Whilst many challenges exist within Zambia’s power sector, including the well-documented shortages, outages and off-taker issues, recent changes may usher in a new era.
Although Zambia’s power sector is liberalised, with private sector participants playing an important role in generating power, ZESCO Limited (ZESCO), a vertically integrated electricity utility, has historically dominated the Zambian market in generation, transmission, distribution and supply. Is this about to change?
Recognising the challenges facing the country, the Government of the Republic of Zambia had been working towards changes in the regulatory framework. In late 2019 the Government enacted changes to the legislative framework that may present a constructive path forward for the future. In December 2019 two new pieces of legislation, the Electricity Act No. 11 of 2019 (the Electricity Act) and the Energy Regulation Act No. 12 of 2019 (the Energy Regulation Act) were enacted into law and later came into effect in February 2020. It would appear that both were designed to support the further liberalisation of the energy market, making it easier for independent power producers (IPPs) and other actors to play a greater role in the generation, transmission and distribution of power in Zambia.
Will this change in the structure unlock the Zambian market, and will we see the advent of corporate power purchase agreements?
What is a corporate power purchase agreement?
At its most basic level, a corporate power purchase agreement (PPA) allows corporate customers to purchase power on a long term basis directly from an energy generator without being co-located. The traditional model requires corporates to purchase power from the state utility who not only would generate but would transport it on its transmission lines – a start to finish process. Corporate PPAs are long term agreements (typically 10 to 20 years) and provide certainty for the corporate and the generators using fixed or floor pricing structures.
In mature markets corporate PPAs are broadly broken down into three types; physical or “sleeved” PPAs, synthetic or virtual PPAs and private wire PPAs.
Physical or “sleeved” PPAs
Pursuant to a physical or “sleeved” PPA, the corporate off-taker will enter into a long term PPA (commonly with a term in excess of 10 to 15 years) with a renewable energy generator to take some or all of the energy generated by its plant with a defined amount of power sold at a fixed price per MWh. The corporate off-taker immediately on-sells at the meter point to the utility under a second PPA, the utility then “sleeves” the power through the grid and sells power to the corporate off-taker at its site.
In a synthetic PPA structure no power is physically traded. Instead, the agreement functions with a derivative contract structure where the off-taker and generator agree a defined ‘strike price’ for power generated by a renewable energy facility. Each party will then enter into separate agreements with their electricity supplier / utility to sell / acquire (as applicable) electricity at the spot price. The agreement then works as a financial hedge: if the spot price in a settlement period exceeds the PPA defined strike price, the generator pays the excess amount to the off-taker for power generated in that period; if the market price for power is less than the strike price in a settlement period, the off-taker shall pay the shortfall amount to the generator for power generated in that period.
Private Wire PPA
A private wire PPA is structured so that an IPP generates and sells electricity direct to an off-taker. However, unlike the physical or “sleeved” PPA, power will normally be sold directly from the generator’s facility to the off-taker, rather than being passed through a utility’s national power grid. The generating facility is located at, or close to, the off-taker’s assets and will usually only supply power to the off-taker. Private Wire PPAs may often be utilized in conditions where the off-taker wishes to secure its own source of power (for example for use in a factory, or in an off-grid location), or in countries where the grid system is not reliable.
Global Corporate PPA market – importance1
Globally, corporate PPAs are not a new phenomenon, with the first deals occurring 10 years or so ago. However, the corporate PPA market continues to grow. The global cumulative market for corporate PPAs amounted to roughly 114 TWh in 2017. This number includes all renewable electricity procured through PPAs. In 2017, a record level of new corporate PPAs was reached, with over 5 GW of capacity contracted (predominantly wind and solar), up almost a third from the 2016 level (RMI, 2018). The largest markets continue to be Europe and the USA. Multinationals are increasingly conscious about how they manage their energy needs, strategic priorities now include acting in sustainable way by procuring electricity directly from renewable sources.
In relation to the Zambian power sector, the Energy Regulation Board (the ERB) has long played a key role in regulating energy sector as well as being responsible for setting tariffs. The Electricity Act takes a step further and empowers the ERB, in terms of Section 3, inter alia, to secure a regular, efficient. coordinated and economical supply of electricity. So not only is the ERB responsible for licencing and tariff setting, but now has an additional important role and is empowered to facilitate investment in the development, construction and operation of electric plants using renewable energy sources.
Under the previous legislation, the Electricity Act, Chapter 433 of the Laws of Zambia, it was debatable as to whether anyone other than ZESCO could generate electricity. This has been specifically addressed. Part II of the Electricity Act explicitly contemplates and provides for the generation, transmission, distribution and supply of electricity. Subject to compliance with the terms of the Electricity Act and any requirement of the ERB, any person may produce and distribute power. Section 14 of the Electricity Act enables producers of power to access the existing transmission and distribution network. What the new Act therefore enables is for IPPs to produce power and wheel it through ZESCO’s existing grid.
ZESCO is the current incumbent managing the existing transmission and distribution network service in Zambia. In terms of the Electricity Act2 ZESCO will be deemed to be a “system operator” who will in addition to operating the transmission network and its inter-connectors with other networks, ensure non-discrimination between system users. The question, therefore, is whether ZESCO will grant access to the transmission and distribution network where it is not buying the power from the IPP and on-selling. Will connection to the network become a bottleneck?
It would appear that the draftsman thought of this; Sections 13 and 14 of the Electricity Act set out the process for gaining access and make it mandatory for a transmission network or distribution network service provider to connect a person provided they satisfy the terms and conditions for connection as provided in the grid code, and enter into an agreement with the transmission network or distribution network service provider.
In addition to having responsibility for determining tariffs and amending tariffs3, any prospective parties to a corporate PPA are required to have the agreement approved by the ERB. Section 19 (4) of the Electricity Act sets out the details of what terms the PPA should include. The ERB has 30 days from receipt of the draft to approve or reject the PPA. Where the ERB rejects the terms of the PPA they must notify the applicant of its reasons why. A person aggrieved with any decision of the ERB may appeal to the Minister of Energy and Water Development within 30 days of the ERB’s decision4.
Notwithstanding the ERB’s role in tariff setting, which should, inter alia, be cost reflective and ensure a reasonable rate of return on capital investment, it will be interesting to see how this plays out in the context of corporate PPAs, which in theory should be driven by the willingness of the parties to agree the tariff.
Will there be a favoured model?
Given the recent legislative changes and the nascent renewables market in Zambia it is too early to say whether the corporate PPA approach will be adopted, let alone which model of corporate PPA will be developed as a favourite. In view of the likely physical location of the currently envisaged IPPs, co-location with end users is unlikely. Consequently, it seems likely that any model will develop along the physical or “sleeved” approach, however time will tell.
The market’s commitment to using corporate PPAs as an approach to renewable energy procurement will continue to burgeon globally. Will this trickle down to Zambia, with its new and empowering legal framework? Although it is rather corny, is there finally some light at the end of Zambia’s power deficit tunnel; let’s hope so.
1 International Renewable Energy Agency, Remade Index 2018
2 Section 10
3 Part IV in particular Section 32
4 Section 34 of the Energy Regulation Act