Power Purchase Agreements (PPAs) have gained significant traction in the corporate energy purchasing market in recent years.
In a previous article, we highlighted PPAs as a 2021 Energy Trend in Europe, following their rise in recent years. There are avenues for rapid growth in the PPA market if barriers to contracting are removed, and more innovative PPA products are created.
There have already been some innovations with PPA contracting structures, and newer variants have come to the market in the past couple of years.
To help frame where the PPA market is now and what options are most common in the market, we created this guide to help your company navigate the Corporate PPA maze.
But first, let's give an overview of what is a power purchase agreement and its different types.
What is a PPA?
A PPA is a contractual agreement between a power producer and a power purchaser. It outlines the terms and conditions for selling and purchasing electrical power. PPAs are used in the energy industry, particularly in renewable energy projects.
In the context of renewable energy, such as wind or solar power, PPAs play a crucial role in facilitating the development and financing of projects.
The power producer, a renewable energy developer or generator, agrees to sell the electricity generated by their facility to the power purchaser, who could be a corporate entity, utility company, or even a government agency. PPAs usually are long-term agreements that span several years or even decades.
Corporate PPAs are a specific type of power purchase agreement where the power purchaser is a corporate entity, often seeking to meet sustainability or environmental targets. These agreements allow businesses to buy a certain amount of renewable energy from a power producer.
By entering into a corporate PPA, the purchasing company can secure a long-term supply of renewable energy at a predetermined price, providing stability and often cost savings over the contract duration.
Corporate PPAs are attractive to companies looking to reduce their carbon footprint, show environmental leadership, and hedge against future energy price volatility.
They provide a direct way for businesses to support the development of renewable energy projects, driving the clean energy sector's growth.
Multiple types of PPAs exist, catering to different needs and circumstances. Here are some common types:
Corporate PPAs
As mentioned earlier, corporate PPAs involve a corporate entity as the power purchaser. These agreements allow companies to get renewable energy to meet their sustainability goals. Corporate PPAs can be structured as physical or virtual PPAs.
Physical PPAs
In a physical PPA, the purchasing company commits to buying a specific amount of renewable energy generated by a project. The electricity is delivered to the grid, and the company can either consume it or sell it back to the market.
This agreement involves a renewable energy generator and an off-taker for the delivery of electricity to a site through the power grid. The parties agree on a price for the duration of the PPA, a fixed €/MWh with annual indexation.
A physical PPA enables a third-party power supplier or marketer to integrate the power volumes into the company's existing energy contract.
Adopting this approach means that the company must manage the variability of the renewable plant's power production and how it aligns with its power consumption. Typically, this risk is transferred to a power marketer whose trading teams are responsible for balancing the power volumes.
Virtual PPAs
Virtual PPAs, also known as financial or synthetic PPAs, don't involve physical electricity delivery.
Instead, the purchasing company commits to buying renewable energy certificates (RECs) or guarantees of origin (GOs) associated with the renewable energy project. This allows the company to claim the environmental attributes of the purchased renewable energy, even if the electricity doesn't flow to their facilities.
A virtual PPA replicates the financial aspects of a physical one, without involving electricity delivery. It’s a “financial swap” contract that falls outside the scope of physical electricity delivery. The terms of the contract will usually be set up as a contract for differences.
The company agrees to a fixed price for the generated electricity and assumes the risk of the wholesale market price outcome. They will benefit from the contract if the market price exceeds their fixed price. But, if the market price is lower, they will incur a loss as they are locked into a higher fixed power price.
There are also different options on virtual or physical PPAs due to some variations on the contracts signed, as they can be:
- Short-Term PPAs: These PPAs have a shorter duration compared to long-term agreements. They are often used to provide flexibility and manage energy supply or demand fluctuations in the short term. Utilities or power generators commonly use short-term PPAs to meet immediate electricity needs or balance their portfolios.
- Sleeved PPAs: A sleeved PPA involves an intermediary, a utility or a power marketer, who acts as an intermediary between the power producer and the purchaser. The intermediary facilitates the transaction and ensures the delivery of electricity from the power producer to the purchaser. Sleeved PPAs can be useful when the off-taker (purchaser) has specific requirements or limitations that prevent a direct agreement with the power producer.
- Offsite PPAs: Are agreements in which the power producer and the purchaser are located in different geographical locations. The electricity generated by the power producer is fed into the grid, and the purchaser receives financial benefits or renewable energy credits based on the agreed-upon terms.
