Explaining the Economics of PPAs

June 9, 2016 Jason Wykoff

Power purchase agreements (PPAs) are one way for a company to support the development of new clean energy while meeting its corporate sustainability targets. But sometimes, offsite PPAs can make commitments to clean energy also pay off financially.

How?

In a PPA, a creditworthy offtaker (such as a corporation) agrees to pay a fixed price for an anticipated volume of electricity over a defined term from a renewable energy installation such as a wind farm. Thanks to increasingly low prices for renewables—combined with available tax subsidies—the offtaker can potentially lock in a rate that remains below wholesale electricity market prices. Offsite PPAs are also referred to as a “fixed for floating” swap, or contract for differences, because whenever the volatile market price for electricity outpaces the fixed price of the PPA, the offtaker benefits. However, it is important to note that offsite PPAs are subject to equal risks which buyers should carefully consider before engaging in a PPA. 

How does this work? For example, let’s say you agree to a price of $20/megawatt-hours (MWh) for 100,000MWh/year for 12 years. The savings or revenue of this PPA is returned in one of two ways, depending on the PPA structure:

Direct PPA:

In a direct PPA, the offtaker and generator must be located in the same electricity grid region.  In this example, your utility purchases power from a wind farm and sells it to you at the agreed upon rate. For purposes of our example, let’s assume that in a one month period you use 10,000 MWh of purchased electricity and half of that came from your wind farm PPA at $20/MWh. For the same period, the utility’s wholesale power rate for normal business is $25/MWh. You’ve saved $5 per MWh for half of your 10,000 MWh utilization, or $25,000 for the month.

Without PPA: 10,000 MWh at $25/MWh = $250,000

With PPA: 5,000 MWh at $25/MWh + 5,000 MWh at $20/MWh = $225,000

Virtual PPA:

A virtual PPA works much the same way as the direct model but it isn’t sleeved through your utility. In virtual offsite PPAs, the offtaker and generator can be located in different regions. As a result, instead of purchasing both renewable and brown power from your utility, you directly settle financially with the generator itself. Using the same scenario as above, if your agreed upon PPA price for the wind power you’re purchasing is $20/MWh and the wholesale electricity market price is $25/MWh, the wind farm owes you a check for the $5/MWh difference for the electricity generated that month. On the other hand, however, if the wholesale electricity market price drops to $15/MWh, you've instead lost $5/MWh. 

In a virtual PPA, you still pay your $250,000 utility bill as you have before, but are simultaneously reimbursed with the $25,000 difference, reducing your net energy cost to $225,000. Or, if the market price drops, you owe the $25,000 difference, and your energy cost increases to $275,000.

In the same way that a direct renewable PPA has the potential to save you money upfront, a virtual renewable PPA would pay you for the delta between your PPA rate and market prices. Because you also have the option to retain the energy attribute certificates (EACs) from the PPA, you can simultaneously use your PPA to make renewable energy purchasing or carbon reduction claims. As mentioned, the risk in this scenario is that, if the market softens and your PPA price is above wholesale power market rates, you end up paying more on your utility bill (direct PPA) or cut a check to the generator (virtual PPA). If you retain the EACs associated with the PPA, you still receive the environmental benefits, only at a cost rather than for free.

Working with a trusted, independent advisor can help mitigate PPA risks. By thoroughly vetting potential projects and performing financial modeling and analysis on different forward pricing scenarios – from bull to bear – the right advisor will be able to find you the absolute best option to meet your company’s unique financial & sustainability needs.  Learn more about the risks of offsite PPAs—and the risks you face without one—in our white paper.

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.

Understanding how to identify and negotiate a PPA contract requires nuance and experience, but is critical to ensuring your company can reap the highest benefits from your green power investment.

To Learn more about the economics of a PPA, and other renewable energy strategies, we invite you to download our white paper: The Economic Case For Renewable Energy

Hypothetical performance results have many inherent limitations, some of which are described below. No representation is being made that any program will or is likely to achieve profits or losses similar to those shown. In fact, there are frequently sharp differences between hypothetical performance results and the actual results subsequently achieved by any particular trading program.

One of the limitations of hypothetical performance results is that they are generally prepared with the benefit of hindsight. In addition, hypothetical trading does not involve financial risk, and no hypothetical trading record can completely account for the impact of financial risk in actual trading. For example, the ability to withstand losses or to adhere to a particular trading program in spite of trading losses are material points which can also adversely affect actual trading results.

There are numerous other factors related to the markets in general or to the implementation of any specific trading program which cannot be fully accounted for in the preparation of hypothetical performance results and all of which can adversely affect actual trading results. Past performance is not indicative of future results. No representation is being made that scenario planning, strategy, consistency or discipline will guarantee success or profits.  You should not rely on any of the information as a substitute for the exercise of your own skill and judgment in making such a decision on the appropriateness of any particular transaction.

Every effort has been made to ensure that the information in this presentation is accurate and complete, but neither Schneider Electric ESS, nor our officers, principals, employees or agents shall be liable to any person for any losses, damages, costs or expenses (including, but not limited to, loss of profits, loss of use, direct, indirect, incidental or consequential damages) resulting from any errors in, omissions of or alterations to the information. The foregoing shall apply regardless of whether a claim arises in contract, tort, negligence, strict liability or otherwise.

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. This material has been prepared by a sales or trading employee or agent of Schneider Electric ESS and is, or is in the nature of, a solicitation. Reproduction of this information without prior written permission is prohibited.  No part of this proposal should be considered apart from the Disclosure Documents and disclaimers herein.

 

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