Indexation of RES Tariffs
In the world, there is a globally intensive trend in the development of the electricity sector in the field of renewable energy sources (RES). Large global organizations (hereinafter we will refer to companies such as Investors) are in a state of continuous search for favorable conditions aimed at paying off renewable energy projects at all stages of their development and operation. Countries, in order to attract funding to their economies, consider, discuss and make appropriate changes to create favorable conditions for Investors. This trend has not bypassed Kazakhstan, where the number of renewable energy projects is growing rapidly. As a result, the legislation of Kazakhstan in the field of renewable energy is constantly being improved.
Due to the current peculiarities of local legislative regulation of the issues of payback of RES projects, the issue of tariff indexation plays a special role in establishing economic attractiveness for Investors. The attractiveness lies in many aspects, including the speed of return on invested (in particular borrowed) funds. As you know, in Kazakhstan, electricity purchase agreements (PPA) are concluded in the national currency - tenge, and borrowed funds and imported equipment - in US dollars. Therefore, Investors bear the risks associated, among other things, with the high volatility of the exchange rate of tenge against the US dollar, and therefore, indexation issues have a particularly important economic role.
Various RES players and associations discussed and proposed many ideas for making changes and additions to the provisions of the Rules, including those regarding tariff indexation formulas, the time of application of indexations, the objects on the basis of which indexations are applied, etc. In this review, we suggest that you familiarize yourself with the latest proposed changes and additions to the Rules (hereinafter referred to as the Draft Rules).
The main proposed changes and additions to the Draft Rules are (i) the introduction of a one-time indexation of auction prices for the construction period, and technical details for determining the time of application and calculation (ii) the return of marginal prices to the indicators as of 2014, approved by the Decree of the Government of the Republic of Kazakhstan dated June 12, 2014 No. 645, and (iii) the introduction of an option to select an object for which indexation will be performed (consumer price index or the difference between the tenge exchange rate against the US dollar). Below, we will consider each proposal separately.
One-time indexing
One-time indexation refers to the indexation of auction prices for the construction period from the moment the purchase agreement is concluded and until the start of the supply of electricity from renewable energy sources to the settlement and financial center. It is noteworthy that the current version of the Rules does not provide for indexation of auction prices for the period of construction of renewable energy projects. It is believed that thanks to the proposed formula for calculating a one-time indexation, Investors can cover their risks, including risks associated with the volatility of the national currency, since this risk is one of the main barriers.
Period of application and calculation of one-time indexation
In terms of determining the moment “when to apply the one-time indexation and its calculation”, the Draft Rules provide for the following. In accordance with paragraph 21 of the Draft Rules, the application of a one-time indexation of auction prices is carried out from the date of complex tests, during which the supply of electric energy to the unified electric power system of the Republic of Kazakhstan, a fixed automated system for commercial accounting of electric energy is carried out. And the calculation is within 30 calendar days from the date of these tests. That is, the actual application and calculation is carried out before the start of operation of the RES facility.
Limit auction prices
The current version of the Rules determines the maximum auction prices, according to the results of previous auctions at the maximum price of the winner. That is, for example, if the winner won at a price of 12 tenge per kWh, then the next limit price of the winner cannot exceed this amount. However, in accordance with the proposed wording of paragraph 16 of the Rules, the ceiling auction prices will have to be determined at the level of fixed tariffs established by the Decree of the Government of the Republic of Kazakhstan dated June 12, 2014 No. 645 (hereinafter referred to as the “Resolution”).
If the Decree for 2014 set the limit price for electricity generated, for example, from the Solar Energy Station (SPP) in the amount of 34.61 tenge per kWh, then the current limit price is set at 12.87 tenge per kWh . That is, the actual proposal is to increase the marginal auction price of SES by almost three times.
In addition, these marginal prices established by the Decree will also be applied in order to calculate the formulas for one-time and annual indexation.
It is believed that the proposed proposal will significantly affect the payback rate of RES projects, however, it is also expected to increase tariff prices for electricity for end consumers. In this connection, the issue of settlements by the Government, both of the interests of Investors and the interests of end consumers, remains open.
Features of choice
It is noteworthy that the choice must be made on the basis of the decision of the applicant, sent by an official letter to the settlement and financial center 30 calendar days before the date of the annual indexation. In this case, the choice of indexation is carried out once for the entire period of the purchase agreement. Taking into account the fact that electricity purchase agreements are usually concluded for long periods, the question of which of the above options will be more economically beneficial for investors remains open.
Consumer price index or exchange rate difference
Starting from 2022, it is proposed to provide Investors with a mechanism for choosing the object of annual indexation of auction prices. Investors have the following choices:
- or apply indexation based on changes in the consumer price index for the previous 12 months before October 1 of the year of indexation (for more details, see footnotes);
- or apply indexation to the difference in exchange rate changes of the Kazakh tenge against the US dollar for the same period (more details in the footnotes).
Based on the development of the above proposals, the Draft Rules were guided by the following financial risks of the Investors:
- Increased capital costs in case of requirements for energy storage systems;
- High volatility of the tenge exchange rate against the US dollar and other currencies;
- Lack of currency risk hedging mechanisms;
- Currency risks when attracting long-term loans in local and foreign currencies.
Features of choice
It is noteworthy that the choice must be made on the basis of the decision of the applicant, sent by an official letter to the settlement and financial center 30 calendar days before the date of the annual indexation. In this case, the choice of indexation is carried out once for the entire period of the purchase agreement.
Taking into account the fact that electricity purchase agreements are usually concluded for long periods, the question of which of the above options will be more economically beneficial for investors remains open.
First use of auction price indexing
In connection with the proposed introduction of a one-time indexation, the draft Rules propose to establish a time frame for applying the first indexation of auction prices, namely not earlier than one calendar year after the application of a one-time indexation. The question of implementing this norm without temporary losses for investors in practice remains open, since this norm does not set a deadline for applying the first indexation.
The provided version will allow managing the risk of interest rate volatility and to some extent increase the attractiveness of long-term loans in tenge. This, perhaps, is confirmed by the decision taken by the National Bank of the Republic of Kazakhstan on April 25, 2022 to increase the base rate to 14%.
Conclusion
It is believed that the proposed changes to the Rules are aimed at creating and improving an economic favorable climate for Investors. With the introduction of a one-time indexation, Investors can cover their risks of tenge volatility by the time construction is completed and the RES facility begins to operate. The transition to the price indicators for electricity from renewable energy facilities established in the Decrees, to increase price barriers to the marginal auction prices, and, accordingly, it is expected that the payback percentage of renewable energy projects will increase over time. Providing the Investor with a choice of an object from which he would express a desire to carry out indexation awaits its practical application. Which of the objects will be more profitable will determine the time, as well as the question of whether these changes will be made at the legislative level to the Rules, we will find out soon.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.