Buy a PPA and get a Cannibalisation Index for Free!

Buy a PPA and get a Cannibalisation Index for Free!

With the race toward renewable energy happening compounded with ESG targets, Power Purchase Agreements (PPA) are all the rage these days. But what few corporate buyers know is that when they buy a PPA they are implicitly buying a renewable power cannibalisation index. Let us buckle up and let me explain what is happening here.

Power Purchase Agreement

A Physical Power Purchase Agreement is a contract between two parties, typically a power producer and a power purchaser, which specifies the terms and conditions for the sale and purchase of electricity generated by a specific power plant or renewable energy facility.

In a PPA, the power producer agrees to sell a certain quantity of electricity to the purchaser at an agreed-upon price for a specified period of time, typically ranging from 10 to 25 years. The purchaser, in turn, agrees to buy the electricity at the agreed-upon price and is responsible for taking delivery of the electricity at a specified point of interconnection or delivery location.

A physical PPA differs from a financial PPA, in which the purchaser agrees to pay a fixed price for the electricity, but does not take physical delivery of the electricity. In a physical PPA, the purchaser takes delivery of the electricity and is responsible for managing the physical transmission of the electricity from the power plant to the point of consumption.

Renewable power generation price cannibalisation

Renewable power generation price cannibalisation is a phenomenon that occurs when the increasing penetration of renewable energy sources (such as wind and solar) in the electricity grid causes the price of electricity to decrease even to a point where it may become unprofitable for renewable generators to operate. This can happen because renewable energy sources have low marginal costs, meaning that once they are installed, the cost of producing additional electricity is very low.

As more renewable energy sources are added to the grid, the overall supply of electricity increases, which can lead to a decrease in the wholesale price of electricity. This, in turn, can reduce the revenue that renewable generators receive for their electricity output, making it harder for them to cover their fixed costs and remain profitable.

Renewable power generation price cannibalisation can be a concern for policymakers and investors who want to promote the transition to renewable energy sources, as it can make it more difficult to attract investment in new renewable projects. To mitigate this risk, policymakers may implement measures such as carbon pricing, renewable energy certificates, or capacity markets to support the deployment of renewable energy sources and ensure their economic viability.

How to measure renewable power generation price cannibalisation?

Please let me briefly introduce the Speedwell Climate / EPEXSpot Solar Power Quanto indices. For renewable power producers, asset holders and investors, our Wind and Solar Power Quanto Indices reflect both wind/solar and spot price fluctuations over a period of time (day, month, season, etc.). Designed for risk transfer, these indices are integral to risk management programs that ensure revenues' stability, resulting in increased financing and development in the renewables market.

Out of the three published indices, the Quality Factor index is of interest here. The Quality Factor (QF) is a measure of the actual price received on a weighted basis per MWh divided by the baseload price. The formula for the QF is:

This index combines the Speedwell Modelled Wind or Solar Power Generation Index with the EPEXSpot price and is by definition a measure of cannibalisation. A high index value means that the renewable power producer is capturing a price close to the baseload price. A low index value means that the renewable energy producer is capturing a price less than the baseload price.

As an example, for the Germany market, the monthly Quality Factor index is degrading as the renewable power generation capacity is increasing:

So why when a corporate buys a PPA it buys a cannibalisation index?

When a corporate buyer buys a PPA, the buyer agrees to pay a certain price for the energy. But as explained above, as the renewable energy installed capacity is changing, the ratio between the achieved price and the baseload price changes. It tends to go down. Over the long period of PPAs: 10 to 25 years, this Quality Factor index could go down to say 50% meaning that the renewable energy company would normally only be capturing 50% of the market baseload price. The thing is that as a corporate buyer you may have implicitly agreed to a higher price for the energy or said differently a higher Quality Factor.

Price cannibalisation is a serious concern in the renewable industry. Whilst PPAs offer a static hedge and are great to get financing for new projects, dynamically hedging the cannibalisation of prices is becoming a red-hot topic. The Speedwell/EPEX indices were designed to allow the transfer of this risk to the market.

Speedwell Climate is the leading provider of data for the climate risk transfer business. We also provide the Speedwell Environmental System for pricing and managing climate derivative contracts. Speedwell Climate also provides independent valuations of weather derivatives, quanto pricing, and portfolios of climate risks.

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