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What is a PPA?
Pursuant to a Power Purchase Agreement (PPA) a producer sells the energy produced by its plant to a trader, that, in turn, sells it on the energy markets.
The reason for which producers often do not operate directly on the energy markets but enter into a PPA is that trading on such markets requires a certain technical expertise and minimum financial requirements.
On the basis of the PPA the trader shall act as “dispatching user”, becoming the interface of the production units with the grid. In particular, the trader shall be liable vis-à-vis the Transmission System Operator (TSO) for imbalances between the production programs – which are to be submitted to the TSO on a certain notice – and the actual production of the production units. Such liabilities/costs are normally charged to the producer pursuant to the PPA.
PPAs expose producers to the risk of traders’ insolvency, as invoices normally follow a certain production period. Hence, producers should thoroughly assess traders’ credit worthiness, negotiating for adequate collaterals where necessary.
What is a Long Term PPA?
Most common PPAs in the Italian market provide a short term (typically one year) and indexed prices, linked to the price determined on the energy organized market (IPEX).
However, starting from the experience of other EU markets and as a consequence of the general review of incentive mechanisms granted in the past to renewable resources, there are signs of an increasing demand for more structured products, with a medium/long term (up to 10 years).
Differently from short term/indexed PPAs, such contracts allow producers to share with (or transfer to) traders a part of risks which normally affect the value of their investments, namely price risk – deriving from the volatile nature of energy market price – and volume risk – deriving from the unpredictability of renewable resources like sun or wind.
With respect to price risk, leveraging on its view on forward prices curves, traders may offer to producers fixed price solutions – neutralizing adverse market price movements but limiting producers’ gains in case of upward movements – or options granting to producers a certain floor.
PPAs may also contain formulas ensuring to producers (also from photovoltaic or eolic plants) payments calculated on the basis of pre-determined quantities of energy, irrespective of the actual production of the plant, thus creating a swap effect: payment of predetermined amounts vs delivery of variable quantities of commodity.
The level of prices in Long Term PPAs depends mainly on the risk appetite of producers, determined by the financial structure of the investment.
In case producers are available to bear or share with traders a part of the risks, they may obtain commercially aggressive prices and maintain the possibility to benefit from gains deriving from price upward movements or from higher than expected production volumes.
In case investments are to be realized through a debt structure, PPAs should meet bankability requirements, therefore compressing considerations in exchange for an higher financial stability in the long term.
What is a Corporate PPA?
Producers may also find opportunities for financial support if the demand side is also involved in a PPA structure.
Big consumers are in fact showing an active interest in long term supply contracts for two main reasons.
On the one hand, more and more companies include environmental sustainability in their business strategy in order to address the increasing public awareness on climate change. Hence, being involved in a contractual structure sustaining the construction of new renewable plants offers a tremendous chance from a communication point of view.
On the other hand, also consumers are exposed to volatility of energy prices. Signals of increasing forward prices may therefore induce also the demand side to plan long term supply strategies, to hedge such risk.
In foreign markets this has led to the conclusion of long term PPAs between renewable producers and consumers.
In the Italian context, for regulatory reasons, such type of PPAs may be implemented through a triangular structure involving a trader that shall: (i) act as the dispatching user for both the production and the consumption units[1], (ii) ensure modulations of production and consumption profiles[2] and (iii) certify through the Guarantees of Origin (GO) mechanism that the energy delivered to the consumer is “renewable”.
[1] Energy shall be delivered to the consumer through the grid and this requires, as mentioned above, that a trader acts as dispatching user vis-à-vis the TSO.
[2] Since it is extremely unlikely that production and consumption profiles match in the daily life of the contract, the trader shall have to act on the spot market to sell off the energy produced in excess of consumption or to buy the energy consumed in excess of production.
