Creative marketers of electricity keep searching for innovative concepts that help them increase sales. The acronym PPA (or Power Purchase Agreement) seems to be such a concept at this moment as our clients are bombarded with PPA proposals, often presented as super solutions.
In the following blog article, we will focus on two aspects of PPAs:
End users are interested in PPAs for two reasons. First of all because they are a great tool to comply with renewable energy commitments. It’s stronger than the standard method of buying guarantees of origin because you can really show that you buy electricity from a specific asset. And signing a PPA shows the company’s commitment to develop renewable energy.
Secondly, PPA’s can lead to cost savings. In some cases, the PPA allows you to buy electricity at a lower cost than the electricity that you would buy from the grid. This arrangement can come in two ways:
Which set-up is the best for you depends on your risk profile. For market risk clients, whose primary concern is to have a price that is never high above that of their competitors the “discount on market prices or tariff” is the best solution. For a budget risk client that wants to avoid unexpected increases in cost, the fix price arrangement is the preferred choice.
Of course, we can ask two questions here:
On-site versus off-site production
For both questions we need to look at the regulatory context and more specifically explore whether a saving can be made on the regulated part of the electricity bill, the grid fees and taxes. This depends on whether your produce on-site or off-site:
In case of a positive situation, a PPA can be made that creates a real win-win situation for both seller and supplier. Let’s say that grid electricity costs 50 euro per MWh for the commodity only and 100 euro per MWh total costs, including grid fees and taxes. If you then make a price arrangement at 75 euro per MWh or commodity price (wholesale reference) x 1,5, then both sides of the deal win. The buyer has electricity at a lower cost than buying it from the grid. The seller makes more money for the electricity than in the case that he sells it to the grid.
Producers in renewable energy seem to have developed a huge interest in selling their output through PPAs. They tell us that they need the PPA to get their financing. Investors and borrowers are apparently not satisfied with the engagement to sell the electricity in the mainstream power market and prefer the long-term engagements of PPAs.
Therefore, in some countries where the pure win-win based on avoidance of grid fees and taxes is not possible due to the regulatory situation, we see that producers of renewable energy are signing PPAs with prices below the price that they could get at that moment in the open market. We believe that this is absurd and based on a financing environment that is too focused on stable streams of money.
For a long time, renewable energy was completely financed with subsidies. That was an environment of fixed figures. The investment cost is well-known and in many cases the subsidy or minimum income in case of certificates systems was also known. Investors and creditors made their analysis based on the rate of return guaranteed by the subsidies. A project developer told me in those days of generous subsidies that the financial world just wasn’t interested in what you did with the sales of the electricity itself, they just looked at the fixed figures of the subsidies.
These days, most countries have turned down the subsidies, some of them even all the way down to zero. Fortunately, the declining investment costs have made subsidies unnecessary. Thanks to grid parity, the income of selling the electricity itself is in more and more cases sufficient to win back your investment.
Hence, this sudden interest in PPA’s as project developers look for a long-term supply agreement to convince investors and banks. And in their hunger to have that PPA, they accept discounts on what you can get in the wholesale market.
I have a whole series of remarks to that, these are the most important ones:
We have helped renewable energy project developers to set up and implement solid strategies with layered buying of futures and / or options in the wholesale markets that make sure that a minimum return on the investment is protected without blocking the opportunities of increasing markets. Let’s hope that the PPA frenzy doesn’t destroy the willingness of the financial world to accept such good trading practice.
For the buyers of PPAs, we have three big recommendations:
Renewable energy has reached the historic point of grid parity in many countries. This opens up new opportunities of buying electricity at structurally cheaper prices. But think beyond the PPA buzzword rhetoric to create real long-term value for your company, whether you are on the selling or on the buying side.