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As the China-Uzbekistan relationship deepens, Uzbekistan¡¯s abundant energy resources have made it a popular destination for Chinese enterprises expanding abroad. The Uzbek government has been working on its power sector reform in the past two years. This article discusses key points of attention in a power purchase agreement (PPA) in Uzbekistan against the backdrop of the ongoing power sector reform, offering advice to Chinese investors.

Typically, the Uzbek party that purchases electric power (offtaker) prepares a PPA template for the party that sells electric power (seller), and both parties negotiate the terms and conditions before reaching an agreement. During the final review of all the details, the seller (usually also the investor and the power station owner) is advised to pay special attention to the following points.

Change of the offtaker entity. One major change from the power sector reform is that from 1 July 2024 the exclusive offtaker in a PPA is no longer the National Electric Grids of Uzbekistan (NEGU). Instead, it is Uzenergosotish (UES). NEGU is now responsible only for grid operations. So, a seller can enter into a PPA only with UES, and should sign an agreement with NEGU separately for the purpose of grid connection.

Take-or-pay principle. When negotiating with the offtaker, the seller often opts for a take-or-pay clause. The Chinese investor/seller is advised to ensure that there is a such clause in the PPA in order to protect its interest, specifically, through binding the offtaker to: (1) take an agreed minimum amount of electricity; and (2) pay the seller for the agreed minimum amount of electricity despite any failure to take such agreed minimum amount.

A separate commercial agreement can be reached to allow the seller ¨C in order to protect its economic interest ¨C to seek a new offtaker for its excess electricity due to the offtaker¡¯s violation of the take-or-pay clause in a PPA.

Electricity revenue security mechanism. To ensure the continuity and stability of revenue to repay its prior financing or loans, the seller is advised to incorporate a performance security provision in the PPA and specify types of credit instruments, such as bank guarantees, standby letters of credit, commercial insurance and local government guarantees.

Regarding bank guarantees, particular attention should be paid to the nature of the guarantee, the coverage amount and the drawdown conditions. Assessment of the qualifications and credit ratings of the local Uzbek banks is essential to minimise the risk of the seller¡¯s inability to claim its rights in a timely way.

Currencies in billing and payment. The choice of currency in the billing and payment of a tariff is critical to the seller¡¯s revenue security. If billing in Uzbek som, the seller may face significant risks due to high exchange rate volatility and strict foreign exchange controls. Therefore, the seller is advised to review the structure of the payment provisions carefully and prioritise billing in strong currencies such as US dollars or euros.

Should the Uzbek government insist on billing in som, it is advisable that the seller use a strong currency to bill the tariff, with the government paying in som and compensating the seller for exchange rate losses, thereby mitigating the foreign exchange risks.

Government protection for the offtaker. Multiple energy projects in the past demonstrate that the Uzbek government has provided various safeguard mechanisms to the NEGU, the exclusive offtaker in the country. For instance, the tariff adjustment mechanism allowed the NEGU to benefit from the reduced generation costs of the seller, and the compensation mechanism guaranteed that the offtaker would get compensation from the seller in case of any material breach of the PPA by the seller.

Given the precedent-setting nature of independent power producer projects in Uzbekistan, such arrangements may potentially apply to future energy projects. However, due to the change of the offtaker entity, whether the successor offtaker still enjoys those safeguard mechanisms shall be subject to negotiations in specific projects, as well as the evolution of the local legal framework.

Local content requirements. Given the practical circumstances of the project, the Uzbek government may impose local content requirements under the PPA, such as asking the project owner (the electricity seller) to prioritise the procurement of local resources and equipment, employ a local workforce, purchase local insurance products, etc.

Should Chinese investors predominantly source supplies from China to maintain compatibility with domestic technical standards and cost controls, they may face challenges in complying with such requirements in Uzbekistan, particularly given the government¡¯s recent energy market reforms mandating stricter localisation thresholds.

It is therefore recommended to make a detailed review on relevant clauses during negotiation, clearly define the specifics of such requirements, and reach consensus between both parties subject to commercial feasibility and compliance with local laws and regulations.

Governing laws. In practice, the governing law of a PPA is usually the Uzbek domestic law, with limited flexibility for negotiation. Although Uzbekistan is a rule-of-law state, its national policymaking and enforcement exhibit deficiencies in coherence, transparency and predictability. Particularly during the power sector reforms, the frequent issuance of presidential decrees and cabinet resolutions to supplement existing legislation has resulted in a lack of rigor in legislative amendment procedures.

Therefore, investors should engage qualified legal counsel to make a thorough review of the PPA and closely monitor the local regulatory environment to ensure the PPA¡¯s legality and enforceability and mitigate potential disputes.

The Joint Statement on New Era All-Weather Comprehensive Strategic Partnership, signed between China and Uzbekistan in January 2024, has created substantial investment opportunities in Uzbekistan¡¯s new-energy sector, thus unlocking new prospects for Chinese businesses. To ensure legal compliance and economic returns on investment, it is crucial to address the above-mentioned issues during PPA negotiations and amendments. Meticulous contract management will also serve as an effective tool to mitigate legal risks.

Wang Jihong is a senior counsel and Liang Danni is an associate at Zhong Lun Law Firm