Power Purchase Agreement (PPA)

Power Purchase Agreements (PPAs) are direct marketing agreements concluded between a legal entity and an independent power producer (IPP).

First of all, it is important to differentiate between a utility (also merchant) PPA and a corporate PPA. A utility PPA is a structure where a power supply agreement is concluded between a power producer and a utility company (UC). In the case of a corporate PPA, however, a PPA is concluded between a power producer and a company that is the end consumer.

Utility PPAs are usually characterised by shorter contract periods compared with corporate PPAs. Moreover, in utility PPAs, UCs do not consume the electricity by themselves but sell it to their customers.
Particularly important in PPAs is the differentiation between the various types of PPAs. These are divided into physical and virtual PPAs. What’s more, physical PPAs are further divided into offsite, or sleeved, PPAs and onsite PPAs, as shown below. The chart below illustrates these diverse types:

Illustration 1: Types of PPAs 

Offsite PPA means that the produced electricity is, on the physical layer, fed into the public grid. On the economic layer, the electricity is assigned financially to the balancing group of the PPA counterparty. The benefit is that the renewable energy power plant does not depend on the location of the buyer. As a consequence, the location of the plant can be optimised according to the site-specific requirements of the plant. Balancing group management, delivery of the residual electricity required and sale of excess electricity can be handled either by the company itself or by a utility that then “sleeves” the energy. Illustration 2 presents how this type of PPA works.

Illustration 2: (Sleeving) Offsite Corporate PPA 

Under an onsite PPA, however, the company and the power plant are directly connected. The power plant is located on the property of the company or in its vicinity. In addition, the company has to sign a regular energy supply agreement with the UC in order to ensure a continuous supply of the residual electricity required.

A virtual PPA is a financial product with no physical delivery of electricity. A PPA price is fixed contractually and, based on this, payments are made amounting to the difference between the PPA price and the respective electricity price quoted on the energy exchange (contract for difference). Important is that the electricity is delivered by the UC independently of the electricity produced by the IPP. Under virtual PPAs, guarantees of origin can also be delivered.

Illustration 3: Virtual PPAs (* Responsible person for a balancing group.

Since a PPA is an individual bilateral contract, contract structuring options are very flexible. Thus, standard PPA regulations include e.g. details on the electricity price/offtake price, times of deliveries of electricity volume, grid connection, payment default procedures, billing and accounting aspects, guarantees of origin and duration of the agreement. The range of possible pricing structures is thus also very broad. Depending on preferences, the contracting parties may agree on a fixed-price or discount-to-market pricing structure. With a fixed-price structure, the price does not change throughout the contract period. But nevertheless some additional options can be agreed upon, such as an inflation-adjusted electricity price or, in general, a periodic increase in the electricity price.

With a discount-to-market pricing structure, the electricity price is based on the current electricity price quoted on the energy exchange. In this pricing structure, most diverse models can be used, such as cap, floor and/or a % reduction in the electricity price quoted on the energy exchange. Moreover, there are two other basic types of pricing and/or electricity delivery structures. Under the pay-as-produced model, the contracting party offtakes any amount of the electricity produced by the power producer and pays for it. In most cases, however, buyers decide to follow the baseload model because, here, the amount and/or a range of volumes of the electricity to be delivered is fixed in the contract.

Mostly, PPAs have very long contract periods. These can range between 10 and 25 years, which corresponds to the nature and the lifetime (and, thus, the refinancing period) of a new renewable energy installation. The existing power plants, however, can have contract periods of only 1-5 years.

The current problem is the cannibalisation effect on the electricity prices for renewable energy installations. Companies and merchants have adopted a wait-and-see attitude because, due to technological progress, economies of scale or other experience curve effects, they expect power plants to produce electricity at even more favourable prices in the medium term. In order to enable quicker expansion, the (respective) state has to intervene by taking regulatory measures.