The Pros and Cons of a Power Purchase Agreement (PPA) & How They Work
If you are responsible for shrinking the carbon footprint of your company’s electricity supply, you have probably heard of a Power Purchase Agreement, or PPA. For many large corporations and institutions of higher education, these contracts are the go-to option for making large and relatively quick strides towards their climate goals.
As the renewable energy market has matured, PPAs have become more numerous. But if buyers do not understand the intricacies of how they work, they may not get a good deal. Here is what buyers need to know before exploring a PPA.
(Note: PPAs can apply to a variety of offsite and onsite renewable energy solutions, but here we will focus on PPAs for utility-scale wholesale projects.)
What is a PPA?
A PPA is a 10- to 15-year contract that a large-scale energy buyer (such as a large corporation) signs with a renewable energy project developer when a wind or solar farm is in development. The project can be built in any of the seven wholesale electricity markets in the US.
When the project is up and running, the electricity it generates is sold into the wholesale electricity market like at any other power generation site.
Under a PPA, the developer receives a fixed rate from the buyer. The electricity is sold to the market, and the buyer receives the floating market rate, plus renewable energy credits (RECs). These transactions are settled so that the buyer and developer exchange payments on a net basis. If the fixed rate owed by the buyer is greater than the floating rate that the electricity earns on the market, the buyer pays the difference to the developer. If the fixed rate is lower than the floating rate, the developer pays the difference to the buyer.
A large-scale renewable energy project requires a significant amount of upfront investment, and a PPA allows the developer to approach financing parties like banks with a clear plan to recoup their investment. Therefore, buyers play a key role in driving new renewable energy on the grid and receive RECs so that they may claim reductions to their own carbon footprint.
Wholesale PPAs can be designed to settle ‘virtually’ (VPPA), meaning the buyer only sees the financial transaction and the developer manages selling the energy into the market, or ‘physically’ (PPPA), meaning the buyer takes on the responsibility for selling energy into the market, usually with the support of an agent. There are benefits to both approaches, but typically buyers value simplicity and therefore prefer the virtual transaction.
The buyer continues to manage energy usage at their site as normal, which means they still have a utility bill for electricity. The economics of this arrangement benefit the buyer when they are receiving money from the solar or wind farm on a net basis most of the time, which offsets their electricity bill.
Pros and Cons of a PPA
PPA projects are abundant. There are currently hundreds of renewable energy projects planned or in development and actively looking for buyers. That means that buyers can choose projects that best meet their needs and align with their priorities. For example, a buyer may choose a project based on best projected savings, but another buyer may prioritize projects in their home state.
The solar and wind farms built as a result of PPAs also have important benefits for local communities. They create hundreds or even thousands of short- and long-term jobs, generate tax revenue, and expand electricity supply without increasing air pollution.
However, without careful forward-looking economic and risk analysis, wholesale PPAs can create undesirable electricity market price exposure and result in added costs over time. Selecting a PPA requires deep knowledge of electricity markets and strong capabilities in financial modeling and risk assessment.
Who should buy PPAs?
Any organization with good credit (typically publicly rated and investment grade) can enter into a wholesale PPA. Large-scale buyers can contract directly with a developer, and smaller organizations can band together to create aggregate deals.
Wholesale PPAs are great for buyers with very large and/or very distributed energy usage across the U.S., Canada, and Europe looking to have significant impact with renewables quickly. Buyers must have some risk tolerance and an appetite for long-term energy contracts. For this reason, it is best if the organization has full buy-in from senior leadership.