Boosting Nigeria’s Solar Energy Mix Portfolio: Significance of the Put and Call Option Agreements

On the 12th of April, 2017, it was announced that the Federal Government through the Ministry of Power signed Put and Call Option Agreements (PCOA) for two large scale solar power firms of the 14 large scale solar power firms that indicated interest to build and generate up to 1125 megawatts (MW) of solar power for Nigeria’s national grid and executed Power Purchase Agreements (PPAs) with the Nigerian Bulk Electricity Trader (NBET).

This bold step by the Federal Government paves the way for boosting the Country’s energy mix via increased generation through solar. However, several factors enumerated below must be taken into consideration in boosting the nation’s energy mix via solar or any other alternative energy source.

The executed PCOAs are instrumental to ensuring the bankability of these solar projects by serving as an indemnity for the project promoters to kick off the project cycle from construction to final completion with the ultimate aim of increasing grid power. The PCOAs seal the terms of the PPAs in terms of payment guarantees.

The PCOA is one of many structures used as a credit enhancement tool by Sovereign Governments to backstop the payment obligations of the purchasers of power, i.e. NBET in the case of Nigeria. The negotiation stage usually involves an array of key stakeholders and authorities particularly the institutions that also negotiate the PPAs.

The PCOA guarantees payment for power generated in the event NBET does not meet its payment obligation to the Solar power generators. With such a guarantee, project promoters can develop their projects seamlessly from conception to post completion.

Therefore, in the event the PPA is terminated early or any other grounds for early termination occur other than buyer (NBET) default, the government through NBET will have the right to purchase shares in the capital of the Project Company (‘Call Option’) and on the other hand, the shareholders in the Project Company (i.e. the solar power firm(s)) have the right to require the government through NBET to purchase the shares in the Project Company (‘Put Option’) upon early termination of the PPA or in some cases on the occurrence of a Natural Force Majeure. The shareholder during the Option Period is usually required not to issue any shares, stocks or securities or make any alteration in its share capital to maintain the share sale value. In addition, as a condition to the exercise of a Put Option, disputes under the PPA are usually required to be resolved in order not to alter or dilute the value of the shares.

The key clauses in a PCOA include but are not limited to:

‘Share Repurchase Price’ which is the price at which the shares are repurchased subject to the clause electing parties to purchase shares on the exercise of either the Call Option or the Put Option.

The price is usually determined by the initial purchase price plus an amortized rate reflecting a straight line depreciation over the term of the PPA.

Upon exercise of the Put/Call Option, the value of the repurchase price will reduce where the seller (solar power firm) fails to operate and maintain the plant in accordance with various requirements expected to preserve the value of the plant as stipulated in the PPA.

However, where it can be proven that the fair market value for repurchase of the shares taking into account appropriate adjustments for liabilities and assets is equal to or more than the share repurchase price, no reduction is usually applied to the share repurchase price.

A valuation of the repurchase price to be undertaken by accountants is usually a requirement in the agreement. Where the seller fails to pay an amount that it is obligated to pay to the buyer under the PPA, such amount is usually deducted in calculating the share repurchase price.

‘Buy-Out Notice’ which is usually issued either by the Government stating its intention to exercise the Call Option or issued by the Shareholder stating that it wishes to exercise the Put Option.

‘Option Period’ which is the period between the date of receipt of the Buy-Out Notice and the Option Completion Date.

‘Power of Attorney’ which is usually granted to the government entity to do all acts as required to effect the Call Option in accordance with the Agreement.

‘Consultation Period’ to enable parties to attempt in good faith to find mutually agreeable solutions to any event that is the subject of a termination notice.

‘Negative Covenants’ capturing the Shareholder Covenants which prohibits selling, disposing or encumbering the shares except otherwise stated in the finance documents, assurance of warranties/representations, etc.

‘Plant Condition Audit’ to ascertain the state and condition of the plant following issuance of a termination notice and/or prior to the Buy-Out Date. This also includes an Environmental Audit to certify the presence/absence of an environmental condition on, in or under the plant.

‘Due Diligence Period’ between the date of issuance of the Buy-Out Notice to the Buy-Out Date for a due diligence investigation to be undertaken regarding matters relating to the purchase of the shares, covenant breaches, the condition of the Plant, computation of the share repurchase price, etc.

Whilst the Indemnity Agreement is a positive step by the Federal Government, consideration has to be given to the following issues concerning the contribution of Solar to the Nigerian energy mix for increased national generation output:

The higher tariffs for solar than the average cost of grid generation which is currently around US$11.5/kWh (N40-50/kWh) compared to grid generation tariffs of around US4-5/kWh (N18/kWh). This is not in consonance with the costs Discos can recover in tariffs. Additionally the pass through costs from exchange rate fluctuations in the PPA’s are not recoverable from retail tariffs given the current design of the MYTO (Multi Year Tariff Order);

TCN’s Wheeling capacity to consistently wheel the additional power generated given the poor state of the transmission network worsened by the limited budgetary allocation of N40.2 Billion which is grossly insufficient and at variance with TCN’s Capital Expenditure (CAPEX) provision of N418.504 Billion as contained in the MYTO 2015 Financial Model. The resultant effect of the funding constraint is TCN’s inability to undertake transmission projects and also meet its network reinforcement targets. Thus, the increased generation from solar into the grid will only result in stranded capacity on the transmission end based on the current limited transmission wheeling capacity hinged on the unstable transmission grid. Beyond grid capacity, there are significant stability issues including frequency and reactive power, etc;

Challenges for system operation posed by a shift in the power generation mix (renewables) such as energy storage, ability to vary output which in effect makes some of the alternative sources largely inflexible and at best intermittent, etc.

Although according to the Government “It sits very well with the Ministry’s [plan] to deliver 30% of total energy capacity through renewables by 2030” however, policy formulation has to be well thought out and the right investment incentives need to be in place such as mobilization of investment capital, import duty and VAT exemptions, corporate income tax exemptions and reductions, land use/rental exemptions, etc.

Ivie Ehanmo is an Energy Lawyer/Power Sector Legal and Regulatory Specialist. She is a Partner at the law firm, George Etomi & Partners where she manages the firm’s Energy and Infrastructure Projects and is also a Senior Legal and Regulatory Consultant for Energy Market and Regulatory Consultants (EMRC) (Formerly Mercados EMI).