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What are Power Purchase Agreements?

A Power Purchase Agreement (PPA) represents a formal contract entered into by parties involved in the energy industry, encompassing both energy purchasers and providers. Within this agreement, they mutually consent to the acquisition and sale of a specified quantity of energy that is presently or will be produced by a renewable energy source. Typically, PPAs extend over extended durations, long term agreement spanning anywhere from 10 to 20 years.

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What are PPAs for?

Renewable energy projects often need external funding, often from banks. These banks want assurance that they’ll be repaid. When there are no government subsidies, a PPA for a wind farm or solar energy provides this assurance. Think of a typical 100 MW wind farm in Europe, which can cost between 1 to 2 million euros per MW to build. Since it’s a hefty investment, financial institutions like banks step in to provide the necessary funds.

To secure this funding, the project needs to demonstrate its viability, and a PPA helps with that. Essentially, a PPA is a commitment from the buyer to purchase electricity at a fixed rate for a long period, usually 10 to 20 years. Lenders like this because it reduces the risk.

Lenders also evaluate the financial stability of the the energy provider or seller. If the seller is considered strong and reliable, for example, they are called “bankable” because they can support the project’s financial needs.

COD Project Finance

COD Project Finance, or Commercial Operation Date Project Finance, involves the moment when a renewable asset becomes fully operational, connected to the grid, and starts generating energy. This date also marks the starting point for an off-taker’s obligation to purchase energy under a PPA contract.

For hedging:

Power purchase agreements offer an assurance that an investment will yield a return once the project is finished, mitigating financial risk.

These agreements facilitate the sale of a portion of a project’s future energy production over an extended period, spanning from 3 to as much as 30 years, to an other energy supplier or purchaser. Often, these agreements are reached and formalized before the project commences.

For long-term price predictability:

Electricity prices can vary considerably and frequently. The core feature of a PPA is the commitment to sell a specific quantity of megawatt-hours (MWh) of power generated by a renewable project to an energy buyer at a set price.

This arrangement ensures a reliable future income for the seller, while the buyer locks in a guaranteed supply of energy at a stable price.

What are the different types of Power Purchase Agreements?

Defining various types of corporate PPA contracts can be challenging, given the wide array of possible contract arrangements and the absence of a single, universally applicable system for categorizing PPA characteristics. Nevertheless, we will endeavour to offer an overview:

Physical PPAs

There are three main types of physical PPAs, all involving the sale and supply of a fixed amount of electricity. The distinction lies in how the electricity is delivered and how much energy is used.

On-site PPA

This type of Power Purchase Agreement involves a direct supply of electricity, typically within close physical proximity of the energy generation source and the consumer. The generation facility may be located behind the consumer’s meter, sometimes even on the same premises. The consumer’s energy usage pattern determines the specifics of the setup and the PPA terms. In some cases, any excess electricity generated can be sent to the grid.

Since an on-site PPA directly reduces a company’s energy consumption, it also falls under the category of a corporate PPA. For instance, an industrial company with available rooftop space may choose to cut its electricity costs without taking on the responsibility of installing a solar power system. In this scenario, the company enters into an on-site PPA with a project developer, who installs the installation of solar panels on the roof and sells the generated electricity directly to the company.

Off-site PPAs

Off-site Power Purchase Agreements don’t involve direct physical electricity supply from a facility to a nearby user. Instead, it’s an arrangement to buy a set amount of electricity as specified in the agreement. Unlike on-site PPAs, in off-site PPAs, the electricity is transmitted through the public grid from the generator to the consumer. This involves an additional process through the balancing groups of both the power plant and the consumer.

The power plant doesn’t have to be close to the consumer in this case, offering more flexibility. The operator can choose locations with ideal conditions or use existing plants. Moreover, a single power plant can engage in multiple PPAs with various customers, with each customer receiving their allocated share of the electricity via their respective balancing groups.

The agreed PPA price sets the negotiated price for the electricity supply, ensuring long-term price stability for all parties involved. Nevertheless, there may still be charges and grid fees payable to the grid operator if applicable.

Sleeved PPA

A sleeved PPA is essentially an off-site PPA where an energy supplier acts as a middleman between the producer and consumer.

