Italy: Power Purchase Agreements and Risk Allocation

There are different types of PPAs: Corporate PPAs, entered into by and between developers/producers and buyers/end users of energy. Utility PPAs or Merchant PPAs executed with utilities, i.e. companies that resell energy to their customers or on the market.  On-site PPAs, in which the plant is physically connected to the buyer and only the energy not used by the buyer is being sold to the grid. Off-site PPAs, in which the purchased electricity is delivered to the grid. Physical PPAs or Virtual PPAs.

Beyond their different configurations and classifications, PPAs govern commercial relationships between producers, intermediaries and buyers of electricity from renewable sources (also with regards to the related guarantees of origin) and are functionally linked to contracts for the construction, maintenance and operation of the plants as well as to financing contracts. It is, therefore, extremely important to identify the purposes and contractually protect the multiple and not always convergent interests pursued by the different "actors" involved through a careful drafting not only of the PPAs but also of all related agreements: EPC contracts, O&M contracts, long-term service contracts, surface contracts, financing contracts, direct agreements, to name but a few.

Through PPAs, Producers are interested in securing a guaranteed return on their investment and thus achieve the project bankability needed to access financing related to plant development, buildability and construction, outside the typical feed-in tariff scheme that characterized the renewables market in the early years of its development; Off Takers/Purchasers (mainly energy-intensive companies) are interested in securing the supply of electricity from renewable sources and guarantees of origin at a stable and competitive price, while at the same time achieving emissions reduction targets, accountable thanks to the guarantees of origin and in line with the sustainability due diligence obligations outlined by European regulations. 

From the perspective of purchasing companies, the possibility of lowering and steadying electricity procurement costs is the main objective of PPAs, thanks to which it is possible to reduce cost volatility and generate savings in the long run, contributing to the fight against climate change and to the mitigation of negative impacts and thus ESG risks related to their business. On the other hand, from the perspective of RES plant developers and energy producers, PPAs represent the instrument to secure and regulate future revenues from the sale of energy, guaranteeing the repayment of financing and thus, as mentioned, the bankability of projects.

There are, however, variables and risks typically associated with long-term energy contracts and the non-programmability of renewable energy sources that, especially in the early years of PPAs, involved the necessary intermediation of energy wholesalers, traders and utilities with a broad knowledge of the market and therefore the ability to professionally manage these risks. These are the so-called 'Flexibility Risks' associated with the fact that the power generation capacity of the RES Plant may be lower than agreed with the buyer, resulting in the need to acquire the surplus energy elsewhere. Flexibility Risks can be effectively mitigated by outsourcing to a wholesaler, trader or utility company the task of procuring elsewhere and selling to the buyer/off-taker the energy that the Producer is unable to produce through its RES Plant. Also for this reason, Corporate PPAs are frequently conceived and configured as trilateral or quadrilateral contracts entered into by and between Producers, traders, utilities and Final Buyers of electricity or are however frequently executed according to the scheme of Sleeved PPAs in which two functionally linked contracts coexist: one contract between Producer / Seller and Trader / Wholesaler or Utility and a second contract between Trader / Wholesaler or Utility and Final Buyer.

The main risks to be taken into account when drafting and negotiating PPAs include the following.

If the PPA is entered into prior to the ready-to-build status of the project, there is the risk that the plant will not obtain the necessary authorizations for its construction and connection to the electricity grid or, once it has obtained the ready-to-build-status, it will be constructed and connected to the electricity grid later than the agreed timetable. In the PPA, this risk is to be governed by conditions precedent but also by penalties (serving as a limitation of liability for the Producer and compensation for the Buyer/Offtaker). The Buyer may be offered the option to terminate the contract in the event of a delay exceeding a certain grace period. Upstream, in procurement, development and co-development contracts, the Producer shall negotiate with its contractual counterparts (in particular, with the companies in charge of constructing and connecting the plant to the grid) safeguard clauses that take into account the risks and potential liabilities of the Producer towards the Buyer, providing for compensation measures consistent with the level of liability assumed by the Producer towards the Off Taker. From the point of view of the financing bank, compliance with the timing and good execution of the construction is relevant not only for the authorisation titles, but also for the obtaining of any incentives, and because the bank's resolution cannot envisage excessively long pre-amortisation periods.   

