14 minute read | July.03.2024
日本語: Japan Renewables Alert 68
Today's Topic
As July 19, 2024, the final date for the application period for the Round 3 offshore wind auctions pursuant to the Act on Promoting Utilization of Sea Areas in Development of Power Generation Facilities Using Maritime Renewable Energy Resources (Act No. 89 of 2018, the “Maritime REA”) approaches, this alert will focus on the latest news of how the government evaluates PPAs under the auctions as well as explore some of the major topics of interest in the renewable energy market.
The application period for the Round 3 auctions for offshore wind in general sea areas pursuant to the Maritime REA will close on July 19, 2024 (see here for the Auction Guidelines for Round 3). At the meeting of the expert committee (the joint committee of the Working Group for Promotion of Offshore Wind and the Subcommittee on Promotion of Offshore Wind; the “Offshore Wind Joint Committee”) (see here) under METI (Ministry of Economy, Trade and Industry) and MLIT (Ministry of Land, Infrastructure, Transport and Tourism) on June 21, 2024, METI and MLIT reported on the evaluation process for the selection of operators under the Round 2 auctions to the Offshore Wind Joint Committee. In the report, METI and MLIT explained how the MOUs with potential offtakers for future bilateral off-taking agreements on energy and/or environmental attributes (referred to as power purchase agreements, or “PPAs,” in this alert) submitted by each applicant were evaluated in Round 2. The explanation provided is helpful when preparing applications for the Round 3 auctions and should be carefully reviewed before the upcoming deadline.
For bottom-fixed offshore wind projects in general sea areas, unlike the Round 1 auctions under the FIT scheme, the Round 2 and subsequent auctions have been and will be conducted on the assumption of the FIP scheme being applied. Under the FIP scheme, FIP-approved operators can receive supply promotion subsidies (FIP subsidies) from OCCTO (Organization for Cross-regional Cooperation of Transmission Operators) based on the energy quantity sold on a merchant basis, either in the wholesale market or through bilateral agreements. Applicants for the auctions must submit the plans for their projects and have them evaluated from various perspectives by the third-party evaluation committee, and the feasibility of plans for off-taking is an important element to be assessed under the category of “cash and income/expenditure plans” (10 points in total) for the second and subsequent auction rounds, where each operator needs to come up with plans to earn income from the energy or environmental attributes generated by the projects.
However, practically, applicants cannot execute the PPAs at the time of application, which is far before the commencement of operations, even if they expect that the generated energy and/or environmental attributes will be sold to electricity retailers and/or end-users through bilateral transactions (including ones under a corporate PPA scheme). That said, applicants can submit agreements executed with potential offtakers (MOUs or LOIs provided by offtakers) to have the feasibility of their planned off-taking arrangements evaluated in the auctions (the public comment response for Round 2 (see here), No. 91).
Regarding this point, the public comment response published in January 2024 in relation to the Round 3 Auction Guidelines (see here; No. 626) states that “the feasibility of the income/expenditure plan based on the corporate PPA will be evaluated from the perspective of whether the necessary income can be reliably secured over the business period,” and further stating that, for evaluation, (1) “in addition to checking the consistency of the price, transaction quantity and contract period stated in the agreement with the offtaker and the figures in the revenue plan, will also be determined whether the commercial terms stated in the agreement are likely to be realized based upon the creditworthiness, previous history and the commitment of the offtaker and the content of the agreement, etc.” and that (2) the content of the countermeasures against risks of the default or bankruptcy of the offtaker (both prevention and ex-post measures) will also be evaluated. In relation to the topics addressed in the above response, the Q&A sheet published in April 2024 (see here; No. 224) states that (1) binding agreements are likely to be evaluated highly positively, while nonbinding agreements can be positively evaluated considering the creditworthiness of the offtaker and that, (2) with respect to the countermeasures against risks, while the most important element is whether the transaction quantity covers all of the generated quantity, the number of such agreements may be evaluated from the perspective of risk diversification.
At the meeting of the Offshore Wind Joint Committee on June 21, 2024, METI and MLIT revealed that all the applicants that placed bids at the zero premium level in Round 2 (9 out of 12 operators for all of the four sea areas) were basically planning to secure the revenue through bilateral transactions and explained how the evaluation committee evaluated the submitted plans (pp. 7 et seq. of Document 1 (see here) for the meeting).
