A Fee arrangement provides for a purchaser (usually a sole entity) to manage market risk of demand and price for project output (including products and services). The purchaser is generally a local utility, public service provider or operator which will purchase the output from the project company and then use the output for its own purposes or sell the output, either directly to end users or to other aggregators.
The purchaser will enter into an agreement with the project company to use and pay for project output. The purchase agreement defines and delimits the revenue stream to be received by the project company over the life of the project. It will define not only the amount of the revenue stream but also when it can be interrupted, modified or terminated. A common method of defining the amount to be paid by the purchaser to the project company is by way of a dual payment system, commonly including a capacity (or availability) charge and a usage (or offtake) charge.
The capacity charge is that amount paid by the purchaser to the project company for making the project available to the purchaser and on the amount of capacity the project places at the disposal of the purchaser. For example, a PPP hospital project would include a capacity payment based on the availability of hospital facilities to the purchaser irrespective of actual usage.
The capacity charge will compensate the project company for the fixed costs it incurs in producing the output including, for example, financing charges, labor and insurance. Therefore, no matter what amount of output the purchaser decides to draw, it must pay for the fixed costs of the project company in consideration of the project company making the project available to the purchaser. Where the project does not perform sufficiently well and does not make available the capacity required, then the capacity charge can be reduced.
The usage charge is that paid for the amount of project output actually taken, or used, by the purchaser during the payment period. This payment will cover the variable costs of operation, such as the cost of input, some or all of the equity return and variable maintenance costs. The input cost may simply flow through to the purchaser; however, care should be taken in case the cost of input increases owing to inefficiency of the project, such as high heat rate in the case of a power plant (where the power plant requires more fuel per unit of energy than was intended, or where the fuel is of an insufficient quality requiring more fuel to be burned).
Fee projects involve only one or a limited number of large offtakers, which simplifies the assessment of revenue risk, including collection risk and credit risk of offtakers. It also allows long-term, financially viable offtake arrangements to protect investors from demand and market risks (where offtakers have more familiarity and are more comfortable with these risks).