Power Purchase Agreements PPAs
A power purchase agreement (PPA) is an agreement between two parties to buy and sell power at a fixed price for a set period of time. PPAs are used to secure a long-term electricity supply and provide a stable revenue stream for the generator, while also giving the buyer a predictable electricity cost. PPAs provide a way to finance the development of new power plants or renewable energy projects.
Power purchase agreements have become increasingly popular in the renewable energy sector as they provide a way for businesses and homeowners to finance renewable energy installations. PPAs make it possible to replace normal energy bills with a contract to build sources of renewable energy production and also supply energy. This article will explore different aspects of PPAs: why they are a major part of financing renewable energy projects, how they work, what they are, the different types of assets that can be financed through them, and how virtual power plants can shorten the payback period for renewable energy projects with the help of PPAs.
What is the levelized cost of energy and why is it important for PPAs?
The levelized cost of energy (LCOE) is an important metric in calculating the cost of renewable energy versus traditional fossil or nuclear energy sources. The reason that LCOE is important, is that it can be used to compare the cost per MWh of different generation technologies. The concept of ‘grid parity’ has come about thanks to measurements like LCOE. In this context, grid parity means that the LCOE of renewables is competitive with conventional generation technologies. As the LCOE of renewable energy technologies continues to decrease, they become more competitive. This justifies building more and more renewable energy projects even without the support of subsidies.
The LCOE is used to determine if a project will be viable during the initial business case calculation. In addition, it gives an indication of what revenues a renewable energy installation will need to achieve in order to be profitable.
In the era of grid parity, the research which is used to build a business case for renewable energy installations is critical. As PPAs are an integral part of the financing for many renewable energy projects today, the PPA price needs to take different variables into consideration. Perhaps most importantly, the PPA price needs to be above the current or future LCOE of the project that is being planned. the LCOE acts as a baseline of what the PPA price needs to be to ensure that the project will be financially viable.
In short, thanks to market forces, which can be measured by the LCOE, renewable energy is competitive with fossil fuel sources of energy on a MWh by MWh basis. Thanks to this, it is less and less necessary for governments to provide subsidies to support the development of renewable energy projects. PPAs are a tool used to finance renewable energy projects in an environment of decreasing government subsidies.
What are the main types of PPAs?
A physical PPA involves the electricity consumer receiving electricity from the seller through the grid, as opposed to a “virtual” power purchase agreement. In a physical power purchase agreement, the power is delivered to the customer and consumed as it is generated.
In a physical PPA, an organization enters into a long-term contract with a third-party seller who will construct, maintain, and operate a renewable energy system on or off the customer's premises. Regardless of whether the system is on-site or not, the physical PPA consumer receives electricity through the grid in both cases.
The consumer agrees to purchase power at a certain price for a stated period, and the seller assumes the risks linked with owning and operating the system.
Many physical PPAs with on-site systems conclude with the consumer having the option of renewing at a lower rate or acquiring the equipment for a fair market price. In this manner, some clients may enjoy immediate savings on their energy bill (through the physical PPA) while eventually owning the system - and gaining all the associated benefits.
On-site vs Offsite
The first major distinction in a physical PPA is whether or not the installation is located on or off-site from the energy consumer. An on-site installation is one where the renewable energy system is built on the same property as where it will be used. The power generated by the system goes directly into powering the home or business, offsetting some or all of the electricity that would otherwise be purchased from the utility company. One of the major benefits of an on-site is a reduction in grid fees.
In contrast, an off-site installation is one where the renewable energy system is built elsewhere, and the power it produces is fed into the electric grid. The customer pays a fixed price for power from the installation but does not receive any of the power directly. The main advantages to such a system are that the renewable energy system can be built wherever it needs to be and doesn’t have to be located at the same site as the off-take point. Therefore the energy consumer doesn’t need to be associated with the producer other than as a customer to receive their energy production.
A power buyer (consumer) agrees to buy the renewable energy produced by a project for a set price under the terms of a virtual power purchase agreement (VPPA). According to this agreement, the utility-scale solar plant will be paid the going rate for the electricity when it is sold.
The consumer receives the difference if the market price exceeds the fixed VPPA price.
The consumer pays the project the difference if the market price is less than the fixed VPPA price.
