Summary Lessons Learned

The Procuring Authority signed a PPP contract with the Project Company for this hydropower project in the early 2000s. However, due to challenges faced by the Project Company in securing the permits needed for construction, the project did not reach financial close until five years later. The plant has a generating capacity of above 70 MW.  As per the PPP contract, the Project Company built the plant with the right to operate it until the expiry of the PPP contract, with a provision to extend the operational timeframe, before transferring the asset to the government.

This project was one of the early energy generation PPPs awarded in Brazil. The construction was delayed due to difficulties in obtaining environmental permits. The Procuring Authority consequently allowed, through a renegotiation of the PPP contract, additional time for the Project Company to complete construction. The lessons learned from this early hydropower PPP project and other projects awarded at the same time have been incorporated in the later Brazilian energy PPP contracts.

Goals and Objectives of the Partnership

The project was part of a wider programme of adding 2,607 MW to the generation capacity in Brazil. The projects awarded so far are expected to generate BRL 3.9 billion (USD $2 billion) of revenue for the Brazilian government over their contract life. With an estimated total investment of BRL 4.8 billion (USD $2.4 billion), the hydroelectric plants were built in ten States spread across five Brazilian regions: Rio de Janeiro, Minas Gerais, Santa Catarina, Paraná, Tocantins, Goiás, Rio Grande do Sul, Bahia, Mato Grosso and Pará, benefiting a population of about 19 million.

The Economic and Political Environment during Inception

In the early 2000s, there was a big push from the Brazilian government to increase the generation capacity of its energy infrastructure. Coupled with new reform policies being introduced in the country, foreign investors became more confident about their investments in Brazil. The new government’s reforms assisted in increasing the country’s GDP, and as a result, more foreign investments started to flow into the country as it became an attractive emerging market.

Construction Phase

The Project Company has responsibility for the full design and construction of the asset, according to the specifications set out in the PPP contract. In addition to the Procuring Authority’s specifications, the Grid Operator, Operador Nacional do Sistema Elétrico, has its own requirements for the Project Company to meet.

The Procuring Authority only approves the compliance of the basic design with the specifications of the PPP contract, and is not responsible for securing the required construction permits for the Project Company. Acquiring the necessary permits, such as the environmental licences, caused delays for the Project Company, which are described in further detail under the heading ‘Key Events’ below.

Once construction began on the project, it proceeded smoothly and was completed about two years after financial close.

The Grid Operator had further specifications which the Project Company also had to meet. These are designed to protect the grid from damage, facilitate a smooth integration of the plant into the grid and guarantee safe operation during the operations phase, and the Grid Operator was therefore also involved in the commissioning of the project. After the approval of the Grid Operator was reported to the Procuring Authority, permission for the project to enter operations was given.

Operations Phase

Since the start of operations, no major challenges have been faced during the operations phase. There is no power purchase agreement (PPA) or other offtake agreement with the Procuring Authority, and the Project Company is therefore responsible to sell the energy generated freely in the market (e.g. to large industrial consumers) to generate revenue. This arrangement led to a lack of revenue certainty for the Project Company, as it was relying on a small number of contracts with large industrial users. In later contracts, the Procuring Authority has introduced a clause which specifies the percentage of energy to be sold to regulated utility providers through PPAs, which increased the revenue certainty for the Project Companies.

Performance Monitoring and KPIs

Other than during testing and commissioning, the Procuring Authority did not closely monitor performance during the construction phase. The PPP contract set key milestones that the Project Company was required to achieve, which were:

• Obtaining environmental licences;
  
  
• Start of construction;
  
  
• River flow detour;
  
  
• Start of electromechanical assembly
  
  
• Start of commissioning
  
  
• Start of commercial operation

Failure to achieve the milestones can result in payments due to the Procuring Authority, the liability for which is guaranteed by a performance bond provided by the Project Company. If there are any issues or failure in meeting the milestones, the Procuring Authority could undertake site visits to investigate the causes.

The Procuring Authority’s role in the monitoring of the project reduces after the testing and commissioning phase is completed. When the power plant entered into service, the Grid Operator took over the performance monitoring of the Project Company from the Procuring Authority. The operations are monitored in real time and the associated performance monitoring reports are made available on the public domain. The Procuring Authority continues to be responsible during the operations phase for the monitoring of the Project Company’s compliance with the contract terms and any breaches could lead to liabilities for the Project Company for agreed compensation payable to the Procuring Authority.

Payment Mechanisms

The Project Company has no access to revenue prior to completion of construction and availability of the asset, so no payment mechanism is set for the construction period.

