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Kenya Power: Legal and Commercial Considerations in Varying Power Purchase Agreements

2023-04-25

Kenya Power: Legal and Commercial Considerations in Varying Power Purchase Agreements

  1. Introduction

A Power Purchase Agreement (PPA) is the primary contract entered into between power producers and power purchasers to facilitate the movement of electricity from the generator to the distributor and finally to the end consumer. The Kenya Power and Lighting Company PLC (Kenya Power) is the main distributor of electric power in Kenya and as such, routinely enters into PPAs to meet its key mandate of planning for sufficient electricity generation and transmission capacity to meet demand. While the majority of power is purchased from the Kenya Electricity Generating Company PLC (KenGen), Kenya Power has also entered into PPAs with several private power producing companies also known as Independent Power Producers (IPPs). However, despite its power distribution monopoly, the state-controlled company is in dire financial straits and has been hard-pressed to avoid increases of already high consumer tariffs to stem its financial losses. This has raised interest in how to control costs on the supply end by addressing the cost of power purchased from the various entities with which it has entered into PPAs. This article will explore the potential remedies available to Kenya Power in seeking ways to cut power purchase costs arising from existing PPAs.

  1. Background

In the mid-1990s, Kenya Power began inviting private power companies to develop power plants to meet the nation’s projected power demands. In addition, the Government of Kenya subsequently published fixed tariffs, also known as feed-in tariffs, that would apply to producers of clean/renewable energy like wind, solar, small hydro, geothermal and biogas to encourage private investment in and development of renewable power projects. This led to Kenya Power negotiating PPAs with several IPPs, which stood at 17 in number as of June 2020.

As with all contracts, PPAs create legally binding rights and obligations for both parties with unavoidable implications as to the allocation of the risks and benefits of the commercial arrangement. Due to the heavy investment requirement that goes into the development of power generation plants, PPAs are generally designed to provide investors with a sense of security and predictability by guaranteeing the power producer fixed cash inflows over a long period of time, which will, in turn, guarantee their ability to service the credit facilities taken to finance the power project. A PPA is therefore often a prerequisite for a potential power producer to obtain financing to begin a power project. 

With the above in mind, one key feature of Kenya Power’s PPAs is that they are generally long-term contracts (about a minimum of 20 years) that do not allow for early termination in the absence of breach or default by a party. Secondly, they adopt a Take-or-Pay payment approach based on an agreed capacity of power to be generated by each power project. This means that provided the power producer makes the capacity available, they are entitled to a fixed capacity payment, whether or not there is offtake by Kenya Power of the energy produced. This arrangement guarantees the power producer’s ability to service their debt and enjoy a return on investment, in addition to covering their fixed operating costs such as insurance and salaries, among others. There is usually also a variable payment component to cover variable costs, including plant maintenance and wear and tear on the machines, which costs fluctuate depending on the actual supply of power from the plant to Kenya Power.

It is also important to note that when Kenya Power enters into PPAs they are usually accompanied by several backing documents to support the viability of the arrangement and validity of the agreement, thus bolstering the financier’s confidence in funding the power project in question. These documents include an instrument of approval from the Energy and Petroleum Regulatory Authority (EPRA) and an enforceability opinion issued by Kenya Power’s external legal counsel to confirm that the PPA is valid and enforceable. In addition, the Government of Kenya issues a letter of support together with an enforceability opinion from the Attorney General. For the Kenyan Government to be seen to renege on their support for these agreements would therefore be scandalous.

Nevertheless, power demand has proven to be lower than projected while consumer tariffs are perceived to be higher than ever. In light of these challenges, coupled with the financial difficulties Kenya Power is facing, the President established a Taskforce by a Gazette Notice on 29th March 2021, to assess how best to address these problems including, potentially, renegotiation of PPAs or even termination. Of note, the Taskforce was asked to “review the Take-or-Pay approach applied under the PPA structure and recommend a viable Pay-when-Taken (merchant plant) approach, or any other viable payment structure, for use in independent power generation projects.”

  1. Legal and commercial issues to consider in varying PPAs

This raises the question of what legal remedies are available to Kenya Power. What would it take to renegotiate PPAs or terminate them before the expiry of their terms? Following from this is the question of the potential impact on private investment in Kenya should Kenya Power, a state-controlled company, fail to honour its contractual obligations under the PPAs.