A virtual PPA functions in this way as a financial safeguard against fluctuating electricity prices. Usually, the project's Renewable Attributes, or Renewable Energy Certificates, are given to the buyer.
The virtual PPA is a fantastic option for large electricity users with a fragmented/distributed electric load to support the development of new renewable energy resources because there is no physical delivery of power.
How do virtual PPAs work in practice?
There is no actual physical delivery of power to the buyer's load centers while using a virtual PPA. In actuality, the purchaser will carry on making their regular utility payments. A Virtual PPA is a contract that serves as a price hedge for electricity. Additionally, as part of the VPPA, the buyer receives Renewable Energy Credits, which enables the buyer to claim that their renewable energy purchase and greenhouse gas reductions were successful.
It is crucial to highlight that VPPAs demand market liquidity, which allows the project to sell its electricity straight into the grid for the going wholesale rate.
Major benefits of virtual PPAs
For developers wishing to finance new projects, virtual PPAs are incredibly helpful since it ensures that a project will receive a fixed price for its energy production. The new "additional" renewable energy facility that is supplying the grid with additional clean energy and replacing fossil fuels is directly responsible for the energy bought through a virtual PPA.
Businesses interested in virtual PPAs are usually interested in green energy, carbon footprint reduction, and sustainable business practices. The impact of these "green" projects is crucial in determining their actual return on investment, just like it is with any investment. For instance, buying unbundled renewable energy credits is a low-impact way to meet your renewable energy targets.
This enables businesses to assert that the inclusion of a new renewable energy project is directly and significantly impacted by their purchase of renewable energy. Organizations are definitely catching on to this impact's huge marketing and branding opportunities.
The buyer secures a price based on the wholesale market price of power by entering a long-term virtual PPA. The cost of the buyer's traditional energy source will probably increase if wholesale prices go higher. The VPPA sale will probably result in a profit for the buyer, and the earnings might be used to offset rising costs for conventional energy. On the other hand, if the virtual PPA price is higher than the wholesale market price, the buyer will be compelled to pay the project the net difference in order to secure their necessary fixed revenue stream, albeit they will probably also save money on traditional energy. The VPPA serves as a buffer against growing conventional energy costs in this way.
On the other hand, in a situation where energy costs are extremely high, such as after the Russian invasion of Ukraine, it becomes harder to arrange PPAs because there is greater uncertainty about future energy prices.
How can virtual power plants improve the business case for renewable energy projects via PPAs?
One of the main benefits of a virtual power plant (VPP) is that it allows for the flexible management of energy assets. With the help of a VPP, energy can be sourced from multiple generators and also energy storage systems. This allows for the balancing of energy supply and demand in real time. When the demand for energy is high, the VPP can decrease consumption or increase the output of its connected distributed energy resources (DERs) to meet the heightened demand. Alternatively, demand-side response can be utilized to decrease demand. When demand is low, the VPP can reduce its output or fill energy storages that are connected to the VPP.
In addition, a VPP can also participate in the electricity market by buying and selling energy on the spot market. This can help to further balance the grid by allowing the VPP to purchase energy from the market when the output of its connected DERs is insufficient to meet demand, and by selling excess energy back to the market when the output of its connected DERs is greater than needed. By participating in spot markets, i.e. buying low and selling high, a VPP can further reduce costs and improve the payback period of the PPA.
When combining otherwise inflexible renewable energy with the flexible management of energy consumption and participating in spot markets a VPP can dynamically adjust energy consumption in response to changes in energy prices and demand. This allows the VPP to take advantage of favorable market conditions and reduce energy costs.
Virtual power plants can help reduce the cost of imbalances for a balance responsible party by aggregating the output of multiple distributed energy resources, reducing the need for otherwise expensive balancing services. Additionally, by participating in demand response programs and other grid services, a VPP can generate revenue for the balance responsible party, which offsets the cost of imbalances.
PPAs are an important tool for financing renewable energy installations, but they are not without their drawbacks. Before entering into a PPA, it is important to understand all of the details, and how they might affect long-term cash flow. With that in mind, PPAs can be a valuable instrument for financing renewable energy and dramatically increasing the rollout of installations of solar and wind.