Main benefits of PPA

Savings on the electricity price

Electricity offered through cPPAs is usually cheaper than electricity offered by retailers and traded at energy exchanges. The differences can reach up to several tens of percent.

Long-term hedge of electricity price

cPPAs are the only realistic option to fix the costs of energy purchases in the long term (more than five years). Higher predictability of costs positively impacts companies regardless of their scale and industry.

Meeting green energy targets

cPPAs are globally approved measures for the realization of green energy targets. Moreover, this type of contract is prioritised in the European regulations and widely used by global players in almost all energy-consuming (and not only) industries.

Challenges of PPA

While the savings from the cPPA are important from a business perspective, they are the backdrop to the entire contract, which is primarily aimed at hedging the risk of electricity prices and supplies. The main value for the recipient is the defined effective price of electricity covered by the contract during its term.

cPPAs, despite their huge potential related to green energy and possible savings, aren’t the easiest contracts to tackle from the accounting perspective. This relates especially to virtual cPPAs, which are financial instruments, and as such, they need to be presented at fair value on each reporting date.

Therefore, despite the many benefits of cPPAs, it is important to recognise the complexity of the process and the challenges involved. Contracts require proper goal setting and preparation for the negotiation process. When those risks aren’t properly addressed in a contract, they may result in financial loss and — in the long term — the loss of control over electricity costs.

PPA (Power Purchase Agreement)

A power purchase agreement (PPA) is a contractual agreement between energy buyers and sellers. They come together and agree to buy and sell an amount of energy which is or will be generated by a renewable asset. PPAs are usually signed for a long-term period between 10-20 years.

cPPA (Corporate Power Purchase Agreement)

Corporate Power Purchase Agreements (cPPAs) are long-term contracts for the purchase of electricity from renewable energy sources (RES), i.e. photovoltaic and wind farms, concluded directly between energy producers and corporate consumers. The location of the energy source is also not a limitation, as agreements can be in-border or cross-border.

Physical PPA

A physical PPA contract is a contractual agreement where the asset and the offtaker are in the same grid network. This means that there is a physical transfer of the energy – contrary to a virtual PPA. A third party such as a utility is appointed to manage the electricity delivery on behalf of the project. This implies that the physical aspects, such as balancing , need to be included in the contract.

Virtual PPA

That’s another common term used for a Financial PPA. It is treated as a financial instrument, often based on the International Swaps and Derivatives Association (ISDA) contract.

Peak load PPA

This is one of the many PPA volume/contract structures, although not a common one It represents a structure where the agreement is around the peak hours of consumption from Monday to Friday. All-day is typically from 8am to 8pm.  So, the buyer only commits to buying energy for their consumption during these hours. There are different blocks to pick from, such as off-peak – i.e., purchase power for night load only.

Offtaker

In a PPA deal, it’s the party that buys the energy, also known as the buyer. It’s the purchaser who buys power from a project developer without taking ownership of the plant.

Corporate

A non-utility, non-trader consumer of electricity. Industrials are often referred to as corporates, but the difference is that industrials’ energy needs are significant, and energy costs are directly linked to the cost of production.

In an annual baseload PPA, the buyer agrees to buy a determined volume of energy for every hour over the year. Profile and volume risks sit with the seller, because they have to deliver the agreed energy no matter what. If there’s low production and the seller cannot meet its obligations through its plant, the agreed volume will be sourced from the spot market.

In this commercial structure, the buyer agrees to pay a pre-agreed amount of electricity for every hour of each month. This way, the seller is taking into consideration the seasonal variability of production. The difference between the produced volume and the contracted volume is settled at the spot market.

The acronym stands for Commercial Operation Date. It’s an important date for PPAs, because it marks when the project can start selling its output.

Renewable production volumes that are committed for delivery within a PPA agreement. Depending on a buyer’s needs, they may want to contract the entire volume (100%) or part of it (i.e., 50%).

It refers to the rate at which photovoltaic panels degrade over time. For instance, a producer might estimate production volumes with a degradation assumption of 2% per annum, which means that every year the solar panels output 2% less electricity than the year before.

It’s the technical assessment of the expected annual energy yield of a planned power plant. It’s carried out by an engineering firm and plays a crucial role in the volume a plant can commit to selling.

The acronym stands for environmental, social and governance. ESG are non-financial factors to identify a company´s sustainability and societal impact. In recent decades in financial markets, special attention has been given to companies with an ESG focus, for instance funds that invest in carbon-neutral companies. In Fixed Income markets, some special bonds (called ‘green bonds’) were issued specifically to finance green projects. Financial data vendors have also developed benchmarks and indicators to track the ESG performance of individual companies.

When a power plant is merchant, it is exposed to the volatility of wholesale electricity markets. It’s exposure, also known as merchant exposure, depends on how much volume it has contracted under fixed-price instruments. If a generator expects an annual output of 10GWhm and has contracted 6GWh through a corporate PPA, its exposure is 4GWh. Exposure is also known as revenue risk.

The difference between forecasted, often on a day-ahead basis, and actual realised production of a plant.

A guarantee of origin is an electronic document with the purpose of proving the origin of energy to the customer in such a way that a certain share of the electricity used for its consumption was produced from a certain primary energy source.

