Types of Power Purchase Agreements and Why Each PPA Might Be Used

Stakeholders are increasingly pressuring corporations to become more sustainable, and often that means using renewable energy to help meet their electricity needs. Most non-power companies don’t want to take on the responsibility of constructing and operating their own wind or solar farms, so they turn to power purchase agreements (PPAs) to source renewable energy. There are many different types of PPAs, however, so it’s important to understand how and why each is used.

A power purchase agreement (PPA) for renewable electricity is generally defined as a contract for the purchase of power and associated renewable energy credits (RECs) from a specific renewable energy generator (the seller) to a purchaser of renewable electricity (the buyer). PPAs often have terms of 10 to 20 years and they define all of the commercial requirements for the sale of renewable electricity between the two parties, including when the project will begin commercial operation, a schedule for delivery of electricity, penalties for under delivery, payment terms, and termination conditions.

In late July, Infocast held a two-day-long virtual master class titled “Negotiating and Documenting Corporate PPAs.” The event was co-hosted by K&L Gates LLP. Among the sessions was an overview covering the evolution of corporate PPA structures, which Bill Holmes, a partner with K&L Gates, and Lana Le Hir, a senior associate with the firm, presented. The duo described many of the most common PPA types and uses, which will be covered below.

On-Site Versus Off-Site

One of the first decisions that a commercial and industrial (C&I) corporation must make when sourcing renewable energy for its business is whether to pursue an on-site or off-site system. This is usually driven by the load or demand the company is looking to fill. On-site systems are generally smaller (often in the 500 kW to 3 MW range), and include equipment such as rooftop solar panels or small wind turbines. These can be good options for warehouses or retail stores, among others.

For C&I companies that have larger needs, off-site systems are usually required. These systems could have capacities in the 50 MW to 400 MW range, and might be ground-mounted solar systems or multiple large wind turbines that require a large amount of space. In some cases, the PPA may only be for a portion of a larger project’s output. Off-site systems often make sense for corporations that have a data center that uses a lot of electricity (Figure 1) or for a chain of retail outlets that have stores spread out over a fairly wide area.

1. Apple invested in two of the world’s largest onshore wind turbines, which are located near the Danish town of Esbjerg. The power produced at Esbjerg will support Apple’s data center in Viborg, with all surplus energy going into the Danish grid. Courtesy: Apple

It’s usually preferable for corporations to buy renewable electricity and/or RECs from a project through a PPA because it shifts development and operations risk to an independent power producer (IPP). Decision-makers will need to dive deeper into the rules and regulations in their particular location to better understand what is possible. Working with a reputable professional experienced in the PPA process is likely to benefit most companies.

Green Tariff 1.0

“When I first started doing renewable energy deals in any large volume, which was in the late 1990s, a lot of the transactions were essentially REC sales,” Holmes said. In those transactions, an IPP would develop a renewable energy project, such as a wind farm, sell the electricity to the grid, and reserve the RECs. These were commonly called unbundled RECs.

The unbundled RECs could then be sold to C&I customers that wanted to tout that they were using green energy. Another option for the IPP was to sell the unbundled RECs to utilities or aggregators, who could then sell them to customers who wanted green energy. “I call this Green Tariff 1.0,” said Holmes. “This is the old school way of doing business.”

The Green Tariff 1.0 program provided no economic benefits to customers, because it was basically an adder above what customers were already paying for electricity. While it gave customers the bragging rights for using green energy, it came with a price. These programs usually didn’t require a long commitment, however, which was a plus. REC sale agreements were often for three to five years, rather than decades.

Physical Delivery PPA

In physical delivery PPAs, the developer sells electricity and RECs from a utility-scale project directly to a customer. They’re not particularly common because many utilities in the U.S. have exclusive service territories and effectively operate as monopolies. Therefore, other companies can’t sell electricity directly to customers, except in competitive markets.

Furthermore, if a developer makes a sale to a retail customer, it may find itself subject to regulation as a public utility, which would mean the public utility commission could regulate the rate that the IPP charges customers. This would be a serious turnoff for lenders. Still, the opportunity for physical delivery of power does exist in some locations.

“We see that in Oregon, we see that in Pennsylvania, and in other jurisdictions where that is permitted to one degree or another, but there’s always a somewhat limited supply, and some complications associated with doing those transactions, such as whether your load is in a place where you can get the physical delivery, that we find them to be less common,” Holmes said.

