Harvard Institute forInternational DevelopmentHARVARD UNIVERSITYAn Integrated Analysis of a PowerPurchase AgreementGlenn P. Jenkins and Henry B.F. LimDevelopment Discussion Paper No. 691April 1999© Copyright 1999 Glenn P. Jenkins, Henry B.F. Lim,and President and Fellows of Harvard CollegeDevelopment Discussion PapersHIID Development Discussion Paper no. 691An Integrated Analysis of a Power Purchase AgreementGlenn P. Jenkins and Henry B.F. LimAbstractA Power Purchase Agreement (PPA) is at the heart of any BOT or BOO type power generationproject that is to be undertaken by an Independent Power Producer (IPP). During the past decadeprivately owned IPPs selling electricity to the power industry has become common place. Sucharrangements require some version of a PPA. In this paper we model a multi-currency loan andequity financing package for a 100 MW combined-cycle gas turbine generation plant that is to bebuilt in India. Using this financial model we evaluate a sophisticated power purchase agreementin order to identify the relative importance of each of the variables found in such an agreement.Variables become important if they represent major elements of costs or revenues or aresignificant sources of risk.This paper provides an example of the benefits that an integrated financial-economic-stakeholder analysis can bring to the evaluation of a PPA and BOT contracts. The integratedapproach allows various scenarios to be compared from different perspectives and points ofview. The economic analysis looks at the project’s impact on a country’s overall economy. Thefinancial analysis of such an infrastructure project checks on the profitability and sustainabilityof the project over time. Sensitivity and risk analyses are central to the evaluation of this projectsince they identify the most critical variables and allow a probability distribution of values to beused in the model, rather than a single predicted value. The distributive or stakeholder analysisidentifies who would be the major winners and losers if the power plant project were undertaken.This approach enables the partners to the agreement to “test” the sustainability of the contractthrough the analysis of the project’s outcomes under a wide range of situations and combinationsof scenarios before the PPA is entered into. The technique of testing contracts for their futuresustainability is area of research of potentially great benefit to the parties entering into long termcontractual arrangements for public services.JEL Codes: D61, H43, L94Keywords: India, electricity, agreement, foreign investment, privatization, appraisal.Glenn Jenkins is an Institute Fellow and Director of the Program on Investment Appraisal andManagement at HIID, and Director of the International Tax Program at Harvard Law School.Henry Lim is a Research Fellow at the International Tax Program, Harvard Law School.HIID Development Discussion Paper no. 691An Integrated Analysis of a Power Purchase AgreementGlenn P. Jenkins and Henry B.F. Lim 1I. INTRODUCTIONThe Indian government, in their 1992 five-year development plan stated that the countrywould need 142,000 MW of power capacity by the year 2005. This would require an additional48,000 MW of electrical generating capacity to the existing 75,000 MW. In the 1990’s the rate ofeconomic growth in India accelerated from near stagnation in 1990-1992 to 6% in 1993-1994,6.3% in 1994-1995 and 6% in 1995-1996. If the electrical energy demanded is not supplied, thisexperience of improved economic performance could be put in jeopardy.In 1992, the government amended India’s Electricity Act of 1910 and opened theelectricity sector to privatization and foreign investment. An incentive package was enacted in1993 to provide a five year tax holiday for new projects in the power sector and a guaranteed16% return on foreign investment. Additionally, the protracted project approval system wassubstantially revised. In January 1996, the government announced new guidelines governinghow India’s state-run electricity boards should evaluate their power projects through competitivebidding. Even though the states have the responsibility for negotiating their own power deals,they are likely to follow the new guidelines, as the federal power ministry’s approval is requiredfor all new projects.The state of Sendara Pradesh2 requires substantial additions to its present powergenerating capacity to meet the power demands of its growing industry, agriculture and othersectors. For the period 1998-2000, the shortfalls in peak capacity are 1,471 MW, 2,035 MW and2,263 MW. The state is experiencing an acute shortage of power to a point where there has been 1 The collaboration of José F. Azpurua Sosa and Alberto Barreix in the completion of this study was essential,and greatly appreciated. The comments of our colleagues, Baher El-Hifwani, D.N.S. Dhakal, G.P. Shukla andMigara Jayawardena have helped to enhance the analysis. A special thanks to the participants of the ProgramAppraisal and Risk Analysis for the Power Sector, held at the National Institute for Financial ManagementFaridabad India in January 1998, who provided us with many insights on the role and operation of Power PurchaseAgreements in India. Any errors that remain are the responsibility of the authors alone.2frequent power failures as well as demand cuts on high-voltage industrial customers andrestrictions on low-voltage businesses and residential customers during peak hours. This trendhas to be reversed to satisfy the unrestricted demand of power and to provide adequate reservesfor periodic overhauls and emergency outages. The Sendara Pradesh State Electricity Board(SPSEB) has already identified a number of industrial projects that have been stalled at variousstages of implementation due to power shortages. For a large part of the state, the supply ofadequate electricity is an immediate requirement for industrial development and for improvingthe living conditions of the people. By the year 2000, the State of Sendara Pradesh is expected toface a deficit of 2,263 MW in peak power availability. The Government of Sendara Pradesh isencouraging several private power developers to participate in the construction of new powerplants within the shortest possible time.As a result of this policy, a Memorandum of Understanding (MOU) was signed betweenthe Government of Sendara Pradesh, Sendara Pradesh State Electricity Board (SPSEB),Industrial Power Supply Private