Risk Audit for Distributed Generation Investors | Fedotov & Partners

Distributed generation is becoming the cornerstone of business energy resilience: reducing grid electricity consumption, hedging against price volatility, and unlocking new revenue streams (such as balancing and ancillary services, active consumer models, and power purchase agreements). At the same time, the regulatory and market landscape is shifting rapidly, with major legislative updates affecting distributed generation operations occurring almost monthly. In such a dynamic environment, staying ahead of the curve is essential to maintaining the most profitable operating model.

Audit of commercial models and distributed generation revenue

The purpose of the audit is to identify, assess, and mitigate risks affecting the cost of generated electricity, internal rate of return (IRR), fuel component costs, and investment payback periods.

It is best to conduct the audit in layers, ranging from the asset's legal status to technical reliability and market monetization models.

Layer 1. Asset structure and legal framework

- Rights to the facility and land/roof: ownership or usage rights, zoning, urban planning conditions, easements, lease terms, and protective restrictions (heritage sites, power line or gas pipeline zones).

- Legal entity structure (energy company): articles of association, corporate restrictions on power purchase agreements or collateral, quorum and veto procedures, and screening of ultimate beneficial owners for sanctions.

- Licensing: While not all distributed generation projects require a license, there are specific cases where one is mandatory. Therefore, verifying compliance with licensing legislation is a critical and essential step.

- Software and monitoring system rights: access terms for management and metering systems, cybersecurity requirements, and verification of the legal status of generation performance data stored in third-party software.

- Litigation and arbitration: active lawsuits, creditor claims, and any encumbrances in public registers.

Layer 2. Regulatory framework and permits

- Design and construction documentation: classification of consequences, environmental impact assessment (if required), certificate of completion, and other relevant documents.

- Technical specifications and grid connection agreement: verification against the actual connection scheme and analysis of grid constraint risks.

- 2024–2025 regulatory changes: new price caps on the day-ahead and intraday markets, implementation of European electricity market reforms, and legislative changes regarding renewable energy support.

Layer 3. Commercial model (profitability)

- Revenue structure: on-site consumption, selling surplus to the grid, sales via power purchase agreements (fixed or indexed pricing), providing services to the system operator (ancillary services), and operating as an active consumer.

- Contractual structure: settlement models, cost and pricing mechanisms, imbalance liability, penalties for non-performance, force majeure clauses, and more. 

Layer 4. Technical aspects (from design to operation)

- Contractor vetting for design and construction: certifications, track record, warranties, delay penalties, and the allocation of liability between contractors and suppliers.

- Equipment: manufacturer warranties for modules, inverters, and other distributed generation components. Design: shading analysis (for solar installations), cable losses, redundancy, fire safety, compliance with occupational health and safety requirements, and more.

- Operations and maintenance: availability and efficiency metrics, maintenance schedules and checklists, spare parts availability, and emergency procedures.

Level 5. Market risks (prices, constraints, balancing)

- Analysis of price volatility in organized market segments: scenario modeling for the day-ahead and intraday markets, and the impact of changes in price caps.

- Fuel component analysis: for gas-fired power plants, it is necessary to consider natural gas procurement sources and associated risks. 

Related article: Requirements for importing and storing natural gas in Ukraine

- Balancing market: analysis of the feasibility of participating in the balancing market and calculating optimal prices that distributed generation can offer in this market.

- Analysis of sales contract terms: when selling on the wholesale energy market to other participants (traders, suppliers), it is necessary to consider contract risks, terms, and adjustments to price formulas.

Level 6. Financial and banking requirements

- Financing: obligations to creditors (debt service coverage ratio, minimum availability levels, insurance requirements), and direct agreements with contractors and electricity buyers.

- Financial risk hedging: using contracts and financial instruments to mitigate the impact of currency fluctuations and interest rate changes.

How is a distributed generation risk audit conducted?

The risk audit is carried out in stages to provide the investor with a consistent and structured view of the project—from initial document review to the final investment conclusion. Each stage has its own purpose and set of deliverables:

Stage T0–T1. Preliminary screening

- Client questionnaire: 20 to 40 questions for an initial project assessment.

- Information base request: obtaining key materials for analysis.

- List of identified gaps and risks: drafting a description of deficiencies that require further processing and legal resolution.

Stage T2–T6. Full legal and technical audit

- Legal due diligence: ownership or usage rights (title), contractual framework, compliance with regulatory requirements, and analysis of litigation and administrative risks.

- Commercial due diligence: review of the electricity sales model.

- Technical due diligence: design solutions, construction works, operations and maintenance, monitoring and control systems, health and safety, cybersecurity, and fire safety.

- Financial due diligence: financial model, sensitivity analysis, and documentation package for banks and potential lenders.

Stage T6–T7. Risk Register and Mitigation Plan

- Risk matrix: classification by probability of occurrence and impact level.

- Client requirements for EPC (Engineering, Procurement, and Construction) and O&M (Operations and Maintenance) contracts: establishing clear criteria and technical standards.

- Term sheets for power purchase agreements (PPAs), prepared with necessary amendments and protective provisions.

Stage T7. Investment Memorandum / Key Risk Report

A final conclusion is formed regarding the project's investment viability, the terms of investor entry, and the conditions precedent that must be met before financing or implementation begins.

Most common risks for investors in distributed generation

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During distributed generation audits, we encounter a number of typical issues that significantly impact the investment attractiveness and financial stability of projects. Below are examples of the most common risks:

- Power Purchase Agreements (PPAs) lacking a clear indexation formula and failing to define the range of acceptable price fluctuations.

- Technical specifications do not match the actual connection scheme; risks of restrictions by the distribution system operator or dispatcher have not been assessed.

- Monitoring and control systems (SCADA/EMS) are inaccessible to the investor or lender, with no event logs or cybersecurity policy in place.

- Operations and maintenance contracts lack performance indicators (KPIs and liability for non-performance) and do not include a reserve of critical components.

- Underestimation of the risk of imbalance settlement and deviations between the generation profile and actual consumption profile (in cases where a portion of the energy is consumed for self-supply).

- The legal status of the land plot does not align with the project's objectives.

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Risk audit results for distributed generation projects

Upon completion of the audit, the investor receives a comprehensive document package that allows them not only to assess existing risks but also to understand mitigation strategies and their impact on the project's financial model. The key findings are presented in the following documents:

1. A key risk report detailing critical and medium-priority risks, along with specific recommendations for contract amendments. 
2. A risk register and mitigation plan: tables prioritizing risks by probability of occurrence and level of impact.
3. Financial model analysis featuring various operational scenarios for distributed generation.

If you require an audit for a specific distributed generation project or templates for power purchase agreements to operate in the electricity and natural gas markets, The Fedotov & Partners team will conduct a key risk audit and prepare a report for you that will significantly protect your project from errors.

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