How a Power Purchase Agreement works and the advantages of adopting one

Submitted by Acriziomar Alves on Thu, 01/14/2021 - 10:45
How a Power Purchase Agreement works and the advantages of adopting one plus Eolic Field

Among the benefits of adopting a PPA are economy, predictability and increased sustainability in your business 

 

Electricity is undoubtedly present in all existing industrial processes, however it might be used, and is generally used intensively. Therefore the global market is increasingly demanding in looking for sustainable processes and operations so that the environment is preserved as much as possible.

In this sense, the organizations that can seize the existing opportunities to stand out right now will certainly be more competitive in the future. Among these visible opportunties are Power Purchase Agreements (PPAs), which were conceived in Brazil with the opening of the energy market in 1995, although they are not yet common in Brazil.

What is a Power Purchase Agreement?

Power Purchase Agreements or PPAs are long-term contracts for purchasing energy, usually 10 years or more, signed between electro-intensive companies (those that consume large amounts of electricity in their operations) and operate in the Industrial/Commercial segments (C&I), and agents responsible for developing electricity generation projects (generators). These contracts, most of which are applied to businesses aimed at renewable energy sources, such as wind, solar, SHP (small hydro power) and biomass.

Main features of the PPA

The PPA can be developed in two distinct types: physical or virtual. The physical PPA is applied where there is construction of a new generating enterprise, even the points of generation and consumption are not directly connected. Thus in the case of Brazil where a large part of the electrical system is interconnected, the buyer can contract energy from any supplier that is connected to the SIN (Brazilian National Interconnected System). In this type of contracting, the registration and accounting of generation and consumption must be linked to the Chamber of Commercialization of Electric Energy (CCEE), the agency responsible for regulating the energy market in Brazil.

On the other hand, the virtual Power Purchase Agreement has more flexible rules, since the negotiations occur via Contract for Difference (CFD). Thus the parties perform their financial settlements based on the market price of the traded asset, in this case energy. This second scenario is more common in countries such as the US and Germany where energy is traded in markets, the famous Power Exchanges.

Panorama of adoption of the PPA in Brazil and around the world

The PPA model is already widespread in North America and Europe. In South America participation is still modest, however there is very considerable unexplored potential. According to information from O Setor Elétricocorporate contracts for purchase and sale of clean energy PPAs have experienced accelerated growth in Brazil. By March 2019, PPA contracts for renewable energy for 250 MW had been signed and registered in the country; by November of the same year, this volume doubled, jumping to 590 MW”, that is, this model of contracting has intensified both in number and in power brought online.

PPA Contracts Map Brazil

Figure 1 - PPA Contracts in Brazil. Source: Bloomberg NEF 2019, translated by Vetta

 

PPA Contracts Worldwide

Figure 2 - PPA Contracts around the world. Source: Bloomberg NEF 2019

Why choose Power Purchase Agreement for your company?

The PPA naturally presents certain benefits to contractors, three in particular:

Economic

Because it is a new enterprise, the price of energy is linked to the cost of production of energy itself and not to the price applied by the market, which regularly suffers from various external influences (supply and demand, reservoir levels, reserve power, charges etc.). Thus the buyer will certainly be able to obtain reductions in the cost of energy by negotiating price with the supplier.

Predictability

Because it is a long-term contract, usually for at least 10 years, the PPA leaves the company less exposed to the volatility of market prices. Thus the buy will better be able to plan from the point of view of the cost of their future energy. Moreover, many institutions consider predictability more important than cost reduction.

Carbon Footprint

Considering that the overarching objective of the PPA is to develop an enterprise aimed at generating renewable energy, the company interested in this type of contract may use it as carbon offsets. Since there is the possibility of the delivered energy coming with Renewable Energy Certificates (RECs) or Guarantee of Origin (GOO), which assists in the global commitment of companies to reduce greenhouse gas emissions in their operations.

What are the risks in contracting a Power Purchase Agreement?

As with all long-term decision-making, there are some inherent risks. The process of energy procurement by PPA is no different; these are the main risks:

Economic risk

In view of the term of the contracts, if the future price of the energy traded in the market falls below the price previously established with the supplier, the buyer (company) will have long-term injury and loss of competitive capacity and loss of operating/production cost reductions.

To mitigate this risk, it is possible to negotiate early periodic price reassessments along the duration of the contract with the supplier, provided that both parties are in common agreement.

Consumption planning

Considering the duration of the PPA contract, the consumption planning and forecast of future increases by the consumer must be performed quite prudently, since an exposure to the short term market – positive or negative – during this period may lead to less-than-optimal results in the company's balance sheet.

In addition, many companies still have great difficulty understanding the dynamics of the energy consumption of their operations. To mitigate this risk, there is the possibility of negotiating with the supplier certain contract tools that are widely applied in today's energy market, such as delivery of energy according to load, flexibility, or flat contracting.

Counterparty

Because the PPA is a bilateral contract and usually linked to the construction of assets, the contractor must take into account the risk of non-compliance by the supplier with the agreement between the parties.

Thus in order to reduce these inherent risks as much as possible, it is important that the institution cover the deadlines set for construction, verify the commercial coverage and capacity of the supplier, certify that the delivery deadlines are within expectations, and in addition establish legal safeguards including specific clauses covering the characteristics and delivery deadlines of the product traded.

In this article we present the main advantages and certain disadvantages of adopting Power Purchase Agreements. It was possible to see that the contracting of energy through PPA contracts are attractive from an economic and environmental point of view, but it is of paramount importance to fully assess the prospects of such contracts over the long term, especially in terms of strategic planning, so that the risks mentioned above are controlled, facilitating educated decision-making.

Sources: https://cebds.org/ and https://www.osetoreletrico.com.br/

Energy Management Analyst, Viridis

Acriziomar Alves is an Energy Management Analyst at Viridis, working in Energy Management and Strategic Planning at Bayer. He holds a bachelor's degree from the Brazilian Federal University of Uberlândia in electrical engineering with a focus on power systems. Mr. Alves has participated in R&D projects with Petrobrás, with research directed toward the creation of computational models for power flow analysis and energy quality.

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