Ministries of finance are often asked to guarantee a state-owned electricity utility's payments to an independent power producer under a power-purchase agreement (PPA). The decision whether to grant the guarantee is unlikely to be straightforward.
There are several reasons why a government would consider granting this type of guarantee. If demand for electricity in a country is growing, there may be a need to invest in new power-generation plants. Alternatively, the government may be seeking to mitigate climate change by increasing investments in renewable energy such as solar, wind or biomass.
However, ministries of finance have reason to be cautious about the risks of guarantees. The reasons behind this conservatism may stem from previous negative experiences with guarantees granted to state-owned companies. In addition, financial markets or other stakeholders may perceive a government’s guarantees as a potential source of fiscal risk.
To decide whether to grant the guarantee, the ministry of finance should have at least a rough estimate of the guarantee's expected cost.
The paper Power to the Fiscal? An Exploration of the Use of Credit Ratings to Estimate the Expected Cost of a Guarantee of a Power-Purchase Agreement proposes a method for estimating the expected cost of such guarantees. Making use of an analogy between a power-purchase agreement and a debt contract, it illustrates how credit ratings can be used to generate a rough estimate of the expected cost of guarantees of PPAs. It further discusses some of the advantages and disadvantages of the approach and argue that despite many assumptions and simplification to obtain the cost of the guarantee, this method may be easier to apply than alternative approaches, and the average cost estimate may provide useful input for policymakers.