Whether as an individual or a company, switching to renewable power is one of the fastest and easiest ways to reduce carbon emissions. As the cost of renewable power generation continues to fall, a growing number of companies are turning to corporate power purchase agreements (PPAs) to enable that switch.
PPAs are contractual agreements between the seller and purchaser of power, typically the power generator and a utility or trader. They are the primary long-term contracts by which most electricity is traded. A corporate PPA, on the other hand, involves the end consumer of that power transacting directly with the power generator.
Compared with simply buying power from a utility, entering into a corporate PPA is complex and time-consuming. It usually requires the company to contract for power for much longer than they are accustomed. As a result, it usually requires a wider number of decision makers to engage with the process than is the case with a typical decision to buy power.
Despite this, corporate demand for PPAs has rocketed in recent years. Figures from the International Energy Agency show corporate PPAs were signed with 18.6GW of projects worldwide in 2019, up 49% on the previous 12 months and 750% on 2014.
So what is their appeal, and what does the prospective corporate buyer need to know?
The case for corporate PPAs
The primary attraction of a corporate PPA has been to demonstrate a company’s environmental credentials, says Paul Orstavik, Oslo-based lead originator at World Kinect Energy Services.
Before a project developer can raise finance for a new project, it needs to secure a revenue stream to repay the debt. With government subsidies drying up, a corporate PPA can provide that revenue certainty. That means the buyer can make a demonstrable claim that it has directly supported the development of new green renewable energy capacity. “A corporate PPA enables a company to make a clear contribution to the energy transition,” says Orstavik.
The alternative route many companies take is to buy green certificates equivalent to their electricity use. Qualifying renewable energy projects earn green certificates for each megawatt of power they produce. However, green certificates do not directly support new renewable energy capacity, and they represent an additional, ongoing and unpredictable cost to the power buyer.
A corporate PPA can provide price certainty and a long-term hedge against volatility in power prices – often at a discount to the prevailing market. This is of particular appeal to large power users with predictable, long-term demand, such as industrial companies like aluminium smelters or technology companies with energy-hungry server farms.
However, entering into a corporate PPA is not without its challenges. First, developers need sufficiently long-dated contracts to match the tenor of their debt. PPAs therefore tend to need to be at least ten years, says Phil Dominy, a director at advisory company EY in London. Given that projects rely on the PPA to repay their debt, termination fees are often very expensive, he adds.
Buyers also need to be comfortable with anticipating sufficient power demand over a long time period. Getting buyers comfortable with the tenor involved “is a question of education”, Dominy says.
Other challenges that corporate PPA buyers face is getting involved in matching the profile of its electricity demand – whether across different countries, or during different times of the day – with the generation offered by the PPA seller.
Entering into a corporate PPA requires a commitment in time and resources, says Orstavik. “Every project and every corporate is different, meaning these contracts are fairly bespoke, running to 50–100 pages,” he says. “They take some time to negotiate.”
The complexity of the process means large companies have dominated the market. The four largest buyers in 2019 were Google, Facebook, Amazon and Microsoft, show figures from Bloomberg New Energy Finance. Other big buyers include IKEA Group, Apple, Walmart and US telecommunications company AT&T.
Given they involve the development of new renewable energy capacity, Dominy estimates the process can take around 12 months for PPAs agreed with solar projects, and two years for wind projects.
However, he adds that, in terms of the balance of supply and demand in the market, “buyers are in the driving seat”. As subsidies for renewable energy decline, project developers need to find long-term buyers for their power, making it somewhat of a buyer’s market, particularly in Europe, he says.
Different types of PPA
There are, broadly speaking, two different corporate PPA arrangements.
The physical or sleeved PPA places an intermediary – a utility or a power trader – between the project and the buyer. The generator contracts with the utility to sell the physical power as it is generated, which then contracts with the corporate buyer to supply power at a time and volume to meet its needs. While a sleeved PPA is contractually more complicated, it can, for a buyer with demand in only one jurisdiction, provide greater price certainty, says Dominy.
The alternative approach is a virtual or synthetic PPA, which is a contractually simpler and usually slightly cheaper approach. However, it is a purely financial transaction, where the two parties agree a fixed price, while both generator and buyer sell and buy their power in the wholesale market. If the wholesale price is above the strike, the generator pays the corporate buyer, and vice versa.
Synthetic PPAs are particularly useful for buyers with demand across a number of different countries, as they can offer flexibility in the locations where power loads are delivered. They can also be structured with more than one corporate buyer.
The disadvantage of such an approach is the introduction of ‘basis risk’. This is the danger that the agreed reference price (the benchmark power contract in a particular market) on which the PPA is based diverges from the price at which the buyer and/or seller actually transact in the wholesale market. Such contracts are also regarded as derivatives under the International Financial Reporting Standards, which can cause accounting complexities.
Grappling with low prices
Another challenge for companies looking to enter into PPAs during late 2020 is the low level of electricity prices in most markets, the result of suppressed demand related to the Covid pandemic. While a PPA can allow a company to fix its power costs, potentially saving money over its lifetime, it is likely to be a hard sell internally if it is struck at a higher price initially than prevailing wholesale power prices, says Dominy.
This is leading to interest in ‘sculpted’ PPAs, he says. These either involve stepped pricing, where the strike price of the PPA increases from a lower initial step, perhaps for three years, followed by a number of increases over the life of the contract. Alternatively, they can include indexation; for example, to a measure of inflation, which would reduce the initial price demanded by the developer in exchange for higher prices later.
The US dominates the market for corporate PPAs, but Europe has become a more significant player in recent years. The Covid pandemic has trimmed activity in the US, particularly, in 2020, although Latin America is due for a record year, says the Global Wind Energy Council. South East Asia is seen as a promising market for future growth, given regulatory developments and the growth of large energy consumers in the region, it adds.
Certainly, market participants expect growth to continue and spread to new jurisdictions. This, they say, will be driven by the liberalisation of power markets around the world, the decline of renewable energy subsidies forcing developers to actively seek long-term buyers, and large global companies increasingly expecting their suppliers to reduce their carbon footprints.
Featured photo by Patrik Stollarz/AFP via Getty Images.
Contributing editor Mark Nicholls, co-founder and former editor of Environmental Finance, specialises in sustainable finance and responsible investment, including ESG disclosure and carbon markets.