What's the Next Phase for PPAs?

In Brief

The volume of power purchase agreements (PPAs) for renewable energy is growing, but not all potential corporate buyers have sufficient experience and expertise to negotiate effective deals. There is a need for more innovative and accessible PPA solutions for smaller players, especially as firms navigate the growing economic slowdown from Covid-19. 

Third-party entities are starting to provide standardized products that reduce both costs and risks for buyers and sellers across multiple projects.

More information and transparency around renewable energy contracts and transactions will help the bulk power grid better accommodate increasing amounts of renewable energy.

New flavors of PPA can help new entrants lock in renewable supply.

Power purchase agreements can spur megawatts' worth of energy transition- once more companies learn how to find, operate and improve them. 

According to Bloomberg New Energy Finance, corporate procurement of clean energy in the U.S. grew from 9.1GW in 2018 to 15.7GW in 2019. This growth was in large part the result of innovations in power purchase agreements (PPAs), which have enabled primarily large corporate entities to procure increasing amounts of renewable energy. Virtual PPAs accounted for 80% of corporate procurement in the U.S., with much of the remainder coming from green utility tariffs. 

As the number of completed PPA deals increases, experts are developing new financing models to expand the pool of possible market participants to include small and medium-sized companies. 

To date PPAs have played a crucial role in enabling utilities, corporate entities and large consumers of energy to buy electricity from renewable resources. However, as our previous articles outlined, PPAs introduce a number of important risks for power producers, buyers and financiers, including weather and performance risk, basis risk, geographic risk, among others.

In addition to these risks, the increasing  penetration of zero-marginal cost renewables has contributed to a decrease in energy prices. Despite the growth in the use of PPAs, industry experts are considering whether reforms to PPAs may be necessary in order to ensure future returns and incentivize the required investment needed in renewable technologies. 

An increasing number of smaller companies are interested in procuring renewable energy. At the same time, some corporate entities are raising questions about long-term contracts with fixed PPA prices, given the ever-declining costs in renewable energy, and are starting to pursue shorter term lengths. Companies are balancing the benefits of long-term fixed prices to hedge against volatile electricity prices with concerns over locking in PPA terms that might be perceived as more expensive than necessary. However, contracts with shorter term lengths reduce long-term revenue guarantees for project developers, imposing greater financial risks over the lifetime of the project. 

Given these trends, the traditional models for procurement and investment in renewable energy are ripe for reform. 

Large, sophisticated purchasers of clean energy like Alphabet and Apple have made up the bulk of corporate procurement using PPAs, as a result of both their large electricity demand, which is conducive for long term contracts, but also because they developed the internal resources and expertise required to understand and participate in complex energy transactions. 

Despite the growing interest in procuring renewable energy, smaller corporate entities that are new to the world of renewables often do not possess the same level of resources and expertise that are necessary to effectively negotiate renewable energy contracts. Without new financing tools or resources, the risks and complexity of energy procurement deals can create barriers for smaller companies to enter the market. 

As more companies set ambitious emissions and renewable energy targets, there is an increasing need for corporate energy managers to understand the financial risks involved in PPAs so that they can be well-positioned to effectively negotiate contracts that meet their needs. Industry participants are building on the experience of first movers like Google to develop innovative models that de-risk renewable energy transactions and make it easier for less sophisticated companies to participate. 

In 2018, for example, Microsoft and several of its partners and insurers, including REsurety, a clean energy risk management company, developed what it calls a volume firming agreement (VFA), which it hopes can serve as a model for smaller companies. Brian Janous, General Manager of Energy and Sustainability for Microsoft, and Kenneth Davies, Microsoft’s Director of Innovation, Energy Strategy & Research (now no longer at Microsoft but an advisor to REsurety), and REsurety co-founder and CEO, Lee Taylor, led the VFA development process. 