Which type of PPA is best suited for my company?
Choosing between Physical and Virtual PPAs can be difficult as it can be hard to see the benefits and drawbacks of each option. The following table outlines the main considerations for both Physical and Virtual PPAs.
When comparing Physical and Virtual PPAs, we find remarkable similarities. Both options offer comparable cost savings, additionality, and market image. However, the nuances lie in the finer details. Let's explore the two main differences and how they might impact a company's decision-making.
Same Power Grid location
When contracting a Physical PPA, the off-taker needs to be located in the same power grid as the renewable energy plant. Physical delivery of the electricity wouldn't be possible otherwise.
This restriction does not limit virtual PPAs; the renewable energy generator can be installed anywhere. This opens up the potential for cross-border PPAs and gives a company more freedom to buy different types of renewable energy or even larger amounts.
However, the company may still want to have strong energy cost alignment with its local energy market. In this case, the renewable generator under a Virtual PPA would need to be located in the same grid as the off-taker or in a power market that is highly correlated with the off-taker home market. This ensures an effective price hedge is made through the PPA.
Even though the off-taker and generator may be on different power grids, the production of cross-border Virtual PPAs can still be matched to local consumption using software tools.
These tools allow companies to assess the energy-matching effectiveness of the PPA and, ultimately, its CO2 impact.
Financial Derivative Accounting
The other main difference between a Physical and Virtual PPA is how they are treated from an accounting perspective.
Companies based in the U.S. use the U.S. GAAP accounting standards, and those in Europe use IFRS. Global companies may be required to report financials under both standards.
When it comes to PPAs, the two accounting standards have different rules. One of the main differences is that Virtual PPAs may be viewed as a financial derivative under IFRS rules but not under US GAAP. This is significant as financial derivative accounting can impact a company's ongoing financial reporting.
In essence, the Virtual PPA needs to be re-valued using mark-to-market accounting every time the balance sheet is reported. This is a complex challenge as the PPA's fair value will be based on forward energy prices. As the energy market is volatile, the PPA value on the balance sheet is also at risk of volatility.
Any increases or decreases in value will need to be reported as profits or losses. A company needs to assess if it's comfortable taking on this challenge before choosing whether to pursue a Virtual PPA.
Accounting rules are subject to change, and the goal is for more alignment between U.S. GAAP and IFRS, so rule changes in the future are possible.
To have a better understanding, we can see some PPA examples that have been signed in Europe.
Examples of PPA in Europe
For Physical PPAs, a deal between Spanish supplier Iberdrola and Danone is likely to be an example. The deal isn't stated as being physical or virtual, but it's more likely that Iberdrola is both the project developer and supplier in this case – and "sleeving power" to Danone's facilities in Spain. The contract will result in Danone offtaking some power from what will be Europe's largest Solar PV plant.
On the Virtual PPA side, Novartis recently concluded a significant deal to offtake power from new solar plants in Spain. The contract is expected to "collectively add more than 275 MW of clean power to the grid." This is an interesting example as Novartis will be subject to IFRS accounting standards, and the PPA will likely be subject to derivative accounting. This suggests that corporates are willing to accept some level of financial reporting risk that comes with Virtual PPAs.
In Europe, both Physical and Virtual PPAs will have the same impact from a carbon reduction perspective. The differences lie in the finer details, and each corporate needs to decide which PPA to contract depending on their circumstances. This means evaluating PPA options from a combination of economic, technical, and accounting perspectives.
Are you procuring a PPA now?
If you are in the stage of procuring a PPA, we can help you by providing granular data on your current energy consumption portfolio. This data gives you a much better understanding of:
- The times you consume the most electricity.
- When the hourly gaps are where you currently are not getting supplied with carbon-free energy.
Armed with this information, you can shop around for PPAs which will have the biggest decarbonization impact, where carbon-free energy generation most matches your consumption.
In the case of physical PPAs, this matching can also reduce your financial exposure to wholesale market energy costs and leverage your position when negotiating sleeved PPAs, as you are limiting shape risk (the mismatch between hourly production profile of the generating asset and your hourly electricity demand). Get this information now using CFE Diagnostic.
Do you currently have one or multiple PPAs?
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With many key performance indicators at RESpring such as the RE100 score, annual or hourly scope two emissions, and an energy certificate balance overview, you can optimize your decision-making process and manage all aspects of your energy portfolio.
Reach out to us to fully understand the value and solutions we provide.