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The next big thing in energy procurement: Power Purchase Agreements

By Benedict De Meulemeester

By Benedict De Meulemeester on 9/02/2018

Topics: Energy Trading

What does PPA stand for?

A Power Purchase Agreement is actually a bit of a buzzword. It’s used by many people at the moment and as it goes with buzzwords, it gets as many meanings as you have people pronouncing it. A buzzword is also convenient to use for commercial purposes. A lot of solutions are now sold as being a PPA just because that’s something that is popular at this moment.

So what is a Power Purchase Agreement?

You need a PPA when you buy electricity directly from the production. This is the case when you have solar panels installed on your rooftop. You need a PPA to buy that electricity. Same goes for a cogeneration unit. You might have an external company doing it so you need to sign a PPA with that company.

It can also be off-site of course. If there’s a waste treatment facility in the neighborhood that is producing electricity from the heat of waste incineration, you can use that electricity and sign a PPA.

What is all the buzz about?

I’ve been in the energy markets for 17 years now and it’s clear that people are always looking for the next new thing in the energy markets. As subsidies for renewable energies are currently being brought down, project developers are looking for new ways of making money. We clearly see that in Germany for example, where the subsidies for the EEG are severely brought down. PPA’s seem to be a new way of making income for solar projects.

On the side of the energy buyer we see different things going on. They are looking for a competitive advantage by buying energy in a PPA, at a cost that is structurally lower than the cost they would pay if they consume that electricity from the grid.

Other buyers want to reduce their volatility exposure with such a PPA. They can make long-term fixed-price arrangements, and that way on both commodity and regulated costs. As these tend to vary a lot this guarantees more stability of their electricity cost.

A third reason to sign a PPA is to achieve your sustainability goals. It’s a way of saying that you’re consuming electricity directly from a renewable source.

Are PPA’s a golden solution?

Whether it's the golden solution depends on one key element: can you avoid grid fees and taxes? If so, you can reach a very nice win-win situation where the seller can sell above market price and the buyer still pays less than the grid costs. Let’s say for example that you have a commodity cost of 50 and grid fees and taxes of 50. If you’re in a situation with a PPA where you don’t have to pay grid fees and taxes, you could agree on a price of 75 for the energy. That means as a buyer you are still paying 25 less than if you would consume that energy from the grid. On top, the seller is also making 25 more than in the case where he would sell that energy to the grid. Of course that depends on the regulatory situation.

If it’s an on-site project, you should look very carefully whether there are no regulations that oblige you to make capacity payments even if you’re consuming that energy on-site.

If it’s an off-site project you should check whether you can set up some kind of private grid arrangement. If the energy that you buy on an off-site PPA project travels over the grid, you’ll have to pay the grid fees and taxes anyhow. That take away the structural advantage of course. In some countries we see that the regulations allow you to set up a legal construction with a kind of private grid.

In Brazil for example, you get a structural reduction on your grid costs when you are buying energy from an off-site renewable energy project. This makes PPA projects in Brazil a very interesting option.

Compare PPA's! 

Before you even start thinking about PPA’s, you should look into the regulatory situation to see if a PPA can be an advantage. And is it an on-site or an off-site PPA that can give you that advantage? Once you’ve defined this, it’s important to negotiate a PPA. Launch a tender, talk to different companies. This is an open market and what we see in many cases is that companies or buyers are just signing a contract with the first project developer that walks in and proposes to put solar panels on your rooftop. It’s very likely that someone else could offer the same electricity that comes from those solar panels at 35 instead of 40. So be sure to tender this competitively and make the economic analysis once you’re in the tender phase. Be careful for the common mistake: most people make a forecast of future electricity costs and calculate savings based on this forecast. What we do is an analysis upside down. If you have a payback period of three years or if you have a certain amount of economies in mind, what do you need to have in terms of electricity costs (both commodity and non-commodity) to reach that target? Then you can start making scenario analysis with multiple options. The project would for example be very profitable as long as there is no fundamental change to the grid fees regulations.

The third thing I would like to point out, is that these PPA’s are long-term agreements, often signed for 10-20 years so be very careful in the negotiation of all aspects and all the small letters in that contract. Try to put in performance clauses. It’s very nice to make a good economic analysis and to negotiate for a very long time. But then, once the plant is built, you may end up with getting this energy only a few hours per year due to a technical issue.

Anticipate on different situations and involve a legal advisor

Make sure you also have back-up energy aspect very well negotiated. Those can often be very determining to the efficiency of the project. Think about the afterlife if you have solar panels on your rooftop. What happens if you sell your plant after 15 years and you have to take away those solar panels? Who is going to have the costs for that? Another aspect we often find ourselves negotiating for quite some time is insurances. What happens if something goes wrong with these solar panels on your rooftop? One thing should be clear now. There’s a lot of aspects here to be negotiated very well. Put together a project team and look for legal advice so you’re sure that you’re signing a nice Power Purchase Agreement. One that doesn’t become the milestone around your neck.

If you have questions on this topic or on any other topics regarding energy procurement, please don't hesitate in contacting us via our website and we'll be ready to help you. If you'd like to learn more about sustainable energy procurement, I advise you to have a look at our webinar. 

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