The goal of the VFA is to allow the buyer (i.e. Microsoft) to better manage weather and operational risks associated with pricing fluctuations for renewable energy by moving that risk to a third-party insurer. VFAs seek to address the mismatch between a buyer’s energy needs and the intermittent generation of a project. Microsoft and its partners, including Allianz and RESurety, negotiated an arrangement for Allianz to manage risk associated with hourly market pricing fluctuations by creating a separate financial product that sits on top of Microsoft’s PPA. The insurer provides a separate income stream for the developer, so that the project keeps the revenue difference if production is higher than expected, but pays the difference if production is lower. 

This model moves the operational and performance risk from the buyer to the project, which Microsoft prefers given that it has less ability to control the day-to-day operations of the project. It also enables Microsoft to treat the PPA more like the kinds of traditional retail electricity contracts that it is more experienced negotiating. Microsoft and its partners believe the VFA model can pave the way for simpler, more standardized PPA products that smaller companies can sign onto without requiring the same internal resources of large companies. 

While large companies like Microsoft are designing creative PPA contracts at the level of an individual deal, other third-parties like LevelTen Energy, a startup based in Seattle, Washington, are rethinking the broader marketplace for PPAs overall to make it easier for smaller companies to procure renewable energy.

LevelTen creates standardized, aggregated PPA products that connect multiple buyers and sellers, reducing costs and enabling new commercial and industrial consumers to enter the PPA market. LevelTen’s portfolio approach to PPAs spreads production risk across many buyers and generation projects and can be tailored to meet the needs of each individual buyer . This streamlines the procurement process for both buyers and sellers and overcomes the hurdle of needing sufficient electricity load and expertise to justify an individual procurement contract. To date, LevelTen has developed a PPA marketplace totaling 109GW of wind and solar projects across the U.S.  

In an interview, Eric Gimon, senior fellow at Energy Innovation, a nonpartisan energy and environmental policy firm, said he sees significant opportunities for third-party intermediates like LevelTen to provide standardized products for companies that lack expertise in electricity markets and to manage basis and geographic risk on their behalf.   

While companies like LevelTen are developing innovative solutions to expand the role that PPAs can play in accelerating corporate renewables procurement, project developers are also pursuing alternative business models to help mitigate the risks they face under traditional PPAs. In response to decreasing PPA prices, a growing number of project developers are selling directly into wholesale markets as merchant generators, which have the potential to increase returns compared to long-term PPA contracts. However, merchant generators face additional risks, such as uncertainty over future energy price fluctuations, which require creative hedging strategies. The kinds of services like those that LevelTen provides could address this dynamic by creating increasingly attractive financing arrangements for both buyers and developers.  

Questions about PPAs and their evolution naturally lead to larger questions about the need to transform electricity markets overall to accommodate increasing amounts of renewables. 

As renewable penetration grows, clean energy resources place more pressure on the traditional bulk power system. Without fundamental electricity market design changes, this poses long term risks, including grid congestion and curtailment, which undermines the many benefits of clean energy resources. 

According to Eric Gimon, innovative financing mechanisms could eventually open the door for forward purchasing and long-term contracting of renewable energy, which would create significant opportunities to transform the bulk energy system. Gimon sees the lack of data and transparency around long-term contracting and the details of resource adequacy transactions as a key barrier. Basic information about the terms and details of bilateral contracts is difficult to access because it can involve proprietary and confidential information. Gathering more of this data  will help markets run more efficiently and become more standardized as  the penetration of renewables increases. 

By developing new financing structures that shift risks to entities that are better equipped to manage it and by establishing portfolio approaches to bring in  new market participants, innovative models for PPAs can facilitate broader changes on the bulk power grid, increasing the penetration of even higher amounts of renewable energy. 

However, this transformation will require financing models and market designs that properly value the energy, capacity and ancillary benefits of traditional renewable technologies like solar and wind, as well as complementary resources like storage. While these technologies are capable of providing services to the grid that improve reliability and flexible operations, the rules that govern wholesale markets often impose barriers for renewable resources, which are unable to fully participate.

More uncertainty lies ahead for clean energy's role in economic recovery. A comprehensive valuation of the benefits of clean energy technologies, combined with financing tools that enable market participants to capture those value streams over the long term, can create more incentives for even greater investment. 

Find additional related content on these topics: 
CBEY logo bug