulation as a utility in the Philippines.

The SRPC, however, has several other options than long term productive operation of the facility.

The PPA does not preclude the SRPC’s ability to sell the project after completion, or even before the end of construction. This could be done in differing ways: the San Roque Power Corporation could sell the project, which would require written, prior permission by the NPC (para 18.2). It is likelier that the more subtle mechanism would be used of the SRPC parties selling their shares in the San Roque Power Corporation to a different group.

Another option for the SRPC is early transfer of the project to the NPC. The PPA (see para 8.16) has provisions which come into effect if the NPC is ever privatized, or in fact if it ever sells any assets, and if these actions can be construed to impinge on the SRPC’s privileges under the PPA in any way. These can also come into effect for a plethora of other reasons (see articles 5.4, 8.15, 8.16, 10.4, 14.4 or 14.5). Under these provisions, the SRPC can demand that the NPC buy the project from them immediately, at a price for which a formula is given in the PPA.

Another possibility, real and profitable for the San Roque Power Company, is to continue to hold and operate the project throughout the "Cooperation Period" even if it suffers diminishing or near zero productivity. Even at a low level of production, the SRPC would be assured of a market for all the power it did produce. Moreover, it would be paid "Capacity Fees" regardless of whether it produced power, if insufficient water or certain other reasons (para 8.5) were held causal. For example, if the reservoir experiences significant sedimentation, and the storage capacity of the reservoir is compromised, the generation shortfall could be determined to be caused by insufficient water, and the SRPC would continue to receive capacity fees (discussed above as hydrological risk). As calculated in Appendix B of this review, even if electricity is not generated for lack of water, in the first 12 years the fee is equivalent to US$10 million per month.

Appendix A: Example Fee Calculations Expressed as Unit Rates

Exchange rate of the Philippine peso, in foreign currency per peso, as of 24 March 2000
*Source: Central Bank of the Philippines

U.S. Dollar
0.0244696
Japanese Yen
2.6253610

PhP = Philippine Peso
US$ = U.S. Dollarv
JPY = Japanese Yen

The following three examples are taken from THIRTEENTH SCHEDULE, SAMPLE COMPUTATION OF MONTHLY BILLINGS AND INCENTIVES.

Example 1, "Plant operation incurred no outages" 

 

(Philippine Peso)

Capacity fee, yen portion

JPY764,550,000

291,217,093.57

Capacity fee, U.S.$ portion

US$8,949,000

365,719,096.35

Energy fee

US$458,001

18,717,142.90

Operating fee

PhP37,500,000

37,500,000.00

Total example monthly fee in Pesos

713,153,332.83

Peak energy delivered in month

43,330,400kWh

Off-peak energy delivered

10,832,600kWh

Total energy delivered in example month in kWh

54,163,000.00

Total example monthly fee in Pesos per kwh

13.17

Total example monthly fee per in US$ per kwh

0.32

Example 2, "Plant operation incurred outages within the allowable limits"

  

(Philippine Peso)

Capacity fee, yen portion

JPY764,550,000

291,217,093.57

Capacity fee, U.S.$ portion

US$8,949,000

365,719,096.35

Energy fee

US$282,609

11,549,391.90

Operating fee

PhP37,500,000

37,500,000.00

Total example monthly fee in Pesos

705,985,581.82

Peak energy delivered in month

27,573,600kWh

Off-peak energy delivered

6,893,400kWh

Total energy delivered in example month in kWh

34,467,000.00

Total example monthly fee in Pesos per kwh

20.48

Total example monthly fee per in US$ per kwh

0.50

Example 3, "Plant operation incurred outages outside the allowable limits"

  

(Philippine Peso)

Capacity fee, yen portion

JPY692,227,211

263,669,343.38

Capacity fee, U.S.$ portion

US$8,102,467

331,123,802.60

Energy fee

US$164,846

6,736,767.25

Operating fee

PhP37,500,000

37,500,000.00

Total example monthly fee in Pesos

639,029,913.23

Peak energy delivered in month

24,421,600kWh

Off-peak energy delivered

6,105,400kWh

Total energy delivered in example month in kWh

30,527,000.00

Total example monthly fee in Pesos per kwh

20.93

Total example monthly fee per in US$ per kwh

0.51

 

Appendix B, Fee Calculation For Zero Monthly Output

Exchange rate of the Philippine peso, in foreign currency per peso, as of 24 March 2000
*Source: Central Bank of the Philippines

U.S. Dollar0.0244696
Japanese Yen2.6253610

The following computation is based on the formulas in the EIGHTH SCHEDULE for the case of zero monthly power production due to insufficient water. Assuming that:

Actual energy generated = 0
and
Contracted Capacity for the year is 150,000kW per the examples in Schedule Thirteen.

Since actual energy (Ep) is 0, then calculation of Equivalent Capacity (CE) goes to 0.

Then Contracted Capacity (CC) > CE, and CE < Dependable Capacity of 85,000 kW (DC),

so F, the Factor in calculating capacity fee goes to zero, and the capacity fee is simply the Capacity Fee multiplied by the value set as Dependable Capacity.

  

(Philippine Peso)

Capacity fee, yen portion

JPY433,245,000

165,023,019.69

Capacity fee, U.S.$ portion

US$5,071,100

207,240,821.26

Energy fee

US$0

0.00

Operating fee

PhP37,500,000

37,500,000.00

Total example monthly fee in Pesos

409,763,840.96

Total example monthly fee per in US$

10,026,757.28

Peak energy delivered in month

0kWh

Off-peak energy delivered

0kWh

 
Total energy delivered in example month in kWh

0.00