The Project Company’s winning bid for the project was significantly above the set minimum bid of about BRL 300,000. The investment fee payable to the Procuring Authority of approximately BRL 2 million is broken down into annual fees, adjusted for inflation, which are paid in monthly instalments. In addition to the investment fees paid to the Procuring Authority, the Project Company is required to pay usage fees to transmission line operators to connect to the grid. The PPP contract allowed for these fees to be reduced if the generation drops below 30GW, which has occurred a number of times on the project.

Although not specific to the PPP contract, it is important to highlight some additional fees/taxes that the Project Company is required to pay. All PPP contracts in Brazil are required to pay taxes that are dedicated to fund the Procuring Authority’s operations in regulating and inspecting the market. In addition, there is a “wire-charge” mechanism, where all Project Companies are required to set up a fund where one percent of their annual revenue is deposited. This fund is then used to pay for investments in energy efficiency and Research and Development (R&D).

The management of the fund is the responsibility of the Project Company. However, proof of the deposits is required to be presented to the Procuring Authority, and all R&D or efficiency projects carried out by the fund are submitted to the Procuring Authority for review. If it is found that the projects do not meet the Procuring Authority’s requirements of what counts as R&D, the Project Company will have to reinvest the money spent.

Project Company Change of Ownership

The Project Company went through a variety of changes in ownership guided by changes in the equity investors’ legal structure and ownership. The changes had to be reviewed and approved by the Procuring Authority. The Procuring Authority does not believe they had a detrimental impact on the performance of the Project Company. When granting its approval for a change of ownership in the Project Company, the Procuring Authority’s main concern was to ensure that the new equity investors were financially stable and technically capable to continue the operations of the project.

Facilitating Access to Low Interest Financing

Since the 1940s, the Brazilian government has been supporting local development by providing flexible financing to developers. The main development bank in Brazil is the National Bank for Social and Economic Development (BNDES) which was founded in 1952. It offers loans at more favourable rates than commercial lenders.

The senior debt loan for the project was provided by BNDES. As BNDES is willing to take on more risk than private commercial banks, its financing solutions provided better and more attractive interest rates. The solutions provided by the bank made the project commercially feasible for the Project Company.

Team Set-Up and Staffing

The Procuring Authority generation team is a large team within the organisation, responsible for 200 large (greater than 30 MW) and 1,000 small hydropower projects. There are 40 people dedicated to administering the contracts and managing events such as changes and renegotiations, as well as 50 staff responsible for routine monitoring and operations. The Procuring Authority’s team manages all contracts, and no dedicated teams are established for each individual project. The Procuring Authority believes it is adequately staffed, given its responsibilities.

Training and Development

There is an annual training programme provided by the Procuring Authority to all its employees upon joining the organisation. The programme covers a wide range of skills considered key to successful management of PPP contracts. Thereafter, individual offices provide their own training programmes designed in line with specific staff requirements. These training programmes can be delivered either by experienced internal staff or by external training providers. Quite often, seminars, workshops and dedicated courses are provided by international market leaders and institutions such as the Council on Large Electric Systems (Cigré), universities and equipment producers.

The Procuring Authority does not use a contract management manual. The required contract management skills are typically developed from on-the-job training and from experience and knowledge gained from completed and ongoing projects and academic publications.

Communications

The relationship between the Procuring Authority and the Project Company is seen as transparent. The Procuring Authority recognises the importance of a good relationship with the Project Company and its positive effect on the success of the project. It was noted that transparency allows the Procuring Authority to help solve challenges faced by the Project Company.

The official communication between the parties is done through formal letters. However, more recently the Procuring Authority has introduced regular quarterly management meetings with Project Companies on all large contracts.

Delays in environmental permitting

The project faced significant delays due to environmental permitting. Delays to the start of construction, often for more than a year, were a major issue faced by many of the hydropower plants procured at the same time as this hydropower project. At this time, the Procuring Authority did not require an environmental assessment to be submitted with the bid, and the Project Company in question would find it difficult to get the required environmental licence in the time allowed after the contract award.

The licensing process is rigorous and requires significant research, and the requirements from the environment agencies also varied between national and state governments and from state to state. Additionally, as environmental permitting did not commence prior to signing of the PPP contract, the first time the licensing body saw the proposed design was when the Project Company submitted its application, after contract signature. This procedure increased the risk of delays, and a number of power plants were cancelled entirely. In this project, the PPP contract was not terminated, and the Project Company was given the additional time needed to obtain the required licences.

Where there is a significant risk that the Project Company is not able to obtain the necessary licences, the Procuring Authority should have plans in place on how to handle resulting delays.

