There's a ton of confusion about the market for renewable energy, and part of our mission is to replace the black-box with a completely transparent marketplace. We've put together a list of some of the most common questions related to renewable energy finance and the market for PPAs.
What are PPAs?
Power Purchase Agreements are contracts that define the commercial terms for the purchase and sale of (renewable) energy. They are often used by corporations and utilities to procure 100% renewable energy and renewable energy credits (RECs) in bulk at the most competitive prices possible. PPAs are almost always pre-requisites to develop and construct new solar/wind power plants. By entering into a PPA, a seller hedges its exposure to future price volatility and attracts project lenders, while a buyer secures competitively priced renewable energy to authentically offset carbon emissions, typically for a period of ten to twenty years.
PPAs function as swaps that aim to provide assurances that cash flows from the future purchase or sale of power will be stable despite inevitable fluctuations in power supply and demand. At their core, PPAs are complex, bilaterally negotiated electricity price hedges. Buyers make a profit when the market price of electricity is higher than the fixed price of the PPA. PPAs should be evaluated as if a buyer is making a large investment that does not closely correlate with major equity indices or fixed income benchmarks.
What are "Virtual" PPAs?
VPPAs are purely financial transactions, meaning that buyers are not required to take physical delivery of electricity that is generated by the seller. This structure relieves a burden for the buyer and provides the buyer with more flexibility to achieve sustainability and profitability goals. These contracts function as swaps or "contracts-for-differences" in which parties settle financially based on the amount of electricity that was "delivered" and the difference between the fixed and floating price of electricity during each settlement interval. This solution is becoming increasingly popular, especially with corporations.
How should we think about VPPAs vs. REC-only deals?
Besides installing solar panels on your property to directly offset CO2e emissions, PPAs are the most effective and genuine offset strategy available. PPAs are risky by nature, but require no upfront CAPEX investment and are designed to generate a profit for the buyer. On the other hand, REC-only transactions are far less risky by nature, but guaranteed to be an ongoing operating expense. They are more of a financial or accounting solution to achieving your sustainability targets. Furthermore, purchasing RECs rarely causes a new solar or wind power plant to be constructed and physically offset fossil fuel emissions. In summary, both methods can help achieve your sustainability goals.
Why do corporations hire advisors for PPAs?
Most corporations are not in the energy business. PPAs can come with $10-$100+ million of long-term financial exposure. Until recently, most corporations preferred to mitigate risk and expertly navigate the transaction process with a specialized PPA advisor. Transaction advisors run and manage requests for proposals and make a market for inexperienced buyers. Increasingly, firms with some PPA experience are considering circumventing PPA advisors to dramatically reduce expenses.
Do all corporations hire advisors for PPAs?
No. Our customers include F500 corporations who do not use PPA advisors. Instead, our technology is used to source and recommend the best deals while significantly reducing fees.
What are some major PPA contracting pitfalls to avoid?
PPAs are complex. Many are poorly structured, primarily because advisors and buyers are laser focused on low prices and disregard other, important aspects of the contract. A significant risk is that sellers may fail to raise debt to construct their solar or wind power plants after executing a low quality PPA. This is typically referred to as “financing risk.” Sometimes PPAs will need to be renegotiated, and, unfortunately, some deals fail completely. Failure and delay may result in the loss of millions of dollars and hundreds of hours of work for both parties. Ideally, the seller and project will be successful. However, it is important to keep in mind that PPAs typically come with inherent “performance risks” (see below), which can be mitigated with proper contract structuring. Finally, the procurement processes can be poorly managed, causing massive delays and losses of top prospects. It is important to work with a trustworthy advisor that does not charge exorbitant fees.
What is basis risk?
Basis is the spread between the price of power at the point of power generation and the price of power at the delivery or settlement point. When the spread is large, it can significantly impact the economics of the transaction. This risk is increasingly borne by sellers in a PPA, but that is not always the case.
What is shape risk?
Renewables are inherently intermittent resources, generating when the sun shines and the wind blows. However, some offtake agreements known as “fixed shape” contracts include hourly guarantees, obligating the seller to deliver a fixed amount of electricity according to a pre-set schedule, regardless of whether the facility generates during those intervals. Shape risk is the spread between the amount of electricity the seller has committed to deliver and the amount of electricity the seller actually generates. Sellers manage shape risk by generating more electricity than they are obligated to deliver, creating a financial “buffer.” The revenue generated by the buffer should cover the rare events when they are unable to deliver on their own and need to turn to the spot market to meet their contract obligations. Typically, the seller aims to over-generate 95% to 99% of the time, compensating for losses incurred from the 5% to 1% exception. This type of contract demands a premium over “as-generated” or “unit-contingent” contracts, in which the buyer agrees to purchase electricity and RECs from the seller only when generated.
What is economic curtailment risk?
When the grid is overwhelmed with electricity supply, the market or balancing authority will send low or negative price signals to various sellers. When prices are extremely low, the seller may be incentivized to curtail its generation so that supply and demand can re-balance. However, if the seller does not react to the price signals, then the buyer in a PPA will be required to pay for electricity that is effectively worthless.
How are PPAs collateralized?
Credit-worthy buyers typically collateralize the PPA with a large, investment-grade parent guarantee. Otherwise, PPAs are collateralized with letters of credit and/or cash held in escrow. The sizing of the collateral can be significant and the concept of posting collateral may be prohibitive for some buyers. Sellers will also collateralize the PPA, typically with a letter of credit from an investment-grade financial institution.
What should I look for in a PPA partner?
There are many fantastic solar and wind developers / energy sellers out there! It is important to work with folks who stand behind their formal offers and have a track record of properly executing transactions. These firms are eager to hear from you. We encourage you contact us and learn about how to best define your needs so that you can be matched with the appropriate seller and PPA.
Our team of PPA experts would be pleased to demo our solution for you
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