In energy sales, hedging is a process to reduce price risk, as in protecting against price uncertainty, by taking an offsetting position of approximately the same size but opposite price direction. Hedging can be done by using standard products traded on an exchange or over-the-counter to transfer price risk to other market participants. Analogous transfer of risks can occur through a PPA or any other bilateral agreement. The hedged position is the volume not exposed to price risk.

In the energy trading lingo, it’s the percentage of a hedged position with respect to the open position. In simple words, it shows how exposed one is to energy risks. In a PPA, it’s common for a producer to hedge 70% of the production. In trading lingo, it’s the comparative value of an open position’s hedge to the overall position.

PPA contracts are complex. Commercial risks, Force Majeure, Change of Control, Termination, and Conditions Precedent are amongst key clauses that need to be negotiated. This is the risk of a change in the law that affects the balance of revenue or risk between the parties, for example, tax change.

A core concept in financial trading, which includes trading of energy. The market price is made up of bids and offers for certain levels of volume arranged in a stack. If there are not enough offers on the market, one may not be able to transact at the desired price or at all. Liquidity is fostered by the market, the number of market participants, their risk appetite and market regulation. Ideally, the market has enough liquidity, so that electricity or natural gas can be sold and bought with reasonable transaction costs, and without small trade volumes impacting the price of the commodities.

A market access contract, also known as direct marketing, is for the sale of electricity at market prices. It’s provided by utilities or traders for generators. It covers services such as forecasting production, imbalance management and trading to wholesale markets. A market access PPA does not provide fixed revenue to generators.

PAP is the most widely known volume structure. In this structure, the offtaker buys any volume produced from the asset at any time. It is similar to a prototypical feed-in-tariff.

Is a form of credit support to shield the counterparty from losses from failure to perform contractual obligations. It can be provided to any party of the contract.  If the offtaker has a low credit rating – or no credit rating at all – the investment-grade parent company may need to act as guarantor. Lenders usually make it a requirement for a loan agreement.

Likewise, an offtaker may ask for such a guarantee from a project developer to mitigate the risks of a project not moving forward after signing the PPA.  Other examples of credit risk mitigation tools include bank guarantees or the provision of cash into an escrow account.

Some countries are divided into separate pricing/bidding areas. Pricing is defined by local supply and demand, and interconnection. A prime example is the Nordic energy market. The physical production is always renumerated in the local area price as quoted and realised on Nord Pool Spot. Nasdaq exchange created the Electricity Price Area Differentials (EPAD) as hedging product allowing members on the exchange to hedge against this area price risk. Another country with different market zones is Italy.

In the PPA world, price risk is the uncertainty of not knowing what price you will get for the energy you produce. If you are an offtaker, it’s the uncertainty of not knowing at what price you will buy energy. The uncertainty (e.g., probability of loss) stems from the high volatility in the wholesale market prices. Price risk is unavoidable but can be mitigated through hedging instruments, such as a PPA or a futures contract that will fix your price.

Profile risk arises from the fluctuating nature of renewable energy (for example, no solar energy is produced at night). In markets with high renewable energy penetration, times of high production can mean a significant decrease in power price, that is, revenue. This will depend on the location  and type of the plant (solar or wind). You can mitigate this risk by choosing certain PPA structures.

It’s a risk stemming from regulatory changes impacting a business model. For renewables assets, a regulatory change can take many forms such as instances of regulator making generators liable for all transmission losses or retroactively cutting down pre-agreed feed-in tariffs.

The cost of a seller having to replace the PPA’s fixed price in case the counterparty defaults on its obligations or goes bankrupt. In this occasion, it needs to be sorted which portion can be recovered given market prices in force at the time of this default. Whether prices are lower or higher will define the size of the loss. Typically, mitigation tools are guarantee instruments, such as PCG or Bank Guarantees.

Renewables’ production volume is driven by external factors such as wind speed and solar irradiation, which are subject to fluctuation. This introduces uncertainty to the likelihood of achieving expected volumes and meeting contractual obligations. The annual energy production of a renewable asset is an estimate and the uncertainty around it is typically calculated and assessed on basis of long-term meteorological data.  Volume risk illustrates the long-term variations between expected and actual production, contrary to profile risk.

The risk of falling renewables revenues due to reduced price following high market growth of renewables assets. When large volumes of solar PV are produced simultaneously, the capture price in the system during their production time will decrease as other, more expensive technologies will not be needed to produce electricity and therefore not set the price in the market.

It’s a risk relevant to the intermittent nature of renewable energy. A plant has production commitments not only to the seller but to the system operator as well. On the one hand, if the buyer doesn’t receive the expected production volume, the energy needs to be acquired elsewhere. On the other hand, when the plant deviates from what the grid expects production volume to be, there are imbalance costs for the project charged by the system operator.

The magnitude of the imbalance cost is driven by the actual deviations between scheduled production and real production (“forecast error”), the regulatory design of the balancing market (i.e., punitive design with penalties) and finally, whether portfolio effects may exist.

The seller usually has a balancing agreement with a third party for a fee as a mitigation tool.

The duration of the PPA contract, from its start to the end date. It’s also known as the delivery period.