Power purchase: Africa's shift to take-and-pay clauses

Out-Law Analysis | 31 Jul 2020 | 8:47 am | 3 min. read

A number of African countries are in the process of converting 'take-or-pay' clauses in power purchase agreements (PPAs) to 'take-and-pay' clauses, in an attempt to alleviate the financial burden of paying for gas or electricity that is not ultimately used or delivered.

However, a shift towards take-and-pay clauses will look unattractive to prospective lenders and investors, potentially hindering the promotion of future energy and infrastructure projects.

What are take-or-pay and take-and-pay clauses?

Take-or-pay and take-and-pay clauses are well-established clauses used in PPAs - long-term gas or energy sale or purchase agreements under which a generator, producer or seller ('producer') is under an obligation to make a certain volume of electricity available to a purchaser. The obligations on the purchaser vary depending on which approach is adopted.

A take-or-pay clause refers to a situation where a purchaser agrees to either purchase a minimum threshold volume of gas or electricity or, if the purchaser opts not to offtake the minimum agreed volume, to make an agreed payment as a result of having not done so – usually based on a reconciliation calculation or formula.

A take-and-pay clause places an obligation on a purchaser to both take a minimum agreed volume of gas or electricity and to pay a contract price based on that minimum agreed volume on a yearly basis. Should the gas or electricity not be physically taken by the purchaser, the gas or electricity will be calculated and paid for on a deemed delivery basis.

Tanya Calitz

Pinsent Masons

The clauses serve as a type of commercial guarantee, without which investors and financial institutions would be reluctant to finance energy infrastructure projects.

These clauses are effectively designed to protect the producer by providing a guaranteed income even if the purchaser does not use the gas or electricity; giving them the assurance that the product will be sold and making the energy generation project commercially viable. The clauses serve as a type of commercial guarantee, without which investors and financial institutions would be reluctant to finance energy infrastructure projects.

However, these clauses are not always commercially viable when the position of the purchaser is considered, as the purchaser is required to pay for gas or electricity that it does not intend to use without any option to store the additional power. They also have a knock-on impact on the consumer price of gas or electricity, and relevant subsidies.

Developments underway in Africa

In Africa, countries such as Kenya and Ghana are in the process of converting take-or-pay clauses in PPAs to take-and-pay clauses. The main reason for this shift is financial in nature as it will mean that purchasers, who are usually state-owned entities, will not be forced to pay for gas or electricity that is not used or delivered. As part of this shift, purchasers are encouraged to conduct more careful due diligence on the volume of gas or electricity that they will actually require.

In Kenya, PPAs between the state-owned entity, Kenya Power and Lighting Company, and independent power producers (IPPS) are now providing for take-and-pay clauses as opposed to take-or-pay clauses. In Ghana, the government began consulting in late August 2019 in order to renegotiate the hefty costs associated with take-or-pay clauses between IPPs and the state-owned Electricity Company of Ghana. Kenya and South Africa are following Ghana's lead in hoping to reduce these costs.

In addition, the government of Ghana is now aiming to implement take-and-pay clauses in all PPAs that are already in force. Notably, it has stated that a moratorium should be put in place on all prospective PPs while a more sustainable framework is developed for PPA contracting. The government has taken proactive steps to select and appoint a new concessionaire which will replace the current Power Distribution Services (PDS) concession, and to restructure local ownership under a new concessionaire.

Will a shift towards take-and-pay clauses be commercially viable?

There are numerous potential challenges associated with a move towards take-and-pay clauses. Firstly, the implementation of take-and-pay clauses will look unattractive to prospective lenders and investors, which means that energy infrastructure projects may not be promoted and could even be hindered. In Africa, economic growth is directly connected to successful infrastructure and energy projects. Given the generally volatile nature of Africa economies, it is crucial to promote sustainable economic growth at any and every given opportunity.

Current IPPs may experience difficulty securing funds, and may further opt to terminate PPAs due to the material changes that take-and-pay clauses bring to gas or energy projects.

Take-and-pay clauses also impose additional risks on the purchaser, who may be in potential breach if they do not take the agreed volume of electricity or gas. When the contract has a take-and-pay clause, the purchaser is not only obligated to pay a minimum amount for all gas and electricity whether offtaken or not, but also potentially faces liability for damages where the gas or electricity is not in fact offtaken.

Imposing a fixed tariff for purchasing gas or electricity under a PPA is one potential solution. This means that the purchaser will pay a fixed tariff on a per-unit basis for what it offtakes. Producers and sellers should also carry out thorough due diligence to establish the actual demand for gas or electricity, and should not produce more than what is actually necessary or required. The current trend in African countries is for gas and electricity supply to by far outweigh demand.

Co-written by Tanya Calitz and James Todd of Pinsent Masons, the law firm behind Out-Law.