Financial PPAs – Hedging Tenor & Generation Profile, Credit & Compliance Issues,…

Financial power purchasing agreements (PPAs) are often considered the main project financing tool by the banking world. This is because the banks see the PPA as financial protection for the project and a secure cash flow against which the project is paid off safely and securely over time. Regarding renewable energy projects and financial PPA as a hedge, there are more than a few issues that all parties involved in the transaction (bank, investor, PPA offtaker) should be concerned about.

Tenor

The length of the hedging (term of the PPA agreement), expressed in the number of years of validity of the PPA, is problematic. Banks like to see at least 10 years and more to be covered by a financial PPA. In technical terms, this requirement is the main problem to be solved (at least in Europe) because only the first 2 years (of 10+) can be hedged with liquid energy futures on European power exchanges. So the main question to ask the power offtaker is not how to protect the other 8+ years of underwriting, instead the question for the offtaker is about their creditworthiness and their ability to underwrite that huge risk of being loaded into the trading books. So, just to conclude, a maximum of 20% of the tenor is technically possible to solve with standard futures tools such as “Strip Hedge”, while 80% of the tenor is solved with alternative tools from the financial PPA toolkit.

Perhaps someone is now wondering how the buyer, who decided to provide guarantees, solved the 80% hedge of the illiquid tenor? Well, this is another problem, but it is “solved” by “dirty” hedging (proxy year hedging) and active position management using “Stack and Roll Hedging” strategies. And of course, this comes, with a charge reflected in the final power offtake price.

Hedging Generation Profile

This question is the biggest “secret” of the PPA world. Financial PPAs do not clear the intermittent generation profile of renewable energy generators. A financial futures product is equally distributed quantities in each hour of its delivery period, while the actual production profile can be anything between zero and the installed (maximum) power of the generator. Therefore, the entire difference in cash flow between the base load and the generated (even the reality is even worse, as planned (scheduled) one day in advance, and this is too much detail for this paper) goes on the back of the project owner (investor). Of course, a credible investor bank guarantee solves this to some extent (certainly very far from 100%) and leaves the remaining risk spread among the creditors involved.

That anomaly of the financial PPA comes with a price expressed in the costs of creditor loans.

Credit & Compliance Issues

This section is only here to remind you that financial protection is not a product that every investor can buy, and every seller can afford because both clients must pass credit and compliance tests conducted by serious rating agencies and credit counselors, whose professional service is also reflected in the price of the PPA.

Conclusion

Financial PPAs are not coincidentally well-used financial solutions in liquid and developed electricity markets, but they come with significant costs expressed in the form of a solid discount on the quoted (market) price of electricity. In contrast, PPAs for physical delivery, as generated or scheduled with some pricing structures acceptable to creditors, are absolutely more down-to-earth solutions worthy of serious consideration.

#ppas #financial #powertrading #Renewables