On the question of renegotiation, considering that PPAs are legally binding contracts, any variation of terms would have to be based on mutual agreement between the parties. This would require Kenya Power to offer the power producers a commercially viable proposal that would enable them to continue meeting their various financial obligations, including to their financiers, shareholders, and staff. The switch to a Pay-when-Taken approach, although a seemingly attractive option for Kenya Power, is an unrealistic proposal given that the power producers have loans to service and this debt was taken on in the first place at the invitation of Kenya Power and the Kenyan Government. It is therefore unlikely that IPPs would be amenable to this. A better approach might be to negotiate for an extension of the term of the PPAs at a lower fixed capacity payment that offers some relief to Kenya Power while still allowing the power producers to honour their financial commitments. Other creative solutions based on genuine negotiations might also be welcome.

A proposal for early termination of a PPA would run into a similar roadblock of completely disabling the power producer from meeting its financial obligations. Considering that early termination for convenience is generally not provided for in a PPA and would be unlikely to be agreeable to the power producer, the only way to exit the contract early would be by a unilateral move on Kenya Power’s part. While a possibility of claiming force majeure due to a shortfall in demand because of the COVID 19 pandemic has been raised, should this fail to be found valid, Kenya Power cannot justify early termination of a PPA outside of a repudiatory breach of the contract by the power producer. To do so would be a breach of their own contractual obligations, exposing Kenya Power to liability to compensate the power producer for loss of earnings. Moreover, seeing as Kenya Power is a state-controlled entity which had documented government backing when entering into these PPAs, any move by the company to terminate the agreements based on tenuous justifications would be highly detrimental to the perception of Kenya as an attractive destination for foreign private investment. 

It is also worth noting that part of the shortfall in demand is due to deficits in Kenya’s power infrastructure such as the under-development of the country’s transmission and distribution network. The current situation of over-supply of power is therefore not entirely due to a lack of real demand but due to challenges in distribution. As a developing country, Kenya’s power demand is likely to grow with improvements in the power transmission and distribution infrastructure. Early termination of PPAs might therefore prove to be premature and lead to the opposite problem of under-supply of power in the near future. Furthermore, termination of PPAs in a less than optimal manner now would have a chilling effect on future investment in the power sector that might hamper Kenya’s ability to meet the power demand when the need becomes clearer and more urgent.

  1. How have other jurisdictions approached similar issues?

There are other countries such as Ghana, South Africa, India, Pakistan, France and Canada, among others, which have faced similar problems of paying for excess power generation capacity relative to lower than anticipated demand and have also considered renegotiation and/or termination of PPAs as a solution, whether on a negotiated or forced unilateral basis.

In Ghana, as part of a five-year Energy Sector Recovery Programme (ESRP) in collaboration with the World Bank, the Government engaged IPP lenders directly in its PPA renegotiation efforts and offered to refinance the private power producer’s debts at a discount from a designated energy fund. The Government successfully renegotiated two PPAs in 2020 – CENIT Energy Limited agreed to convert a thermal power plant into a tolling structure, while Cenpower Generation Company Limited agreed to switch its primary fuel from light crude oil to natural gas and executed a gas supply agreement with the Government which is estimated to save the country USD 3 billion over the remaining term of the PPA. The reform process is ongoing.

In France, despite the Government enjoying a ‘general interest’ power that allows public authorities to unilaterally vary or terminate contracts on public interest grounds, a unilateral Government-initiated change to renewable energy feed-in tariff PPAs still attracted constitutional challenges for interference with the power producers’ legitimate expectations to continue benefitting from their existing contracts. Furthermore, the French Government faced criticism for weakening the renewable energy sector, contrary to its stated policies, and creating uncertainty that would cause an increase in costs of future financing of renewable energy projects. This is similar to India, where the Government’s trend of renegotiating and cancelling PPAs with solar power projects has been criticised for derailing the clean energy sector and eroding investor confidence, thus destabilising the country’s energy sector as a whole.

  1. Conclusion

While there are no easy solutions to the current predicament, the solutions proposed by the Taskforce must be both legally sound and commercially viable. Any attempt to vary or terminate PPAs must be by mutual consent of the parties or else risks constituting a breach of the contracts. In order to obtain such mutual agreement, the proposals made by Kenya Power must make commercial sense for the power producers and enable them to continue to service their debts and meet their other financial obligations.

Following the example of Ghana, this may necessitate engaging the IPP financiers as part of the PPA renegotiation process or finding other creative solutions that provide relief to Kenya Power while also maintaining cash inflows for the IPPs and a reasonable level of power generation capacity to meet Kenya’s current and future power demand, especially for renewable energy. Conversely, the French example shows that unilateral revisions to PPAs are a dangerous approach. Solving Kenya Power’s current financial crisis should not come at the risk of alienating investors or creating a future power supply crisis in the country by terminating power projects prematurely.

Esther Omulele, Maxwell Mafubo, Sylvia Kimani, and Faith Akinyi Mugo