July 2016 - In mid-June, the Serbian government adopted several crucial pieces of secondary legislation relating to investments in the renewable energy sector. This is a much-anticipated follow-up to Serbia’s new Energy Law, which came into force on 30 December 2015 aiming at (among other things) to encourage investments in Serbia’s renewable energy sector and, more generally, to improve the regulatory framework by removing a number of obstacles impeding the bankability and financing of such projects.
Specific regulatory frameworks are now set out in the government’s adoption of several decrees, including the model for power purchase agreements (“Model PPA Decree”), for incentives relating to high-efficiency co-generation projects (“Incentive Measures Decree”), and on the requirements and procedure to acquire the status of a privileged power producer from renewable sources (“PP Status Decree”).
The adopted decrees were the result of a lengthy public debate over the draft by-laws, through which both investors and lenders tried to introduce solutions that would improve the bankability of renewable projects in Serbia. Legal solutions addressing the concerns of investors and financiers have been, to a certain extent, addressed by these decrees, especially in the Model PPA Decree. In our view, the end result is that the Model PPA Decree has introduced a relatively bankable template for renewable projects, in particular for projects where the installed capacity exceeds 30 MW.
Now that is has been completed, it is widely expected that Serbia’s new renewable energy regulatory framework will give a real boost to investments in the Serbian renewable sector. Investors have already signalled increased interest, especially in the field of wind energy. A clear indication of this is that the quota for wind energy producers, which was set at a maximum of 500 MW, has already been reserved in full.
Given the importance in Serbia of wind power projects and the model PPA for renewable power generation, in this Energy Alert we focus on the model PPA decree and an analysis of its main benefits and pitfalls. We will follow-up with an analysis of the Incentives Measures Decree and PP Status Decree in a future Alert.
Wind power projects
As a general matter, although wind power projects have attracted interest from numerous investors even prior to the adoption of the current Energy Law, no medium to large-scale wind power parks have been constructed and commissioned in Serbia to date. Nevertheless, certain investors with projects of a significant capacity (i.e. 100 MW and higher) have already obtained some of the required approvals and licenses, including construction permits and the status of a preliminary privileged power producer of electricity, enabling them to benefit from the applicable incentive measures. We understand from market sources that some of these early investors are now considering to sell their stakes partially or entirely in a number of such projects. It is expected that the relevant divestment processes should intensify following the recent adoption of new decrees.
One of the long-awaited key elements of the new Serbian renewable energy regulatory framework is the final adoption of the Model PPA Decree, which has put in place the final form of the model PPA for renewable electricity generators.
Under the Model PPA Decree, the term of the PPA assuring regulated feed-in tariffs remains 12 years (similar to the previous regulatory regime), while the feed-in tariff for electricity produced using wind energy is expected to remain around 9.2 euro cents per kilowatt hour. We understand that investors have regarded this incentives’ period and the level of the feed-in tariff positively, allowing them appropriate profits and assuring attractive return on investment.
Generally, the Model PPA Decree provides the form and substance of the PPA that must be concluded between the generator and the off-taker, and the parties may not deviate from it. To this end, the Model PPA Decree explicitly states that provisions inserted in a PPA that aim to amend, supplement or omit the relevant provisions contained in the Model PPA Decree are deemed as null and void. However, if the parties to the PPA determine, prior to conclusion of the PPA, that certain questions are not regulated under the Model PPA Decree or they find it necessary to amend or supplement certain provisions of the PPA in order to adapt the PPA to the particular case, they may amend or supplement the PPA with the approval of the Ministry of Energy.
According to the Energy Law, the off-taker maintains the register of the PPAs and publishes them on its web page.
Key improvements under the new model PPA
- Introduction of a step-in agreement for the benefit of lenders. The model PPA has, for the first time, introduced the possibility for an entity nominated by lenders to a renewable project to become a party to the PPA and enter the project by concluding a step-in agreement with the project company (borrower) and the off-taker. This possibility is, however, available only for PPAs concluded with renewable power plants with an installed capacity above 30 MW. Any of the following events triggers the step-in rights of the lenders through the appointment of the nominated entity: (i) default under the loan agreement; (ii) loss of privileged power producer status or preliminary privileged power producer status by the project company; and (iii) occurrence of an event of default, allowing the off-taker to terminate the PPA.
