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What will it take to commoditise the corporate PPA?

OPINION | RES group commercial director Richard Russell examines the different options for corporate renewable-energy purchasing and explains what steps should be taken to increase uptake

For some time, corporate power-purchase agreements (PPAs) have been discussed as the way forward for securing the required investment in subsidy-free renewable energy and achieving ‘net zero’. Corporate and Industrial (C&I) PPA growth in the USA and Europe has been substantial, but there is still a saying doing the rounds in the industry that ‘we’ve seen more PPA conferences than PPAs.’

The market needs to more effectively engage with its end buyers, not only by communicating the value that can be unlocked by procuring renewable energy directly from its source, but also by standardising and commoditising the PPA offering.

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Virtual PPAs

As is broadly known in the industry, a corporate PPA is an agreement between an electricity generator and a corporate buyer, where the buyer agrees to purchase power generated from a project at a set price per megawatt hour over a fixed period. While a “physical” PPA sees the buyer directly receive and take legal title to the energy produced, a “virtual” or “synthetic” power-purchase agreement (VPPA) involves no physical delivery of energy to the buyer.

VPPAs offer an appealing financial hedge for corporate energy buyers as the lack of physical connection provides a new flexibility to the PPA offering. While the buyer receives “Renewable Energy Certificates” they do not take legal title to the energy generated by the project or stop buying their electricity from a utility.

As with a physical PPA, a VPPA sees a corporate buyer agree to purchase a project’s renewable energy for a pre-agreed price, with payments determined by comparing that price against a market reference. With a VPPA, however, the project owner sells power into the market on the behalf of the business and then receives the market price at the time the energy is sold. Should the market price be greater than the pre-agreed price the corporate buyer receives the difference — if the market price is less than the fixed VPPA price, the buyer pays the seller to make up the difference.

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In this way, a VPPA is a financial hedge against volatile electricity prices and an attractive proposition for companies looking to meet sustainability targets while making substantial cost savings in the long term. But there is still progress to be made in simplifying this offering to appeal to a broad C&I market.

Progress towards standardisation

To date, virtual and physical PPA deals have suited large corporates and technology firms very well. These businesses – largely technology, industrial, consumer goods and telecoms giants – have been able to commit to long-term agreements of ten years or more to either directly or indirectly supply data centres and other energy-intensive operations. They have clear sustainability targets to meet, and, importantly, also have the in-house expertise to negotiate deals to best suit their long-term needs.

In order to fuel the net zero transition, however, it will be crucial to bring on board smaller offtakers from across the C&I community. These firms may not share the same appetite for risk and need a straightforward, cost-effective way to procure renewable energy.

The latest move to address this challenge comes from the European Federation of Energy Traders (EFET), which has launched a standard corporate power-purchase agreement (SPPA). EFET’s SPPA is intended to open up access to unsubsidised renewable energy projects for smaller corporate players by reducing transaction costs and facilitating negotiations.

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Initiatives such as this, WindEurope and SolarPower Europe’s ‘RE-Source Platform’ and DNV GL’s ‘Instatrust’ PPA marketplace, which aims to connect prospective C&I buyers with renewable energy sellers, are an encouraging step forward. In opening up PPAs to smaller players, however, new risks are created, and existing risks become more prominent for sellers. To manage these risks and commoditise the PPA, further innovation is required on the seller side.

Shorter tenors

Shorter tenors (contract durations) could increase the accessibility of PPAs to prospective offtakers. Whilst shorter term PPAs mean that a project becomes exposed to merchant risk in a reduced timeframe, this risk could be offset by innovation in both pricing and volume firming. This is something that is already being addressed in the sector through Proxy Revenue Swaps.

Proxy Revenue Swaps

Volume and price have typically been considered as two independent risk factors, with each hedged independently. However, a Proxy Revenue Swap (PRS) addresses both of these risks by allowing a project to hedge against the correlated risk of both generation and power price.

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For a PRS, the hedge provider pays the project owner a fixed lump sum defined by expected project performance for a set period. The project owner then pays the hedge a variable sum, with this amount defined as price times quantity for each hour. Naturally, this figure will vary with volume and power price.

This means that should the project underperform throughout the agreed period, the owner is compensated. Should revenue be greater than expected, however, the project owner will pay out to the hedge provider. This ability to cover both volume and price brings a unique level of revenue certainty for investors and developers, enabling contracts with better financial terms over longer periods.

PRS mechanisms, offered by dedicated “risk transfer” providers such as insurers, are growing in prominence – and it is likely that we will continue to see these coupled with PPA agreements as sellers aim to minimise risks to buyers, while at the same time tackling their own exposure to volume and price fluctuations.

Aggregation with a ‘cornerstone’ offtaker

‘Aggregation’ is a means of bringing more players to the table, allocating a proportion of capacity to each offtaker, and more effectively sharing risk between parties. Still, this can constitute a significant leap for a C&I firm with no previous experience buying renewable energy.

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Bringing in a ‘cornerstone’, investment-grade offtaker can manage risks and create confidence by allowing members of a consortium to ‘piggyback’ off this lead offtaker. In Australia, for example, RES formed a consortium of offtakers for the 221MW Murra Warra 1 Wind Farm, with the telecoms firm Telstra taking the lead in negotiations, alongside offtakers including ANZ, Coca Cola Amatil, and the Universities of Melbourne and Monash.

A secondary market for PPAs

Further innovations will be required to help smaller corporates manage the financial risk of signing a PPA. Allowing a corporate to pass on its PPA obligation to another company, for example, would add much greater flexibility to the arrangement.

Whilst equal credit standing between the parties involved would likely be a prerequisite, the opportunity for corporates with different credit ratings to be ‘blended’ together by an aggregator could be developed in this secondary market. The flexibility of a secondary market would appeal to smaller corporates looking to scale their renewable energy procurement up or down as their business changes, but secure shorter-term contracts in the meantime.

Technological innovations

It is clear that steps are being taken on the financial side to tackle risks and create a more commoditised offering for buyers. Looking beyond the financial specifics, however, we are likely to see technological innovation play a significant role in facilitating renewable energy procurement.

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Technological solutions on the demand side such as digitisation, load shifting and energy storage would enable buyers to better make use of power when it is generated and reduce the risk of the grid becoming overwhelmed with electricity, causing price cannibalisation as market prices fall to zero or lower.

Likewise, government policy and regulatory support could yet prove to be a definitive factor.

The need for regulation around PPA contracts will grow as the market grows, and certainty for both offtakers and investors must be delivered. Within the next five years, there is a very real chance that the stream of big corporates looking to sign long-term PPAs will dry up and we will need a market better placed to support wider C&I investment in renewables.

In order to underwrite the market and generate scale, governments must develop robust policy and regulation. For example, providing a degree of support by introducing a legally-enforced price floor for wind and solar output would stimulate the market and encourage a new wave of C&I offtakers. While it would not be a subsidy in the usual sense it may require a financial commitment from the government, such as purchasing any surplus energy produced. This would send the right signals to businesses that an investment in renewable energy is not a luxury.

Richard Russell is group commercial director for renewables developer RES.

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