According to their explanation, the agreements with offtakers were classified into three ranks, A, B and C, based on three evaluation prongs. Specifically, (i) the committee checked whether the offtaker’s long-term credit rating was “BBB” or higher. Those agreements that did not meet this criterion were classified as C, while for those agreements that did, in order to assess the certainty of the performance of the agreed terms, (ii) the committee further checked whether the offtaker had clearly expressed intention to perform the agreed terms and whether the usage of the electricity procured by the offtaker was concrete and specific. If this criterion under the second prong was not met, those agreements were classified as C, while for those agreements that did meet the criterion, in order to further assess the certainty of the performance of the agreed terms, (iii) the evaluation committee further checked whether the agreement was legally binding or not and ranked nonbinding agreements as B and binding agreements as A.
As the A and B rank agreements were considered to have a high degree of certainty of being performed, the evaluation committee further checked (a) whether the transaction quantity scheduled under such agreement would exceed the quantity generated, and evaluated the feasibility of the plans submitted by applicants from the perspective of (b) whether the applicant project had secured the certainty of performance by the offtaker of the agreed terms by means of requesting the offtaker to provide bank guarantees in the event of a downward change of the credit ratings, stipulation of early termination payments or other means, and (c) whether the project had specific backup plans such as securing a backup offtaker to take over the initial offtaker in the event of default or bankruptcy. METI and MLIT explained that, in Round 2, assessment for (c) made the difference among applicants, as the granting of an “excellent” rating for the “cash and income/expenditure plans” category depended on the assessment for (c).
For the Round 3 applications, it is recommended that cash and income/expenditure plans and agreements (MOUs) with potential offtakers be double-checked in light of METI/MLIT’s explanation regarding the evaluation methods for the Round 2 auctions.
In April 2024, Miyagi Prefecture became the first local government implementing an ordinance to impose taxes specifically targeting renewable facilities. As we reported in our Japan Renewables Alert 66, the ordinance imposes a tax on owners of renewable energy facilities (solar, wind or biomass) newly installed through the development of forest areas larger than 0.5 ha in proportion to the power capacity. This ordinance is attracting attention as a new measure to drive the location of new renewable energy power projects outside of forest areas, with approximately 60% of all prefectures nationwide being “interested” in such ordinance, according to a news report. In the Tohoku Region, in addition to Miyagi Prefecture, Aomori Prefecture also announced in September 2023 its intention to introduce a new tax targeting renewable energy facilities, especially onshore wind projects (see here; note that; in April 2024, the governor suggested at a press conference that the scope should include solar projects too), and the governor of Yamagata Prefecture also stated at a press conference in April 2024 that she “would like to give positive consideration to the possibility of introducing a new tax of this kind” (see here).
In addition to considering the possibility of introducing the above potential tax, Aomori Prefecture has been considering enacting an ordinance for the coexistence of renewable energy and local communities that will stipulate zoning and consensus building procedures, and the expert panel established by the prefecture (Aomori Prefecture’s Expert Panel on Coexistence of Nature and Local Communities and Renewables; the “Aomori Expert Panel”) has been discussing related matters since May 2024 (see here).
The conceptual draft presented by the Prefecture to the Aomori Expert Panel as a basis for discussion (the “Draft Plan”) lays out a plan to establish four zones: (1) coexistence zones (kyōsē kuiki), (2) adjustment zones (chōsē kuiki), (3) conservation zones (hozen kuiki) and (4) protection zones (hogo kuiki). Among these, (1) “coexistence zones” are defined as zones where a local consensus on a renewable energy project has been reached through means such as discussions at a council composed of relevant municipalities, residents and business operators pursuant to the Global Warming Prevention Act or other laws. The Draft Plan suggests that developers should not be allowed to construct their project without obtaining a prior approval for the project plan from the authority, even in such coexistence zones. Renewable projects are in principle not allowed in (4) “protection zones” and in (3) “conservation zones,” but (3) “conservation zones” can, however, be converted into coexistence zones upon obtaining regional consensus through measures such as discussions at a council. Other zones not falling under any of these three categories are categorized as (2) “adjustment zones,” where developers are encouraged to undertake procedures to convert the project site area to a “coexistence zone” in advance. If the project site has not been converted to a “coexistence zone,” the developer would be required to undertake an information session (opinion exchange session) for local residents and adjust its project plan pursuant to the planned ordinance, and then obtain a prefectural confirmation that the project plan and the consensus with local community are appropriate.
The discussions at the Aomori Expert Panel should be carefully monitored, as such regulations aiming for “local coexistence” may cause a ripple effect and extend to other regions.
