Author: Misti Groves works directly with project developers & purchasers to execute strategic customized contracting solutions.
At industry events and in conversations with prospective clients, we hear this question often: what is a fixed-for-floating swap?
A fixed-for-floating swap is a generic term for a financial arrangement between two parties whereby they agree to exchange cash flows; one party pays a fixed rate, while the other pays a variable (or floating) rate.
When it comes to corporate energy buying, the term is—for all intents and purposes—used interchangeably with a contract for differences. A contract for differences, often in the form of a renewable energy power purchase agreement (PPA), is a strategy that organizations may employ to lock in a fixed rate of electricity in order to save money and receive environmental attributes. Despite there being slight differences between these terms, both are used within the industry to accurately portray the transaction that occurs under a PPA.
Financial PPAs (also known as virtual or synthetic PPAs) are commonly referred to as a contract for differences but also go by a fixed-for-floating swap. This structure allows organizations to enter into a long-term agreement with a renewable energy producer to secure a fixed rate for electricity over the 10 to 20-year duration of the contract. The financial component of this contract for differences results in a regular net settlement between the offtaking organization and the energy producer, whereby the offtaker receives the difference from the developer when the fixed PPA price is below the market (floating) price. Likewise, the offtaker reimburses the developer if the market price falls below the PPA price.
These transactions are appealing to corporate entities because future electricity expenditures can be difficult to plan for due to a highly volatile energy market.
A renewable energy PPA, with adequate risk management measures implemented via contract negotiations, can give corporate offtakers the opportunity to save (or make) money. But it is important to note that there are also elements of risk, which can result in significant losses. Buyers should therefore carefully consider all aspects before engaging in a PPA.
Still have questions? Our industry experts have the answers. Reach out to our team; we will happily explain how these mechanisms may benefit your business.
Past performance is not indicative of future results. Hypothetical performance results have many inherent limitations. No representation is being made that any program will or is likely to achieve profits or losses similar to those shown. Swaps, futures and options trading involve significant risk of loss and may not be suitable for everyone. Therefore, carefully consider whether such trading is suitable for you in light of your financial condition.