It is common for energy generation plants in Brazil to encounter difficulties in obtaining the necessary permits or licences. If this risk has been transferred to the Project Company, the Procuring Authority needs to have a plan in place for managing the impacts of the delay, in particular, when it is due to factors outside the Project Company’s control.

Where approval is needed from an external body, such as an environmental regulator, it is advantageous to engage with that body as early as possible, preferably before financial close.

Environmental licensing is a common challenge for project companies in Brazilian energy PPP projects. On the projects awarded at a similar time to this hydropower PPP contract award, five out of ten awarded projects failed to start construction and were subsequently terminated. To address this, the Procuring Authority has updated its procedures to require that the first of three stages of the environmental approval process is completed before the project is awarded. The new procedure is summarised below:

• The first stage is a design competition. Designers submit concept designs to the Procuring Authority, along with supporting environmental and social impact assessments;
  
  
• These concept designs are passed to the environmental regulator. The regulator’s response states whether the project is feasible or not from an environmental point of view;
  
  
• If the regulator agrees that the concept design is feasible, the design receives the Procuring Authority’s approval and the approved design goes ahead to procurement;
  
  
• If the regulator states that the concept design is not feasible, the designer is given an opportunity to submit re-designs addressing the issues of non-compliance and the procedure starts again;
  
  
• The second stage is the auctioning of the approved design. Bidders assess the proposed project design and submit their bids to obtain the right to build and operate the project and sell the generated energy. One of the bidders might include the original designer of the approved design but not necessarily. In the case the original designer is not part of the winning bid, the winning bidder is then required to reimburse the costs of the design development.
  
  
• Once the procurement phase is complete, the Project Company is still responsible for going through the remaining two stages of the environmental licensing process and the Project Company covers the costs associated with such environmental licensing.

A clear understanding of the Project Company’s financial performance is important for effective management of the operations phase.

It was highlighted that the Procuring Authority did not have a clear view on the Project Company’s financial performance. It was not clearly understood what the reasons were for the changes of ownership other than it was due to legal restructuring. Not having a clear view of the financial health and performance of the Project Company can put the Procuring Authority at risk of sudden insolvency of the Project Company.

Currently, the Procuring Authority is planning to include regular financial monitoring of the Project Company’s performance in its remit. This will give the Procuring Authority the ability to assess the Project Company’s financial difficulties and place itself in a position where it can better manage them.

Policies to reduce demand risk on Project Companies can provide a more sustainable investment environment for PPPs and increased private sector participation.

On early Brazilian PPP generation contracts, the Project Company was responsible for securing contracts to supply end users with electricity. This model did not provide high revenue certainty for the private sector as the market for large end-user contracts is not easy to forecast.

To remedy this issue and reduce the risk profile on Project Companies in energy PPP contracts, the Procuring Authority introduced a policy for future projects that provides a guarantee of a certain percentage of the generated energy to be bought by regulated utility providers. On new hydropower PPP projects, the Project Company signs two contracts; the first is the PPP contract, and the second is a PPA contract, which has a starting date approximately five years after the start date of the PPP contract. If the Project Company completes construction before the PPA start date, it can sell its electricity on the free market. Thus, in addition to allowing approximately five years to complete construction before the start of the PPA, this policy improved the revenue certainty for Project Companies, as regulated utility providers have more certain future demand.

Public perception of environmentally sensitive projects, such as hydropower plants in Brazil, can impact the long-term success of the sector.

The Procuring Authority noted that hydropower plants do not currently have a good reputation with regard to environmental impact, and that there are many stakeholders who wish to be involved in the discussions on future expansion of the sector. The Procuring Authority has responded to these concerns by improving its plans for the future development of hydropower plants, for example, by assessing what combination of plants would be a ‘best fit’ for a particular river and by involving environmental regulators at preliminary studies and planning for each individual project. How a central government addresses the energy needs at its national level is beyond the scope of this reference tool, however this example emphasises how stakeholder views can impact the direction and policy development of a sector.

In a liberalised market, policies can be put in place to incentivise continuous innovation in energy efficiency from the private sector.

The wire-charge mechanism generated substantial funds for investment in energy efficiency and research and development, which may not have occurred in a liberalised market without regulatory enforcement. The mechanism is therefore a tool that regulators can use to drive the private sector’s involvement in improvement in the energy market.

Having a Procuring Authority contract management team that sits across several contracts can increase efficiencies.

The Procuring Authority generation team is a large team within the organisation, responsible for 200 large (greater than 30 MW) and 1,000 small hydro power projects. There are 40 people dedicated to administering the contracts and managing events such as changes and renegotiations, as well as 50 staff responsible for routine monitoring and operations. The Procuring Authority’s team manages all contracts, and no dedicated teams are established for each individual project.