- Introduction of a political force majeure mechanism. The model PPA extends the definition of force majeure to certain political force majeure events, such as war, terrorism, revolution, riot, public demonstration, sabotage or act of vandalism, strike or labour disruption; expropriation or nationalisation of the power plant or its part; events when, due to an act of a public body, a relevant licence/permit necessary for the performance of the PPA is revoked/not issued/modified; international sanctions or the effectiveness of regulations of international organisations binding the Republic of Serbia, due to which the off-taker is not able to fulfil its obligations based on the incentive measures; as well as partial or total system outage occurred during the term of a decision on declaration of an emergency situation. Although this is a major improvement in comparison to the concept of force majeure applicable under the previous regulation, the model PPA does not allow for compensation for lost revenue during the period when the force majeure event is continuing. Instead, the relief available to the affected party is the postponement of the effects of the given event under the PPA, i.e. relief from performing its obligations while the force majeure event is continuing, as well as extension of the term of the PPA for the period of duration of the force majeure event.
- Termination payment explicitly covering the total costs of financing. The termination payment under the model PPA now explicitly provides for the recovery of both the principal and interest of the outstanding debt as well as breakage costs. While this mechanism gives a higher degree of certainty for the investors and financiers, compensation in the event of termination of the PPA due to political force majeure is available only for projects with an installed capacity above 30 MW and for limited political force majeure events, such as expropriation or nationalisation of the power plant or situations when, due to an act of a public body, the relevant licence/permit necessary for the performance of the PPA is revoked/not issued/modified.
No compensation for the off-taker for deemed electrical output in case of system outage.
The Model PPA Decree has failed to introduce the concept of deemed electrical output in cases of partial or total shutdown of the electricity grid, as a result of which the off-taker would be prevented from receiving the feed-in tariffs. Instead, the model PPA provides that in such a case, the off-taker is obliged to advance the payment to the generator for the deemed electrical output during the period of the system outage to be calculated as per a relevant formula. Upon the expiry of the incentive period, the generator is obliged to agree to an extension to the term of the PPA for the period necessary for the generator to deliver, free-of-charge, the amount of electricity equal to the relevant payments made by the off-taker for the deemed output during the incentive period. In effect, this means that the deemed electrical output concept is not a true compensation but a tool to bridge the financial gap of the generator. Whilst this is clearly a better arrangement than the scenario where no such right would exist at all, in reality the solution under the Model PPA Decree merely postpones the effects of economic damage for the generator. A possible solution to mitigate such damage may be to seek appropriate insurance.
No immediate relief for the generator under the change-in-law clause in the model PPA
The model PPA provides for a wide definition of change-in-law, stating that a change in law includes the coming into effect of new regulations or amendments and supplements to the applicable regulations after the conclusion of the PPA, which could result in decreasing the rights or increasing the obligations of the generator and which therefore could result in an increase of the costs of its operations. However, the change-in-law clause does not exempt from its scope those regulations which are non-discriminatory and which equally and generally apply to all legal persons in the Serbia, regardless of their professional activity. Moreover, the generator is only able to rely on the change-in-law mechanism if the given change in law results in a negative effect on the financial status of the generator. Although the definition of the change in law is drafted broadly enough to cover any type of regulation affecting the generator in the aforementioned manner, it is not entitled to immediately seek amendments to the PPA with the aim to be put in the same financial position it was in prior to the change in law. Instead, the generator must first make a proposal for the amendment of the incentive measures. If the competent regulatory body agrees with the generator’s request within 90 days from the date of submission of its proposal, the off-taker is obliged to conclude an annex to the PPA addressing the issue. However, as it seems that the Government must decide on all requests of power producers to change the incentive measures in one decree, it is likely that such a decree will not be tailor-made to cover all losses incurred by the generator as the consequence of the change in law. In such a case, the generator would be entitled to resolve any remaining issues using the dispute resolution mechanism provided in the PPA.
Insufficient payment support by the off-taker
According to the model PPA, the off-taker is only obliged to provide three blank “no protest” promissory notes as financial guarantee. Although such type of security is often used in commercial dealings in Serbia, it is rarely given as a sole security instrument. Although the model PPA provides greater certainty as to when the promissory notes can be enforced, it does not provide certainty as to the maximum amount up to which such promissory notes may be filled in. Thus, it will be necessary to seek further guidance from the regulator in relation to the maximum amount that can be enforced under each promissory note.