The RE-plant, once installed, may not produce the expected volume of electricity or may not generate the electricity during the hours as expected. Such an eventuality represents a significant risk for the buyer (who needs to be supplied continuously) but also for the supplier who has committed to supply energy constantly with baseload contracts, regardless of variations in demand or production. A relevant element for bankability is to confine the Producer's/Seller's liability within the limits of its obligations and to the occurrence of circumstances within its sphere of control, e.g. excluding liability for force majeure events or due to non-performance of third parties. With respect to this risk, sleeved PPA contracts have to balance the opposing interests of the Producer (interested in limiting as much as possible its own liabilities) and the Buyer (interested in guaranteeing a constant supply of electricity) and imply the inclusion of specific performance guarantee clauses in the EPC and O&M contracts stipulated between the Producer and the contractors in charge of the construction, maintenance and operation of the RE Plant. In this respect, it is crucial to negotiate the PPAs together with the other contracts in any case related to the construction, connection to the electricity grid and financing of the RE-Plant.

If the PPA is fixed price, the Seller assumes the risk related to the volume of energy produced and delivered while the Buyer assumes the price risk, exposing itself to the risk that the price agreed in the contract is higher than the price of the electricity it could have found elsewhere in the market. The relevant (and potentially very impactful) risk concerns the purchase price of energy in excess of the capacity of the Producer's RES plant.

The hourly electricity price has a negative or inversely proportional correlation with the level of electricity production. When the production of RES plants peaks in a certain area, the excess of supply over demand reduces the energy price and vice versa. If supply is low, e.g. due to weather, the excess demand leads to an increase in the hourly zonal price. This risk is typically allocated and managed by intermediaries who have contractually committed to supply the energy in excess of the production capacity of the Producer's / Seller's RES plant. But it is also evidently reflected in a risk for the energy buyer in the event that, due to low energy production, it has to resort to purchasing electricity from third parties at a non-pre-determined price, thus bearing the cost. 

Credit risk / Credit settlement

The Buyer may be in payment arrears and therefore in default or even unable to fulfil its payment obligations. Therefore, the PPA may provide for guarantee clauses and instruments - including letters of patronage, bank and insurance sureties, corporate guarantees - that allow the Producer to ensure as far as possible the collection of the energy fee payments. 

Following the protracted default of the Buyer, the Producer could benefit from a clause allowing it to interrupt the supply and identify a new Buyer with which to continue the energy supply relationship. It should also be noted that, pursuant to Decree-Law No. 208 of 31 December 2024 (the so-called "Emergency Decree Law") recently converted into law, the Italian GSE (“Gestore dei servizi energetici”) takes over from the defaulting party in the event of a PPA entered into through the Platform of the GME (“Gestore dei mercati energetici”. However, the GSE only responds as a last resort.

Regulatory and legislative changes, including of a fiscal nature, could interfere with the viability, financial sustainability and profitability of the projects. The PPA should provide for and regulate measures to mitigate legislative and regulatory risks, for example by providing for obligations to renegotiate the economic terms and conditions in order to re-establish, as far as possible, the contractual balance.

There may be prejudicial events that temporarily interfere with the performance of PPA contracts. PPA contracts must therefore detail the consequences of the occurrence of force majeure circumstances that hinder, prevent or render excessively onerous the performance of the contract. 

All the above-mentioned risks must be effectively allocated among the different parties to the PPAs so as to comply with a criterion of imputability, the ability to prevent their occurrence or mitigate their effects, and therefore more effective control, with a decrease in the related transaction costs. A contractual element of great importance on which to focus attention is the duration of the contract, which must be consistent with the duration of all other contracts, legal transactions and authorisations related to the operation of the RE-Plant and therefore to the performance of the PPA. In principle, the longer the duration of the PPA, the better the bankability of the Project (in favour of the Producer) and the stability of energy prices over time (in favour of the Off-Taker).

Beyond the contractual variables to be taken into account, PPAs can be a valuable tool for companies, especially large energy consumers, to protect themselves against price fluctuations and promote concrete actions in support of energy transition and sustainability.​​​