Large companies have been setting sustainability targets since the 1992 Earth Summit in Rio de Janeiro, but today’s headlines are the most clear we’ve seen: Corporations want more renewables in their energy mix now.
About half of the Fortune 500 companies have sustainability goals to reduce their carbon footprint, reduce their energy usage, and/or power a portion, or all, of their operations with renewable energy – a goal that has been made more viable as wind and solar costs continue to decline. What’s more, the single most important reason for corporations to bring renewable energy into their portfolios is turning out to be consumers, who are demanding sustainable products, services and practices from the companies that serve and sell to them.
Interest in renewables among market-leading corporations is positive for the industry, as the linchpin of a renewable energy project is to secure a long-term anchor tenant in the form of a power purchase agreement (PPA) with a creditworthy customer. When this customer is a corporate buyer, the agreement typically takes the form of a virtual PPA, commonly referred to as a VPPA, in which a company agrees to purchase power at a negotiated price from a wind or solar project over a predetermined number of years.
In a typical PPA, a utility would buy physical power at the site of the wind or solar plant and take title of the electrons and renewable energy credits (RECs) as delivered by the facility. A VPPA is a slight variation of a typical PPA. It involves a financial settlement whereby a corporate buyer commits to pay, for example, a wind farm’s owner a fixed price for each unit of electricity produced by the wind farm, while the developer of the wind farm takes responsibility for managing the delivery and sale of the electricity produced on the merchant market.
Under the VPPA arrangement, the buyer pays a fixed price for electricity, whereas the wind facility owner receives the floating market price. If the wind farm generates more revenue than the fixed VPPA price by selling on the market, it pays the surplus revenue to the corporation. Conversely, if the wind farm makes less money than the fixed VPPA price by selling on the market, it receives a true-up payment from the corporate buyer. Therefore, an alternate term for a VPPA is a contract for differences.
The buyer receives the RECs and other environmental attributes of the wind farm but does not typically take physical delivery of or manage the flow of electrons to the electric grid. Under this structure, the buyer remains connected to the local utility and continues to receive electricity and related services from that utility.[adright zone=’190′]
VPPAs add value to a corporate buyer both because they provide low-cost, fixed-price power and RECs for more than a decade and because they represent an additional renewable resource coming onto the grid. By signing long-term contracts for power, organizations provide project developers with commercial off-take certainty, which unlocks the project’s ability to commit construction capital. This is because VPPAs provide clean energy developers and their financiers with long-term revenue certainty.
For non-utility companies, the benefits of a VPPA transaction are many, including fixing long-term power prices, eliminating price volatility, avoiding emissions, satisfying customer demands for cleaner industrial processes and providing an opportunity to save money. Although many of the companies contracting for VPPAs have long participated in the wholesale power markets, the VPPA comes with a new set of considerations that must be addressed.
There are several essential considerations for a successful VPPA that are detailed as follows:
Location. Good wind and solar resources are rarely collocated with electric load. As such, one of the first considerations is where to locate a facility against which a VPPA can be executed. Contracting with a renewable project on the same electric grid or in the same state as one’s electric load is often a goal. For companies with widely dispersed loads, this is less of a concern. Some grid systems or independent system operators are better suited to the VPPA than others. Markets with “open access” or “nodal” markets work best because the physical power can be liquidated without owning transmission rights.
Length of the agreement. A typical VPPA is 15 to 20 years in length. This is often new decision-making territory for corporate buyers, as they do not customarily purchase inputs over that time horizon. However, to keep the power price at a reasonable level, a long-term agreement is required (not unlike a home mortgage).
Long-term power price forecasts. The value embedded in a VPPA is usually measured against long-term power price forecasts. Price forecasting is tricky, and in recent years, deregulation and restructuring of electricity markets have been reshaping the U.S. energy markets. Nonetheless, as with any business exposed to commodity prices, having a view of the future price landscape is unavoidable. There are many consultants and advisory services that provide long-term forecasts based on market fundamentals. Nobody knows for certain where power prices are headed, but given today’s low prices for renewable power, VPPAs are often “in the money” when measured against long-term, third-party forecasts.
Performance security. Building a larger-scale renewable energy project is an expensive endeavor in which the contracting parties have long-term financial exposure to one another. Both buyers and sellers face risks associated with the credit quality of the other party. Buyers typically wish to hold some form of security to be protected against damages if the project fails or is severely delayed. In turn, sellers usually require some form of security as a backstop for a buyer’s failure to pay for the power produced. For buyers, contracting with a highly rated developer with in-house capital to finance construction and a proven track record can appease many of these concerns.
Accounting treatment. The accounting treatment of a VPPA can be a daunting issue for some market participants. However, dozens of corporate buyers have been able to structure their contracts such that consolidation and derivatives accounting are not required.
Locational basis risk. The difference between the prices of power at two differing points of sale is referred to as the locational basis risk. This issue typically emerges when the buyer wishes to “settle” its VPPA at a trading hub that could be hundreds of miles from the project location. Because the prices in these two locations do not necessarily move in tandem, a financial risk is created, i.e., the settlement price (hub price) does not equal the physical power sales price (node price). Buyers and sellers have devised a number of contract terms that allow them to share this risk while still resulting in a “financeable” project.
Additionality. Making a claim of additionality is important to many corporate renewable buyers. Additionality is defined as a determination of whether an intervention has an effect when the intervention is compared with a baseline. Additionality in the renewable energy arena refers to adding a new facility to the electric system rather than contracting for power from an existing facility. The idea is that a buyer not only is purchasing renewable power, but also is actually directly responsible for adding new sustainable generation to the grid that would not have been put in place without the VPPA (i.e., making an intervention that creates additionality).
In light of these and other hot topics in corporate purchasing, the reader may wonder, where do we go from here? Corporate buyers have comprised upwards of 50% of total renewable energy contracting in recent years. As a major source of renewable energy demand, corporate buyers deserve to have their voice heard on all of the topics mentioned previously. At the same time, however, the financing requirements and risk-reward profile of developing wind and solar facilities need to be factored in. Corporate buyers may wish to procure renewable energy at increasingly low prices while concurrently reducing risk. Nevertheless, the prices and terms of these contracts eventually hit the minimum requirements for developers and their financiers. The industry needs to cater to the needs of this critical new customer group and can do so while also striking the right risk-reward balance for all.
Jacob Susman is vice president and head of origination at EDF Renewable Energy, where he leads the company’s relationships with utility and corporate customers around the U.S. for its wind and solar portfolio. Previously, he led OwnEnergy from inception to its sale to EDF Renewable Energy in August 2015. He can be reached at jacob.susman@edf-re.com.
