PPA by Design: Quantitative Analysis to Bridge Sustainability & Economics
Contributed By: Lachlan Caddy, Director of Client Management, Schneider Electric Energy & Sustainability Services - Australia
Over the last few years, particularly following the 2017 closure of the Hazelwood Coal Plant, the Australian energy market was hit by extreme price volatility. Although price trends seem to be stabilizing in the near-term, the roller coaster is expected to continue as more aging coal-fired generators go out of commission, other plants with questionable reliability approach their end of life and poor coal quality affects other coal generators.
Source: Schneider Electric Global Research & Analytics using data from the Australian Energy Market Operator (AEMO).
Pair this volatility with increasing demand for carbon emission reduction from the global community of investors, consumers and institutions, and Australian corporates have a convincing business case to explore new energy procurement strategies. This situation has given rise to a healthy discussion in almost every corporate boardroom about options to secure price certainty, manage risk and embed greater sustainability in choices around electric power consumption.
These two major drivers—volatility and stakeholder pressure—have influenced many corporates to develop an out of the box energy procurement strategy.
Renewable power purchase agreements (PPAs) are rising to the top of the list of considerations for many companies looking to achieve price stability and sustainability in their energy supply. In recent years, we have seen several Australian corporates commit to renewable PPAs with a desire to become more sustainable and hedge price volatility. Solar and wind power have been the primary technologies of choice, however, based on the generating profiles of these two technologies, corporate decision-makers have been understandably concerned with both reliability and intermittency.
Solar generation, for example, creates a ‘natural’ hedge during the daylight hours. But assuming the average corporate is using grid energy from around 7 am through to 7 pm, a solar PPA alone leaves them exposed to price risk during the end of the day by which point the solar hedge has vanished and energy demand increases. These fluctuations in peak demand that occur during specific seasons and times of day create a net demand profile that has the uncanny resemblance of a duck, with demand dipping as solar power floods the grid in the morning and then rising steeply in the late afternoon as solar generation falls off.
This means that from the price-driven corporate’s perspective, the solar PPA may at first look appear to be “out of the money” when generating and provides no (or little) coverage during the evening when price risk presents.
The 'Designer PPA' Approach
Upon reaching this conclusion, most corporates motivated to enter an 'out-of-the-box' PPA purely as a price hedge have been slow adopters. Some corporates with dual goals of sustainability and price stability, however, will persevere to explore the relationship between their usage, high spot price outcomes and renewable generation profiles. Through this exercise, companies can design a highly customized PPA that contributes to the holistic set of goals they seek to achieve.
As your company explores this relationship, you will recognize two fundamental questions that need answering in the search for the economic rationale of a renewable PPA:
- What actions can be taken to reduce exposure to high spot prices in the evening peak?
- How to value these actions so an economically rational decision on risk mitigation tactics can be made?
The first question doesn’t need an expert to answer; it needs some creative thinkers ready to offer their ideas to design a PPA that is both sustainable and economical. Generally, the following list of insights will pop up:
- Batteries for ‘lopping’ or ‘shaving’ supply from the grid during the evening peak
- Moving the process that uses energy into another time slot referred to as ‘load shifting’
- Buying a cap contract to reduce the risk posed by extreme spot prices (>$300/MWh)
- Request for ‘firming’ into a flat swap to provide 24-hour coverage
- Sell the PPA to a financial intermediary and buy it back with a new profile covering the peak
- Sell the PPA to your electricity retailer in return for a ‘whole of meter’ deal
- Diversify with another PPA from an alternative technology (i.e. wind)
This list of actions is by no means exhaustive and each activity has pros and cons that make them unique, however, the one thing they have in common is that they will each change the corporate’s load profile. The spot price risk associated with each permutation of the load profile can then be valued. This designer approach to building an optimal PPA is where an expert is needed.
Building an Optimal PPA Through Predictive Analytics
The right expert can bring sophisticated quantitative analysis tools to bear that will measure the impact of the different tactics available and quantify the financial benefits and risks. It is possible, maybe even likely, that a combination of activities will create an ‘optimal’ outcome that will maximize the revenue generation capability and minimize the costs, while still allowing the corporate to capture the sustainable benefits of renewable power.
Recently, Schneider Electric undertook a significant quantitative analysis project for a client that combined probabilistic spot price forecasts with our quantitative analysis tools. Through this exercise, we modeled a variety of hedge instruments and risk mitigation strategies in combination with their PPA.
The resulting analysis enabled this client to design the optimal portfolio of activities to manage the unique risk associated with their load profile and the attributes of their PPA. Further, by valuing the different revenue outcomes associated with each potential instrument, this client was able to ensure that pricing offered by financial intermediaries for firming and shaping their PPA was fair and representative of the risk they were trying to cover.
The expert quantitative analysis provided insights to this large energy user, allowing them to fit economic rationale into their sustainable future.
Ready to design your optimal PPA? Or, do you have an existing PPA that could do with a quantitative analysis optimization retrofit? Explore our new 2-part guide to learn how to quantify 7 common PPA risks and dive deeper with our experts to examine modeling and analytic strategies.
As always, we're here for your support! We invite you to reach out to us to speak with an expert on how to use quantitative analysis to optimize your positions and PPA opportunities.