Power Purchase Agreements – a strategic choice

Revisiting the case for Power Purchase Agreements (PPAs) and their place in a risk management strategy, Kath Chapman, Managing Director at Ameresco, offers valuable insights.

The joke goes that a strategic decision is one where the numbers don’t add up. Events over the last few months have confirmed that entering into a power purchase agreement (PPA) is such a decision. Wholesale markets remain above pre-crisis levels but are much lower (in the ￡70-80/MWh range at the time of writing), while project costs, and PPA prices, have increased.

Pressure on governments around the world is increasing demand for renewable generation, so costs seem unlikely to fall soon. Indeed, the UK Government’s restatement of the Administrative Strike Prices for the next Contracts for Difference (CfD) Allocation Round is now above market levels.

Given the volume that the Government needs to source and its superior creditworthiness to a corporate offtaker, the numbers are saying that developers should be looking at the CfD scheme as the preferred route to market. Announcements about corporate PPAs are likely to reflect either negotiations that have been proceeding for some time or where an organisation has taken a strategic decision to source power from PPAs rather than the volatile wholesale market.

To be clear, we are not turning our backs on PPAs. They are a sensible strategic option for many firms’ progress through the energy transition, providing both environmental and risk management benefits. But there are headwinds such as from lower wholesale market prices and the decision to enter into a PPA is now definitely a strategic one, rather than an economic one.

Preparing for PPAs

In our webinar on preparing for PPAs that the MEUC kindly hosted, we worked through practical issues that buyers will need to navigate to manage PPAs effectively. We’ll focus on the impact of imbalance volumes here (see figure 1).

This firm has chosen to cover its requirements with two PPAs, one from a windfarm and the second from a solar development. This combination provides a flatter generation profile that is closer to the consumption profile. The supplier will net the PPA volumes against the forecast consumption to determine the volume needing to be bought out of the wholesale market.

At a monthly aggregate level, there are differences between consumption and the volume generated, but these net out across a year. However, if the imbalance volumes are looked at in absolute terms, they amount to 16 per cent of the total consumption.

With half-hourly data, we can increase the granularity of the analysis. If daily totals are used, the absolute imbalance rises to 36 per cent. At a half-hourly resolution, the imbalance volume rises to 76 per cent of total consumption.

In this case, as well as paying for the energy produced, the buyer will also have to cover the cost of the individual imbalance volume buys and sells amounting to three-quarters of its consumption.

Firming contracts provide a solution where the intermittent volumes from the PPA are swapped for a baseload volume that is then transferred into the supply contract. This facilitates the operation of risk management strategies, but deviations in actual volumes from the forecast may still leave our buyer under- or over-hedged.

Some firming contracts will address short-term variations between day ahead forecasts and actuals, but not convert the intrinsic generation profile to baseload. Deviations from baseload are then cashed out. Backtesting this shows that before 2021, this approach would have led to a minor adjustment in prices; however, the impact of the market volatility in 2022 is clearly seen (see figure 2)

While the PPA is central to securing the renewable power in the first place, firming arrangements need to be analysed carefully. Once operational, good processes will be needed to capture and manage the data so that costs like the deviation charge can be validated.

Onsite PPA benefits

From April, firms in Energy Intensive Industries (EII) that pass the eligibility tests are able to secure a 100 per cent exemption from the costs of the renewable support schemes (Contract for Difference, Renewables Obligation and Feed-in Tariff). From October this will expand to include the costs of the Capacity Market and from Q2 next year, relief from network costs will also be available.

Once fully operational, these changes will remove much of the benefit for behind the meter and private wire installations. Firms with existing installations should review the terms to check if price reviews are possible.

The PPA world has shifted significantly over the last few months so that while the risk management and environmental benefits remain, any intrinsic cost advantage has been eroded. Entering into a PPA needs a clear case supported by the commitment of stakeholders, by a good understanding of the commercial issues and with the processes to manage the data. Should we talk?

Contact Kath Chapman: [email protected]

This article appears in Buying and Using Utilities Spring 2024

Read more ??https://meucnetwork.co.uk/buu-spring-2024/