Clean energy transition: NSW to offer revenue underwriting for selected renewable projects

By Stuart MacGregor, Tristan Appleby, Stephanie Centorame, Peter Staciwa, Faith Taylor, Dan Howard and Romany Sloan
19 Aug 2021
The NSW Government has detailed its plan to provide long-term revenue assurance for selected renewable energy projects and is calling for industry feedback on the proposed scheme design.

Renewable project developers, investors, funders and other stakeholders are being given the opportunity to have their say on the proposed design of long-term energy service agreements (LTESA), which offer revenue underwriting for approved large-scale renewable projects in New South Wales.

A copy of the NSW Government's Long-Term Energy Service Agreement Design August 2021 Consultation Paper can be viewed here.

Proposed design

Along with establishing designated Renewable Energy Zones (REZ), LTESAs are a central element of the New South Wales government's Electricity Infrastructure Roadmap. As we outlined late last year, the Roadmap sets out an integrated, whole of system approach to attract and secure investment in electricity infrastructure in New South Wales.

The Electricity Infrastructure Investment Safeguard sits at the heart of the Roadmap, and aims to offer financial support to eligible projects in the form of such agreements and reduce risk premium for investors by providing minimum revenue certainty.

As detailed in the Consultation Paper and in further detail below, LTESAs will offer eligible generation, long duration storage (including batteries or pumped-storage hydropower) or firming projects the option to access price guarantees, structured as a series of derivative options over the design life of the asset.

LTESAs in detail

LTESAs will be contracts between the Scheme Financial Vehicle (to be established for this purpose) and the persons responsible for the operation and management of renewable generation, long duration storage or firming facilities (LTES operator).   These contracts will offer options to enter into a derivative arrangement and access price guarantees for eligible generation, long duration storage and firming projects, with the aim of:

  • incentivising investment in NSW renewables projects by offering a protection mechanism against low wholesale electricity prices;
  • supporting sufficient generation, long duration storage and firming projects to advance the financial interests of electricity consumers in NSW;
  • bolstering participation by projects in the National Electricity Market (NEM) and contracts "markets" such as Power Purchase Agreements (PPAs);
  • attaining an efficient risk allocation between projects and NSW electricity consumers by encouraging investors to provide low-cost capital to finance projects; and
  • co-ordinating with the rollout of REZs and access rights to facilitate a single tender process, thereby providing a more streamlined experience for investors.

According to the Consultation Paper, it is proposed the tender process for LTESAs will focus on projects inside REZs, but will be available to projects outside REZs if they show "outstanding merit". (More guidance on what this might involve will be provided as part of the forthcoming consultation on the LTESA tender design).

Submissions responding to the Consultation Paper will assist with informing the final design and terms and conditions of the LTESA.

Generation LTESAs

A generation LTESA aims to assist in the financing of renewable electricity generation projects of greater than 30MWs in NSW.

Key proposed features of this agreement include:

  • options, available periodically across the LTESA term, granting the LTES operator the right (but not the obligation) to exercise a swap arrangement.Each option will have an associated option period of one financial year at a minimum; and
  • a repayment mechanism for the Scheme Financial Vehicle to recoup net amounts paid to the LTES operator due to an option being exercised should net revenues be materially higher than anticipated.One aspect that is being considered as part of the proposal is whether the repayment obligation may be reduced or removed where the LTES operator has an eligible wholesale market contract (ie. a PPA). This mechanism aims to incentivise participation in wholesale market contracts to support contract market liquidity.

The generation LTESA also proposes a fixed price per megawatt hour, triggered upon exercise of the option. The rationale behind this is for the fixed price to be sufficient for the project to meet its debt service covenants in an option period where the option is exercised.

Long-duration storage LTESAs

The long duration storage LTESA is designed to financially support long duration storage facilities of greater than 30MWs in NSW.

Key proposed features of this agreement include:

  • options granting the LTES operator the right to receive a minimum payment for services provided; and
  • repayment mechanisms enabling the Scheme Financial Vehicle to claim back historic payments made to the LTES operator due to the previous exercise of options.This aims to encourage profit-maximising behaviour to achieve the policy intent of minimising consumer costs.

Indicative competitive LTESA tender process

The NSW Minister for Energy and Environment has appointed AEMO Services Ltd, a subsidiary of the Australian Energy Market Operator (AEMO), as the Consumer Trustee, the independent decision-making body responsible for awarding LTESAs on a competitive tender basis and who will have sole discretion to determine the final structure of an LTESA in the scope set under the Electricity Infrastructure Investment Act 2020 (NSW).

The Consultation Paper indicates that all NSW projects, regardless of their location, will be eligible to compete for LTESAs.  Generation projects located outside of an REZ must show ‘outstanding merits’ (a concept which has not as yet been defined, and may be the subject of submission responses to this paper) in order to successfully gain funding.  Tenders for long duration storage and firming LTESAs are, however, ‘location neutral’.

