As corporates increasingly look for solutions to support the development of renewable energy projects (often referred to as additionality), Virtual Power Purchase Agreements (VPPAs) have emerged as a key tool for achieving sustainability goals. A VPPA is a financial contract between a renewable energy project developer and a corporate buyer, enabling the buyer to secure a long-term contract for renewable energy while providing the developer with revenue certainty.
In contrast to physical PPAs, VPPAs don’t necessarily have to take place in deregulated markets, and the buyer does not need to be located in the same region, RTO, or ISO as the generation project. This is because VPPAs are purely financial transactions that don’t involve the physical delivery of electricity. For this reason, VPPAs are sometimes referred to as financial PPAs, synthetic PPAs, or contracts for differences.
In a VPPA, the buyer agrees to purchase both the renewable energy and certificates representing rights to the environmental attributes of that energy (called renewable energy certificates, or RECs) from a project at a fixed price (called the “strike price”). These RECs can then be counted as reductions toward the buyer’s scope 2 carbon emissions. Rather than delivering the power directly to the buyer, the project sells the energy at the wholesale market price. If the wholesale price is higher than the VPPA’s strike price, the buyer receives the difference; if it's lower, the buyer pays the project the difference.
VPPAs are an attractive option for buyers with multiple sites located in different markets, since they allow the buyer to continue purchasing power from their current retailer while entering a contract to receive RECs from a new project over many years.
If the wholesale price of power is higher than the strike price set in the VPPA, the project developer pays the difference and the buyer effectively receives RECs at a discount (or for free.) Conversely, the buyer must also accept the risk that the wholesale price of electricity dips below the strike price. In this case the buyer must pay the developer the difference, and effectively pays a premium for RECs compared to the spot market price. Further, the buyer may need to hedge against volatility in the power markets, increasing the effective cost of the REC.
For example, a buyer commits to a 10 year contract for 100,000 MWh a year. The strike price for the power is $50/MWh and the RECs are $6.00.
In the first year the wholesale price of power is $46 per MWh, so the buyer is liable to make up the difference of $4.00 per MWh. This makes the buyer’s effective price per REC $10.00. The table below extends this example through the 10-year term of the VPPA.
Year | Wholesale Price (per MWh) | Surplus/(Deficit) for power | Effective price per REC ($50 power strike | $6/REC price) | Total Cost for 100,000 RECS | Total Benefit/(cost) difference for RECs based on $6/REC expected price. |
1 | $46 | ($4) | $10 | ($1,000,000) | ($400,000) |
2 | $50 | $0 | $6 | ($600,000) | $0 |
3 | $52 | $2 | $4 | ($400,000) | $200,000 |
4 | $56 | $6 | $0 | $0 | $600,000 |
5 | $50 | $0 | $6 | ($600,000) | $0 |
6 | $46 | ($4) | $10 | ($1,000,000) | ($400,000) |
7 | $40 | ($10) | $16 | ($1,600,000) | ($1,000,000) |
8 | $40 | ($10) | $16 | ($1,600,000) | ($1,000,000) |
9 | $35 | ($15) | $21 | ($2,100,000) | ($1,500,000) |
10 | $35 | ($15) | $21 | ($2,100,000) | ($1,500,000) |
Total | Average: $11 | ($11,000,000) | ($5,000,000) |
There are several steps corporate buyers must undergo to secure a VPPA:
Step 1: Identifying a Suitable Project
The first step in entering into a VPPA is identifying a suitable renewable energy project. This involves evaluating the project's location, technology, and development stage. The buyer must also consider whether the project will be able to reliably generate enough power to meet their forecasted usage. This process can be lengthy, often taking 12-18 months to complete.
Step 2: Identifying and Modeling Project-Level Risks
One of the unique aspects of VPPAs is their bilateral nature, which means that buyers are exposed to project-level risks. These risks include fluctuations in energy production due to weather patterns, equipment performance, and grid availability. Unexpected weather could result in the project generating too little electricity to meet the buyer’s demand. Worse still is the risk that the project stalls in one of the many hurdles before commercial delivery, and never makes it online at all. These risks need to be carefully managed during contract negotiations, and throughout the course of the agreement.
Step 3: Negotiating the Agreement
Once a project and its risks have been identified, the buyer and the project developer negotiate the terms of the VPPA. This includes determining the strike price, the duration of the agreement (often 10-20 years), and other key commercial terms. These negotiations are often lengthy and complex, and are crucial to ensure that the agreement is financially favorable for the buyer.
Step 4: Navigating Regulatory and Market Complexities
Entering into a VPPA requires an understanding of complex regulatory and market dynamics. VPPAs are classified as swap agreements, and are subject to Dodd-Frank regulatory requirements under the purview of the SEC and CFTC. Compliance with these regulations requires complex accounting and reporting. Along with current regulations, buyers must navigate various energy market structures and potential changes in legislation that could impact the economics of the VPPA. Working through this requires a significant amount of time, expertise, and resources.
Step 5: Ensuring Financial Integrity
VPPAs involve long-term financial commitments, and buyers must ensure that the project developer has the financial integrity to deliver on its obligations over the term of the agreement. A potential downside risk scenario here could be the project developer facing financial distress or insolvency, leading to uncertainties in energy delivery and potential contract default. Further, projects are often sold to new operators 5 years after the commercial operating date which transfers the agreement to a new owner.
Virtual Power Purchase Agreements offer corporations a powerful tool to advance their sustainability goals by directly supporting renewable energy projects. However, entering into a VPPA requires careful consideration of project-level risks, regulatory complexity, and financial integrity.
ARECs as an Alternative Solution
Zettawatts developed the AREC Market specifically to reduce the risks and complexity of VPPAs. The AREC Market provides a way to purchase RECs from net-new generation projects at a fixed price over the course of 5 or 10 years, offering all of the benefits of VPPAs with less risk, less complexity, and a contract cycle of 90 days vs. 18 months.
Read more about ARECs here.
Comments