In relation to the FIT/FIP framework, an amendment to the Act on Special Measures Concerning Promotion of Utilization of Renewable Energy Electricity (Act No. 108 of 2011; the “REA”) took effect as of April 2024. Major components of the amendment included: (1) the introduction of prior information sessions or other notification measures (information session in cases of projects of 50 kW or more) as a prerequisite for applications for new FIT/FIP or amendment approvals; (2) the stipulation of supervisory obligations of FIT/FIP operators over contractors; and (3) the creation of reserve orders and repay orders in cases of any incompliance with approved FIT/FIP business plans. We reported on (1) and (3) in our Japan Renewables Alert 67, together with other issues, but developers and operators also need to be aware that proper attention should be paid to (2) too, since it may require the review of existing contracts.
Due to the amendment, the REA now explicitly states that FIT/FIP project operators are not only subject to the obligation to implement their project in accordance with the approved FIT/FIP business plan (REA, art. 10-3, para. 1), but also, in cases of outsourcing their project in whole or in part to any third party, are subject to the obligation to conduct necessary and appropriate supervision of such third party to ensure the project is implemented in accordance with the approved FIT/FIP business plan (para. 2). To conform with the above amendment, ANRE (Agency for Natural Resources and Energy, under METI) published further details of such supervisory obligation in the Operational Guidelines for Outsourcing of Renewable Energy Projects (see here; “Operational Guidelines”) on April 1, 2024, the day on which the amendment became effective.
The scope of the supervisory obligation is comprehensive, as the Operational Guidelines are intended to cover basically all sorts of outsourcing by enumerating “agent services for administrative procedures and project management, design, land development, construction and installation work, maintenance and inspection (including installation and maintenance of fences, weed removal, etc.), dismantling of facilities, and disposal and recycling” as examples (Operational Guidelines, p. 1, fn. 1). According to the Operational Guidelines, FIT/FIP-approved project operators must execute a written agreement with contractors to clarify the following (Operational Guidelines, Section 1(2)): (a) that the contractor should comply with the approved FIT/FIP business plan and approval criteria (including compliance with applicable laws and regulations), (b) matters related to the project operator’s supervision over the contractor and the contractor’s reporting to the project operator, and (c) that the contractor should obtain the project owner’s prior consent when subcontracting any significant portion of the services.
Regarding (b), the Operational Guidelines further provide that FIT/FIP-approved project operators should, as part of the performance of their supervisory obligations, (i) hold regular meetings with the contractor to ensure that the parties share the understanding on the specific duties to achieve compliance with the approved FIT/FIP business plan and approval criteria; (ii) in the case of contracts involving land development, construction or installation work, to ascertain the actual status of such work by being present at the site at all times or visiting the site on a regular basis; and (iii) in the case of contracts involving land development, construction or installation work, have the contractor communicate appropriately with local residents and ensure proper supervision so that the implementation of the project is conducted with due consideration for local residents (Operational Guidelines, p. 3, sect. 2(1)). The Operational Guidelines also state that FIT/FIP-approved project operators should request contractors to provide periodic reports, as well as prompt reports in case of any abnormalities. Furthermore, in the case of contracts involving land development, construction or installation work, photographs showing the status of construction before, during and after construction work should also be attached to the written report submitted to the project operator (Operational Guidelines, p. 3, sect. 2(2)).
After a certain preparation period, beginning on April 1, 2025, it will be mandatory for FIT/FIP operators to report to ANRE on the status of outsourcing of FIT/FIP projects, including the existence of outsourcing agreements, names of the contractors, the outlines of these agreements and copies of written reports from the contractors at the time of reporting on installation costs and periodic reporting on operational costs (Operational Guidelines, p. 5 and 6, Ref. 3). FIT/FIP operators that take over a project will be required to provide reports on outsourcing agreements executed by the old operator, and the Operational Guidelines note that a transferee in such case should handle related matters properly at the time of the project transfer, including obtaining prior consent of the transferor to provision of the information necessary to comply with the reporting requests from ANRE (Operational Guidelines, p. 6, Ref. 4).
As no special transitional measures are provided for the above amendment, operators that obtained FIT/FIP approval before the effective date must execute written outsourcing agreements stipulating the above for any future outsourcing work, and amend existing agreements to conform to the Operational Guidelines if the existing agreements do not include the above provisions. Please contact Orrick if you have any concerns or questions regarding review of existing agreements and preparation of MOUs, as necessary, in light of the amendment described above.