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PPAs - Benefits, Risks, and Complexities

By: Dave Galinski, Head of Customer Success - Zettawatts


A Power Purchase Agreement (PPA) is a contract between an energy buyer and a generator, typically a renewable energy project, where the buyer agrees to purchase the electricity generated at a fixed price for a specified period, often 10-20 years. These agreements are becoming an increasingly popular tool for corporate buyers to procure renewable energy; in the 5-year period from 2016-2021 the volume of corporate PPAs in the Americas alone has risen nearly 900% from 2.3GW to 20.3GW. PPAs can provide a stable and predictable energy price, as well as support the development of new renewable energy projects.



Benefits

PPAs are a way of investing in new renewable power generation, and therefore further decarbonizing the grid. Along with creating additionality, they provide some key benefits to both the buyer and project developer. The buyer is able to purchase power at a known rate over a predetermined period of time, which simplifies budgeting and allows them to hedge against volatility in the market price of electricity. For the developer, PPAs provide a stable and predictable cash flow, which can be used to help secure project financing.


Risks and Complexities


First, a buyer must determine whether they’re eligible to enter a PPA. To participate in a physical PPA, a buyer must:

  • Be located in a competitive electricity market.

  • Be located in the same ISO/RTO as the generation site.

  • In the case of off-site PPAs, the buyer must have sufficient energy demand to match most or all of the project’s generation capacity.


Eligible buyers must then begin a series of steps, each with its own risks and complexities:


1. Assess Requirements


PPAs come in a variety of types and structures (e.g. on-site vs. off-site, sleeved PPAs, VPPAs, etc.) The first step in the process is for the buyer to assess their energy requirements, financial goals, and sustainability targets to determine the type of PPA which best suits their needs. Entering a PPA can be complex and time-consuming, so this assessment is crucial for the buyer to ensure that the resources they’ll be expending are furthering their sustainability and energy procurement goals. For the following steps, we’ll assume that the buyer is entering a physical PPA, as opposed to a sleeved PPA or VPPA.


2. Select Seller


Once the requirements are assessed, the buyer needs to find a suitable seller. Generally, the planned project must be located within and interconnected with the same wholesale market in which the buyer consumes electricity. The buyer must also ensure that the output of the planned project matches their power consumption. If the buyer is able to identify a project developer that meets these requirements, they’ll typically enter a request for proposal (RFP) process with the developer. Due to the complex nature of the contract (outlined in the following section), the RFP process can often last anywhere from 12 to 18 months.


3. Contract Negotiation


The next step involves negotiation and execution of the PPA. The structure of the agreement will determine how risks are allocated between the buyer and seller, and there are a few key risks that the buyer must carefully consider at this stage. For example, price risk describes the situation in which the market price of electricity drops below the pre-negotiated price determined in the PPA, leaving the buyer on the hook to buy power at a price higher than the market rate. This is further complicated by the fact that contract negotiation can often take months, and market prices for electricity could significantly change during the course of negotiations.

Volume risk must also be managed by the buyer. The output of a renewable energy generator is only an estimate, and actual output is subject to a variety of environmental factors. If the generator produces less power than projected, the buyer will need to procure the remainder of their energy elsewhere, often at the current market rate.


4. Regulatory Approvals


Following the negotiation, the PPA may require regulatory approvals from governing bodies, which can involve extensive documentation and review processes. Risks at this stage include delays in approval, changes in the regulatory landscape impacting the agreement, and potential rejection of the PPA by regulatory bodies.


5. Financial Close


Once regulatory approvals are in place, the financial aspects of the PPA are finalized, leading to the financial close. At this stage it’s possible that the project developer may find difficulty securing project financing, especially if the landscape of financial markets has changed significantly during earlier stages of the process. Issues with insurability may also lead to delays, putting the agreement at risk.


6. Construction and Commissioning


The final steps include the construction and commissioning of the energy generation facility by the seller. This step contains typical risks for a construction project, including construction delays, supply issues, cost overruns, and technical challenges, any of which could necessitate pushing back the project’s commercial operation date.


Aggregated PPAs


If a planned project’s output is far greater than a single corporate buyer’s energy consumption, it might make sense for the developer to enter an aggregated PPA. An aggregated PPA is an agreement (or many agreements) between a project developer and multiple buyers. The process is similar to that outlined above, although the complexity is greatly amplified by the fact that all buyers must come to a consensus with the seller regarding the contract terms, pricing structure, and load to be taken from the project.


ARECs as an Alternative


In cases where a buyer is only interested in offsetting their Scope 2 carbon emissions from energy usage and isn’t concerned with procuring the electricity itself, they can avoid the complexity of a PPA by purchasing Additionality RECs (ARECs). Using the Zettawatts AREC Market, companies can commit to purchase renewable energy certificates (RECs) from future generation projects at a price of their choosing over a 5- or 10-year period, allowing them to offset their scope 2 carbon emissions while adding new generation (Additionality) to the grid without having to enter a bilateral agreement with a single project developer. Read more about how it works here!

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