Scoring on a Levelised Playing Field

Money to be had in the future is not worth as much as money held today. If the sale of electricity is on an average price throughout a twenty one-year tenure, vigilance in computing costs is essential to a power producer.

A levelised cost of energy is the net present value of the total per kilowatt-hour cost of energy over an assumed financial life of a power generating plant. In Malaysia, under the Large Scale Solar (LSS) programme, LSS developers sell electricity to the distribution licensee or Single Buyer at a levelised tariff rate.

From the standpoint of an energy buyer, a levelised tariff removes uncertainties such as generation capacity of a solar plant and evolution or degradation of technology. A levelised price ensures that electricity is bought at a firmed energy price throughout the duration of a power purchase agreement (PPA).

The Energy Commission (ST) selects potential developers under the LSS programme based on a competitive bidding framework. Simply put, on the assumption of complying with technical standards, the selection primarily hinges on the solar rate offered by the potential LSS developer. This solar rate will be normalised by a merit point system.

Considering that the same tariff will be used throughout the duration of the power purchase agreement, attention must be paid to key factors that make up the cost. The ST assumes that a solar rate is structured to reflect, amongst others, the land cost, the financing cost, the project development cost and the operation and maintenance cost.

We will further explore the triumvirate comprising the land cost, financing cost and operational cost – an alchemy of variables which can have a significant impact on a proposed levelised price.

Land Cost

A bidder under the LSS programme is responsible to acquire land or to submit a lease agreement for the land on which it proposes to carry out the project. While a firm acquisition price or lease payment amount would ease in determining the land cost element in the total projection, there is theoretically a more cost-effective approach.

Using State-owned land can mitigate the land cost. This is applicable to ancillary costs associated, as the LSS developer may be able to negotiate quit rents and assessment rates. Chances of successful negotiations may also be increased if such land was (if not for the LSS project) unutilised. The economic growth on the land and its surrounding areas (something not considered for projects on privately-owned/alienated land) can incentivise both parties to negotiate for such an arrangement. Additionally, the premium payable as well as quit rent and assessment rates on the unutilised land can be valued according to its economic output. If this can be realised, the land costs for the LSS project can be fixed from the get-go.

It is also worth to note that, in respect of land, the ST evaluates bid submission based on its usage. A LSS developer is encouraged to optimize land usage for other economic activities. A concurrent use of the project land for agriculture, as an example, will be favoured over land which is used purely for the LSS plant. This is accounted for in the merit system mentioned above.

Financing Cost

Conventionally, project developers would opt for non-recourse or limited recourse financing. The high interest rates imposed by financiers can be due to interest during construction (IDC). The amount of IDC can be quite substantial due to the capitalisation of borrowing costs. As a borrower progressively draws down on a loan, the IDC on the loan correspondingly increases. As there is only one commercial operation date under the LSS programme and the interconnection to the electricity grid is concurrent, developers cannot mitigate the IDC by progressively commissioning partially completed portions of a solar farm (and thereby progressively reducing the IDC).

Another reason IDC may be high is due to the fact that financiers will always price in the risk of non-completion or cost overrun. Credit enhancements such as a completion guarantees can escalate the cost of IDC.

One way of making financing cost more competitive is to have the contractor of the LSS plant bear the financing. In this situation, the engineering, procurement and construction (EPC) contractor appointed by the LSS developer will undertake to finance the construction. This arrangement comes with a commitment from the LSS developer to pay the contractor upon completion of the construction. This can be in the form of a bank guarantee in an amount equal to the project cost. Once the construction is completed, the commitment can then be transferred or converted into a long-term conventional loan.

Operational Cost

Often, a LSS developer will engage in technical service providers. Payments by the LSS developer to a non-resident for such services will be subject to withholding tax of 10% under the Income Tax Act 1967. Alternatively, payments could be subject to goods and services tax of 6% under the Goods and Services Tax Act 2014.

Lack of foresight in costing for these expenses can be disastrous. Potential LSS developers can build this into the procurement cost at the onset of the project. As an alternative, LSS developers can adopt an owner-operator model. Incorporating in-house technical operations removes the exposure to the abovementioned taxes.

The above factors are not exhaustive in the effort to minimize costs. There are other factors such as interconnection cost. Ultimately, it must be understood that a lower cost translates to a lower tariff, and in turn, a lower tariff leads to a favourable bid submission.

IMAN ISHAK, Associate of Naqiz & Partners

By | 2017-09-11T04:55:26+00:00 September 11th, 2017|Uncategorized|