The PPA Phenomenon

Everyone in the industry talks about them: producers, traders, financial institutions, consumers … but few have seen them. All predict that in the short term they will be common, but today in Spain only one has been signed. Everyone talks about PPA, as the new trend for consumers, the great solution for renewables.

But this kind of contracts are not new, the first took place almost 10 years ago in countries like the United States or UK, and took some leverage from 2012, when Google and Apple signed their first renewable energy PPA.

However, in Spain they are still embryonic. But, in Magnus CMD, we have already lived, from nearby, the generation of what is known as the first PPA signed in Spain. It is seen as the solution for many of the producers of the 8,700MW of renewables that, following the auctions carried out this year by the government, should seek urgent financing to meet the deadline and be operational in 2020. With the volatility of the OMIE market, a PPA offers them a stable long-term income alternative. The initial interest in PPAs has therefore been fed by producers, but do they have an interested counterpart? What benefits can they draw from consumers? We will use this article to see the B side of the PPA, that of consumers.

WHAT IS ABOUT?

A PPA contract is defined by its own acronym (Power Purchase Agreement). That is, we are in front of an agreement of purchase-sale of electricity between a consumer and an independent producer, without intermediaries. With that agreement, the consumer undertakes to purchase from the producer a certain volume of energy produced by the producer at a set price and for a specific time horizon. This agreement, therefore, must establish a commercial and financial framework, as well as delimit the risks and responsibilities of each of the parties. It is a peer-to-peer agreement, so it can be totally ad hoc, as long as both parties agree on the conditions of the transaction, as it would be oblivious to the conditions of the wholesale market. They are long-term contracts, in which the same buyer often participates in the investment of the generation plant.

The contractual terms may or may not involve the dispatch of the energy, so we are talking about two main types: the physical PPA and the financial (or virtual) PPA.

Source: ‘Corporate Renewable Power Purchase Agreements: Scaling up Globally’ A report produced by the World Business Council for Sustainable Development (WBCSD), with Norton Rose Fulbright and EY.

As defined by the rules of the electricity sector in Spain, the option of a physical PPA goes through one of these three alternatives:

• Connection with a direct line between consumer and producer, on a self-consumption basis.
• The buyer is Direct Consumer to market and, therefore, establishes the agreement directly with the producer.
• The agreement includes a third party: an utility that acts as a representative of the producer.

This type of PPA can provide more customized solutions depending on the load profile of both parties, establishing totally individualized contracting formulas. However, the risks of profiling, volume, availability, which are associated must be taken into account.

On the other hand, financial or virtual PPAs can be established, the nature of which is a purely financial transaction, independent of the volume actually produced or consumed.

With the volatility of the OMIE market and the regulatory uncertainty, the power to guarantee a stable income is for many producers an important tool to obtain the financing. Therefore, they tend to be long-term contracts (over 10 years), with the objective of financing greenfield projects, obtaining optimum leverage to maximize return on investment in new facilities. Although they also allow to guarantee a minimum income for the already installed generation of certain vertically integrated marketers that include their renewable generation already operative in the agreements with their final clients.

The ultimate goal for most producers is therefore bankability and risk mitigation offered by the PPA. Tp finance a renewable project, a bank requires three main constraints: constant cash flow, proven technology and a stable legal framework. Wind and photovoltaic technology have been proven in recent years and, although energy is not a legally stable sector, it is not the restrictive factor. Therefore, the limitation is in cash flow. With the uncertainty in revenues from the OMIE daily market and the variation of premiums (if any), it makes the PPA the most viable option for financing.

AN OPPORTUNITY FOR CONSUMERS?

It seems that the PPA fits like a glove for those renewables that wants to make their businesses profitable, but in any agreement, there must be two interested parties.

On the consumer side, a PPA agreement can also offer you advantages. Firstly, stability and long-term cost forecasting, with the possibility of achieving a competitive price below current market conditions, which fits with your profitability. Today, it is not possible to establish financial covers for more than 3 or 4 years, which are the products that are listed in OMIP. And even so, only the first year has enough liquidity. This factor may fit consumers who are looking for budget stability first and want to eliminate market volatility. Companies that can not transfer costs to their final product derived from the energy market, or also to large energy intensive consumers, since this option can allow them to get a product with better conditions than the market, totally customized to their consumption profile and requirements.

On the other hand, and not least, it allows you to guarantee the origin of your energy, 100% renewable, by including the transmission of Guarantees of Origin issued by the CNMC under the agreement. Increasingly, large companies are demanding sustainability measures throughout their supply chain, with greater control and steady reduction of CO2 emissions. Participating in the financing of greenfield renewable projects is one of the mechanisms used by many large corporations to achieve these goals. All this in turn contributes in a greater reputation and recognition of the company in its leadership in the accomplishment of environmental measures.

This context of opportunity in achieving a PPA agreement can be disrupted if the risks arising from:

• We are talking about long-term contracts, with no market reference, and in a very volatile market. Taking the historical reference is not valid, and any changes in regulation (eg, generation tax, or interconnections), as well as any technological change, can change the rules of the game quickly. We are ahead of a long hedge, so market risk is present and inevitable. We must seek the price that is comfortable for both parties and fulfill the strategic objectives that are defined previously.
• Legislative changes. The whole framework of the agreement will be based on current market and sector conditions. The clauses should be very broad, allowing any changes that modify the conditions of either party.
• Flexibility of the parts. What happens if the producer does not comply with the volume involved? The applicable procedures and penalties should be included to minimize the operational risks derived, for example, from deviations in production, unavailability, non-compliance with deadlines, demand management, and so on.

From our experience on the consumer side, the main handicap of the conditions discussed so far is the term of these agreements. In Spanish companies, both industrial and services, it is often difficult to come up with such long-term agreements. An intermediate solution could be a 5 year agreement, which for the consumer is already a long commitment, being able to take references to a longer term than those offered in OMIP. But is this deadline sufficient for the conditions imposed by the bank on profitability to be attractive to both parties?

Another aspect that could cause reluctance are guarantees. On the part of the buyer, they should not be required, because their responsibility in the agreement lies in the risk of default, so a company with good rating would be covered. On the part of the producer, one of the options that currently arise is the possibility that the banking entity could adquire the plant in case of breach of contract by the producer.

On the other hand, there is the issue of operations. A financial PPA can be totally peer-to-peer, without market evidence, treated as a settlement for differences. But if the goal is to define a physical PPA, the thing is complicated. Or it is a Direct Consumer, or the management must be carried out through some utility, who will act as an intermediary, and will be the one to nominate and manage the energy taking into account the signed agreement.

As consumers then, should we wait to see what options our current suppliers present to us or should we be the drivers of this type of agreement? If the aspects discussed are analyzed well, the contracting of a PPA can be a great opportunity for the companies. The consumer has a very important role to play, in it lies the strenght of negotiation in the PPA.

Susana Gómez | Energy Consultant