The Consultation Paper offers three proposed stages for tendering:

  • Stage 1 (Expression of Interest): bidders, having been provided with a draft term sheet covering the key terms and conditions of the LTESA, will be asked to nominate multiple price terms.Bidders will then be assessed against set eligibility criteria developed by the Consumer Trustee, resulting in a shortlist;
  • Stage 2 (Request for tender): shortlisted bidders will be asked to nominate multiple price terms as part of their bid.Submissions will be assessed on eligibility, including a portfolio assessment; and
  • Recommendation/LTESA award: The Financial Trustee (appointed by the Consumer Trustee) will award contracts for the Scheme Financial Vehicle (the counterparty to LTESAs) to enter into based on the Consumer Trustee’s recommendations.

Bidders may also submit alternative bids in addition to default bids whose terms conform to the design concept qualities set by the Consumer Trustee, the rationale being to encourage innovation in project design and commercial risk allocation.

The NEM is a complex open competitive electricity market and a key issue for the LTESA proposal will be whether it has potential to create market distortions by providing financial support to specific large scale renewable generation projects and the extent to which the market risk can be controlled or mitigated by the Scheme Financial Vehicle.

The terms and conditions of the proposed LTESAs will also need to be assessed by industry to determine the risk position under the proposed swap arrangements and how well they align to typical industry terms under ISDA electricity swap arrangements.

Contract structure and cash flows

It is proposed that an LTES operator will enter into the following agreements if it has successfully completed the tender process:

  • a project development agreement which imposes obligations on the LTES operator to achieve financial close and construct and commission the project; and
  • an LTESA (with the Scheme Financial Vehicle as a counterparty) comprising master LTESA terms and option terms.

The Financial Trustee will administer the LTESA, including settlements, on behalf of the Scheme Financial Vehicle.

Australia's revenue underwriting and alternative finance ecosystem

Revenue underwriting of renewable energy projects is a well-worn path for governments. Similar schemes, although in different context, have operated in Australia (including in Victoria and the Australian Capital Territory), Europe and other jurisdictions for a number of years. In some cases, revenue support has taken place over significant time periods.  An, example of this is in Germany where developers have for over 20 years had access to security of income through feed-in-tariffs.

In the Australian market, the LTESA scheme would form part of a growing number of underwriting and alternative finance opportunities designed to complement and operate in conjunction with traditional project offtake and debt markets to support a stable, orderly and urgent increase in renewable energy as part of Australia's energy mix.

Among others, the Australian Federal Government offers early-stage and project finance opportunities to renewable project developers through the Clean Energy Finance Corporation (CEFC) and the Australian Renewable Energy Agency (ARENA).

Outside New South Wales, the Australian Government's Northern Australia Infrastructure Facility (NAIF) is a single-purpose development financier of eligible projects located in regional Australia. Its major investments include $650million for the 250MW Kidston Pumped Storage Hydro Project in north Queensland.

What does this mean for you?

Though a lot depends on the final scheme design, we anticipate revenue certainty provided by a LTESA would offer supported projects commercial advantages over competitor projects and, subject to our comments below, improved project bankability as a result of de-risking merchant revenue. That would of course be attractive to both private and institutional investors.

From a bankability perspective, the real test will come when the final terms of the LTESAs are available. Financiers will pay close attention to how the terms differ from government "offtake" arrangements provided by other Australian state governments together with fundamental bankability considerations, such as:

  • term, volume and price certainty,
  • how any revenue refund mechanism will operate;
  • risk allocation (especially around change in law);
  • availability of a tripartite agreement to be entered into with a project's financiers; and
  • how the document work alongside other offtake/revenue contracts that the project has been able to secure.

Something that would be particularly attractive from a financier's perspective is if the Scheme Financial Vehicle had the benefit of a performance guarantee under the Government Sector Finance Act 2018 (NSW) or other government-backed credit support. The Roadmap instead proposes a budget-neutral funding scheme to cover the Scheme Financial Vehicle's costs, and confirms LTESA payments will not be guaranteed by the State. In case of any temporary funding shortfall, the Roadmap suggests a liquidity facility (or other support) could be provided by the State or a financial institution on an arm's-length basis. We expect this will be critical for bankability, however no details have been provided at this stage.

Subject to these and other considerations (in particular how LTESAs will operate in conjunction with the REZ scheme), it may offer a price advantage if the project or an asset is sold with an attached LTESA, as is generally the case for projects with a long-term power purchase arrangement with a government or investment grade counterparty.

Consultation process

Submissions can be made in the form attached to the Consultation Paper and will be accepted until 5.00pm on Friday, 10 September 2021.

Clayton Utz welcomes you to contact the authors of this article to discuss the proposed design of the LTESA scheme and what it means for your business.

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