This energy supplier may handle tasks like managing balancing groups, bringing together different electricity producers under their umbrella, distributing extra electricity, making energy generation predictions, selling green energy certificates, and taking on different risks, such energy market risks such as balancing energy expenses or potential default or insolvency risks from a contractual partner.

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A Power Purchase Agreement (PPA) helps renewable projects secure stable revenue, which is usually challenging in fluctuating energy market conditions without government incentives.

A PPA attracts funding from lenders for the renewable project and enhances risk management by fairly distributing risks among the parties involved in the contract.

Furthermore, it guarantees energy buyers a steady, predictable cost over the long term and allows a company to indirectly support a renewable project while obtaining valuable “green attributes” like Renewable Energy Certificates.

For lenders, it provides revenue predictability by pre-selling a set amount of energy at an agreed price and allows them to stake their contribution to the renewable sector.

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What are the Disadvantages of PPAs?

Power Purchase Agreements (PPAs) are intricate contracts that typically demand extensive time and negotiation before finalization, and their extended duration can pose a challenge if price shifts unfavourably affect one of the parties involved; additionally, electricity production.

Particularly from wind and photovoltaic sources, may vary, and if the predetermined electricity quantities are unavailable at the time of delivery, the plant operator may need to offer financial or physical compensation or involve a third party like an electricity trader.

Who needs a PPA?

The Energy Buyers'

Energy buyers, like utilities generating power, corporations, and industrials, use PPAs to source renewable energy, helping them meet green energy goals.

Corporations, including Google, Amazon, and Nike, buy into renewable sources of energy to reduce their carbon footprint and lower their environmental impact. corporations

Industrials, like mining companies (e.g., Alcoa for aluminium production), enter into PPAs to secure stable, long-term energy costs.

The Energy Sellers'

Energy sellers are typically the owners or developers of renewable assets, and they can be classified into various business categories:

  1. Investment firms specializing in infrastructure.
  2. Independent electricity producers.
  3. Renewable energy asset managers.
  4. Utilities and energy companies are interested in constructing their renewable assets.
  5. Infrastructure funds engaged in renewable energy investments.
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What is the PPA process?

With a PPA, you can execute, enhance, or re-finance your project. This entails defining the contract structure, issuing a Request for Quotation (RFQ) to attract potential buyers, evaluating received offers, engaging in negotiations to establish terms, and ultimately formalizing the PPA contract. Subsequently, you’ll oversee your energy sales and risk management throughout the lifecycle of your asset.

Design Elements

What is a Financial Power Purchase Agreement (Financial PPA)?

A financial Power Purchase Agreement (PPA), sometimes called a virtual or synthetic PPA, lets a company obtain renewable energy without needing to own the physical energy source. This allows companies, especially those aiming to boost their eco-friendly image, to acquire renewable attributes without having to own the actual energy-producing facility.

These green energy attributes create a connection between the buyer and the renewable asset owner, without affecting the source of energy used by the purchasing company. The popularity of financial PPAs is increasing as more businesses seek ways to collectively meet energy demands in various countries or find cost-effective locations for sourcing renewables.

What happens to PPAs after the subsidy period expires?

When a legal subsidy for an operating power plant comes to an end, PPAs offer a means to secure ongoing financial support for the plant’s continued operation, covering expenses like maintenance and leasing of generating assets.

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Who concludes PPAs?

Power producers enter into PPAs either directly with a company consuming the energy (known as a “Corporate PPA”) or with an electricity trader who buys the generated electricity (referred to as a “Merchant PPA”). The electricity trader may then supply this power to a specific consumer (essentially becoming a “Corporate PPA supplier”) or opt to trade it on an electricity exchange.

Many international corporations are already using or planning to use PPAs to secure a portion of their electricity consumption (see here). They use PPAs to lock in stable and predictable electricity prices. PPAs are particularly effective in reducing the risk of fluctuating electricity prices, which is especially beneficial for operators of facilities with high upfront investment and low operational costs, such as solar panels and wind turbines.

By securing payment for the electricity, plant operators and financial institutions gain more confidence that the revenue from electricity sales will sufficiently cover the initial investment, ultimately making the project more profitable over time.

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