Renewable energy transactions involve significant potential risks, including, but not limited to, the following:
Market risk: specifically, electricity prices can be volatile
The valuation of a PPA is susceptible to changes in forecasted electricity prices. Buyers, for example, take a long-term view that future electricity prices at the PPA settlement point will, on average, remain higher than the agreed-upon PPA Price. If power prices drop significantly and do not recover for a long period of time, buyers may incur sizable losses.
Direct credit exposure
PPAs are completed bilaterally and are not centrally cleared. Therefore, parties face each other directly, meaning market participants will be directly exposed to the credit rating and credit risk of their counterparties. Most renewable energy sellers are not rated by Moody’s or S&P. If a counterparty defaults on a PPA and the PPA is ‘in-the-money,’ there is no guarantee that the non-defaulting party will recover all of its potential losses.
Contract duration and liquidity
Typically, PPAs range from 12 to 15 years. Sometimes, contract durations can extend to 20+ years, or be less than 12 years. The length of these contracts may pose risk, especially since liquidity for most energy products are limited to a period of time that is significantly less than the duration of a PPA. Further, the length of these contracts makes it difficult to value PPAs since there are few long-term electricity price forecasts, and they typically do not update daily.
“Unwinding” and managing exposure
Currently, PPAs are bespoke and cannot be traded on exchanges. This dynamic will likely make it difficult for market participants to find liquidity and “unwind” positions or manage exposure quickly.
Some market participants may only ever enter into one PPA with one contracting counterparty in one market. This phenomenon is not uncommon, but worth noting because diversification may not always be feasible for all market participants.
Intermittency of renewable energy
The “fuel” source for clean power plants are forces of nature such as solar irradiance or wind. It is sometimes difficult to predict how much electricity will be generated, and when exactly that electricity will be generated. The difference between expected performance (outlined in the PPA) and actual performance may be significant. Further, if electricity prices spike when the power plant fails to generate electricity (possibly due to an unexpected mechanical failure or unfavorable weather conditions), buyers will not incur the financial benefits that they would have expected to incur under normal circumstances. This intermittency risk may make it difficult to predict financial outcomes.
Contract start date and potential project delays
The renewable energy seller may fail to complete power plant construction by the target PPA start date. In an extreme example, the seller may encounter a binary development issue that will prevent the seller from completing the development project, potentially resulting in an event of default.
Processing breakdowns related to buyer/seller internal information systems or controls, human error, and other operational variables may result in unexpected losses or incorrect PPA valuations.
Legal, regulatory, and compliance risk
Terms and mechanisms of PPAs can be customized and complex. Losses may be incurred if various market factors are not considered from a legal framework and addressed contractually. Additionally, market conditions, rules, and regulations may change in the future. It is important that market participants hire legal counsel that is well versed in regulatory and compliance risks as they relate to the future value of PPAs under consideration.
It is difficult to guarantee that market participants will find the best PPA price for their preferred contract terms. PPAs are bespoke and bilaterally negotiated contracts, so they are difficult to compare side-by-side, and the lowest price deal is rarely the best.
The above list of risks should not be considered advice, and there are other risks not listed above that relate to renewable energy transactions. All renewable energy buyers and sellers should consult expert counsel prior to and while evaluating or executing any commodity or renewable energy transactions.