Green Tariff 2.0

One way to effectively deal with a utility’s exclusive service territory rights is using what Holmes calls “Green Tariff 2.0.” In this type of deal, the IPP sells the electricity and RECs to the utility, then the utility enters into a back-to-back agreement with the C&I customer to sell them the energy and RECs.

Sometimes, the utility will make its own obligations contingent upon the performance of the corporate customer. In that case, the IPP may need to enter into a separate agreement with the customer for credit support.

“These transactions are potentially complicated, they’re not automatic, and they’re not available with all utilities—not available in all states,” said Holmes. One benefit for the C&I customer is that this type of deal allows it to point to a specific renewable energy project that’s located near its facility, for example, and proclaim that it is helping contribute to the local tax base and supporting renewable energy jobs in the community.

Community Solar

Community solar PPAs can follow a somewhat similar scheme, that is, the IPP sells electricity and RECs to the utility, and the utility facilitates the community solar program (Figure 2). However, in some deals, corporate off-takers enter into a subscription agreement with the IPP, pursuant to which the customer purchases bill credits based on its share of the system output. The bill credits are then provided by the utility.

2. Minnesota Power’s community solar pilot program includes a 1-MW array in Wrenshall, Minnesota. Courtesy: US Solar

“The one thing to keep in mind is that the utility may be the party that’s acquiring renewable energy credits, and that may limit the ability of the C&I customer to claim that it is using renewable energy,” Holmes explained. “An important point to bear in mind is that RECs are the key and essential component of a corporation’s claim to be using renewable energy. If you don’t control the RECs, you don’t control the renewables.”

Virtual PPA

Virtual PPAs (VPPAs) are frequently used when physical delivery is precluded by utility monopoly structures. VPPAs require a liquid electricity market, such as an ISO or RTO, in which the price for power can be reliably and publicly determined at various points in the grid. The IPP sells RECs to corporate off-takers, while selling the power to the grid at the best possible market price.

“With respect to the settlement specifically of a VPPA that makes it different from a physical PPA, it is considered a swap, because you’re not delivering physical energy and you’re settling based on the contract for differences structure,” Le Hir explained. “This is basically a formula that settles for every hour of transaction in the market, and then you aggregate and net out the amount owed to each party over the settlement period, which is usually every month.”

For example, if the fixed price was $20/MWh and the market price was $25/MWh in a given settlement interval, the IPP would financially settle by paying the corporate buyer $5/MWh. If in the same example the market price was $15/MWh, the corporate buyer would financially settle by paying the IPP $5/MWh. The parties would usually settle monthly by aggregating and netting settlement intervals to produce a single amount owed by one party to the other.

This structure allows an IPP to assure lenders that it will always get the fixed price, and it allows the corporate buyer to get the RECs and an electricity price hedge. The corporate buyer can also claim “additionality,” which essentially means it can tell customers and other stakeholders that additional renewable energy has been added to the grid that would not exist without the company’s involvement.

Portfolio PPA

The portfolio PPA concept is often desirable for a corporate buyer interested in purchasing renewable energy from a host of projects in multiple regions throughout the country. These are arranged as a master purchase agreement in which the terms are negotiated in one PPA. The agreement has a “confirm structure,” which means, as each project is proposed or getting ready to come online, the developer will offer confirms and the parties will execute each of the confirms for each of the individual projects. These agreements often have the flexibility to alter schedules by shifting projects around, which can also provide benefits.

“This is a way that people can have trusted partners that they have negotiated these larger portfolios from and they can basically be able to procure a larger volume in hopefully a shorter amount of time,” Le Hir said. “Instead of negotiating 10 different PPAs with 10 different developers, they’re now negotiating with one developer.”

Block Delivery PPA

A block PPA requires a physical delivery of energy and RECs to a certain location. It guarantees a shaped and firmed amount of electricity every hour of the term. Usually, the buyer will nominate quantities based on its expected load forecast, with different amounts in different blocks. The seller is obligated to deliver the agreed upon renewable energy.

“Since you can’t just turn wind and solar on or off, the seller has to make up the difference based on market purchases,” Le Hir said. “With respect to the RECs, we make sure that the RECs match the actual deliveries that were from the wind and solar in order to help the corporate buyer meet their renewable procurement goals.”

Aaron Larson is POWER’s executive editor.

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