In the final days before LTESA submissions are due, we reflect on the LTESA scheme, what it could mean for NSW renewable energy projects, the curious appoint of AEMO to award LTESAs, and what the future could hold for those projects who receive a LTESA and those that don’t.
Of critical importance will be the refinement and application of the negative price, option and repayment provisions of the LTESAs, and how AEMO manages its real and/or perceived bias in the LTESA award process. Given the significant capabilities of various NSW Government departments to administer tender processes, it is unclear why the NSW Government has risked, and AEMO has accepted, this clear potential conflict of interest.
On 9 August 2021, the Department of Planning, Industry and Environment released a consultation paper outlining the proposed design concepts and structural elements of long term energy service agreements (LTESA).
The Department of Planning, Industry and Environment (DPIE) is accepting written submissions, addressing one or more of the key terms and conditions, and the design structure in general, of the proposed long term energy service agreements by 10 September 2021. The proposed types of LTESAs are as follows:
a. Generation LTESAs;
b. Long duration storage LTESAs.
On 18 August 2021, the Department hosted the “Make an informed submission: The Long-Term Energy Service Agreement Design Consultation Paper Confirmation LTESA” webinar hosted by DPIE. The webinar provided valuable insights into the motivations of the DPIE and has been key to framing and formulating the submissions we have assisted with. We anticipate there will be several improvements proposed by stakeholders, primarily to resolve some bankability/investor issues.
Key objectives of the LTESAs
The LTESAs are option contracts which the NSW government has developed to achieve the following objectives:
- Encourage investment in NSW by reducing wholesale electricity price risk for investors;
- Provide cheaper electricity to NSW consumers by supporting sufficient – not excessive – generation, long duration storage and firming projects;
- Incentivise participation in the NEM and wholesale contracts markets;
- An efficient risk allocation between projects and NSW electricity consumers resulting in investors providing low-cost capital to fund projects;
- Work in conjunction with the rollout of REZs – i.e projects will obtain REZ access rights and LTESAs if they intend to build in a REZ.
What is an LTESA?
The LTESA has been designed to be an option contract granting the LTES operator (i.e the project) a series of rights, but not an obligation, to access a minimum cash flow for its project over a long period (e.g. 20 years). The LTESAs will be awarded to participants through a tender process administered by the Consumer Trustee; a role that was established as part of the state government’s Electricity Infrastructure Roadmap.
The Generation LTESA will be a fixed for floating swap, referencing the NSW wholesale electricity price. The DPIE has made it clear the Generation LTESA is not a PPA or CFD – projects will be able to access upside from the wholesale markets. As stated by the DPIE the best case scenario would be not to have options exercised.
The long duration storage LTESA will be a fixed annuity to top up a project’s expected revenue as it continues to be very difficult to predict future revenues of long duration storage projects. The long duration storage LTESA is not a capacity reserve, projects can and will be expected to pursue new revenue sources and will not be subject to behavioural requirements.
Both LTESAs will run in conjunction with a Project Development Agreement which will provide for the obligations on the LTES operator to achieve financial close and procure and construct the project.
Prior to the release of the consultation paper, NSW Energy Minister Matt Kean confirmed the appointment of AEMO in the role of NSW Consumer Trustee. To effectively carry out the functions conferred transparently and independently, AEMO Services Ltd was established as a subsidiary.
Specifically, AEMO Services will be tasked with ensuring that all future investments in NSW’s electricity infrastructure are placed towards the best interests of consumers. Importantly, in pursuing value for money for consumers, the AEMO Services will run tenders to select projects that will be awarded LTESAs.
Of particular interest in both the Generation LTESA and Long duration storage LTESA design are the proposed negative price risk provisions, the repayment provisions and the option terms.
- Negative price risk – both forms of LTESA will include negative price risk provisions that set the floor price for electricity at $0. The risk of negative electricity prices will therefore be borne by projects. Will this drive construction of battery storage units that level out this risk? Or will this just increase the LTESA electricity bid price?
- Options – will Lenders demand project principals exercise the options as soon as commercial operation is achieved to maximise project profits? Or will lenders allow projects to operate in the wholesale market to hedge the risk of reduced revenues?
- Repayment mechanism – this is a legislative requirement under the EII Act but will only apply during non-exercise periods and if the LTES operator’s dispatch-weighted average price is above its LTESA repayment threshold price. The repayment mechanism is constrained by a 75% benefit sharing percentage which is aimed to encourage profit maximising behaviour. But how will this mechanism interact with projects’ payment obligations under other project agreements such as PPAs? One idea floated by the DPIE is to reduce or cease the repayment mechanism where the project enters into an eligible wholesale market contract. This is a positive step and will hopefully encourage projects’ participation in the wholesale electricity market.
More generally, however, there is a serious question as to whether there is a conflict between the role AEMO plays as market operator, and the role it will play (albeit as AEMO Services) as a Consumer Trustee ensuring LTESAs are awarded to projects providing the overall best value to NSW consumers.
An energy project which would create significant grid benefits is unlikely to also be the lowest cost and most efficient generator (and hence be the most deserving recipient of a LTESA).
There is a substantial risk that AEMO Services is tempted to promote (by awarding an LTESA) a project that will serve to resolve a market operations issue over another project which does not, despite that non-award project being a more low cost and efficient generator.
Even if this conflict of interest is actively managed with the utmost probity, the perception will remain and any decision by AEMO Services to award an LTESA will be open to the accusation of bias. So – why run this risk and appoint AEMO Services as Consumer Trustee at all?
There are whole departments within the NSW Government that are experts at running tender processes and evaluating bids across a range of objective and subjective tests and quantitative and qualitative criteria. The LTESA assessment will require a relatively simple assessment of the strengths and merits of the relevant project, including its cost of generation. And hence would appear well within the expertise of the NSW Public Service.
Receipt of an LTESA may be the difference between a project being funded or failing. With millions of dollars spent on project development being lost in the event a project does not proceed, unsuccessful LTESA tenderers will rightfully look to all the circumstances surrounding their failure to secure LTESA support. This could put the whole scheme at risk.
The Hamilton Locke team advises across the energy project life cycle – from project development, grid connection, financing, and construction, including the buying and selling of development and operating projects. For more information, please contact Matt Baumgurtel.