8 key definitions to help you understand Virtual Power Purchase Agreements (VPPAs)

8 key definitions to help you understand Virtual Power Purchase Agreements (VPPAs) 

Corporations are waking up to the importance of investing in renewable energy. While many accept their crucial role, not all want to commit to a traditional PPA. Virtual power purchase agreements (VPPA) allow corporations to support renewable energy without taking physical delivery of electricity. A complex concept involving unfamiliar contractual requirements such as renewable energy certificates (RECs), and contract-for-differences, nonetheless, VPPAs allow businesses to become involved in renewable energy procurement and potentially meet carbon reduction goals. 

VPPAs differ from traditional PPAs in that renewable energy is delivered to the grid, whereas a traditional PPA sells energy directly to the energy buyer. VPPAs allow businesses interested in supporting renewable energy to invest in off-site renewable projects without having to receive the energy themselves.  

8 key definitions to know in a VPPA  

1. Virtual power purchase agreement (VPPA):  

A Virtual power purchase agreement (VPPA) is the actual financial contract drawn up for producing and procuring renewable energy. It involves two parties, the project developer, who owns and operates the renewable facility, and the buyer, who enters the VPPA for the purposes of buying the energy, but not receiving it. 

2. Renewable energy certificates (RECs):  

Renewable energy certificates (RECs) are the environmental attributes of clean energy. They can be known under several different guises depending on the region they occur in. In America, these certificates are known as RECs; however, in the UK, they are known as Guarantees of Origin. While the particulars may vary, the sentiment is the same—they confirm the procurement of green energy. 

3. Settlement:  

Settlement is a financial true-up between the market price and the VPPA strike price. A fixed strike price is confirmed for the electricity, while the energy market confirms the actual price of electricity. A true-up calculates the difference between these two rates, which triggers a payment adjustment. A higher market price results in the seller paying an adjustment amount, and a higher strike price results in the buyer paying an adjustment amount. 

4. Hub:  

Hubs are market pricing points used in VPPA contracts or locations used by the energy market to determine how much the market will pay for energy. These hubs might take the form of Independent Transmission Systems Operators (ISOs). Hub prices are then used to calculate the difference between strike and market pricing and used as a focal point for the drafting of VPPAs.  

5. Contract for differences:  

A core mechanism behind the VPPA financial structure, a contract for differences is an act of 'hedging' between the energy procurer and the energy producer based on the strike price. The contractual agreement is then based on the difference between the strike and actual price of energy on the energy market and drafted to reflect this agreement.  

5. Project developer:  

Also known as an energy producer, the project developer builds the renewable asset. The project developer is responsible for all aspects of the plant build, operation and maintenance, as well as the initial funding and ongoing repair cost. The energy generated is then sold onto the energy market, with the VPPA fixing the energy cost for energy procurers over a longer period.   

6. Buyer:  

The buyer is a corporate or institutional customer entering the VPPA agreement with the project developer. While the buyer doesn't receive the energy physically, in exchange for entering a VPPA, the buyer receives renewable energy credits. If applicable, the buyer may also benefit from the difference between strike and market pricing.  

7. Market-based instrument:  

A tool used for GHG accounting under Scope 2 emissions, market-based instruments allow businesses to verify their energy procurement's sustainable and emissions-lowering actions. This includes contractual agreements such as PPAs - and VPPAs. 

Why VPPAs are important for corporate sustainability 

1. Align with Scope 2 emissions reduction strategies 

Scope 2 emissions reduction is reducing greenhouse gas emissions released by energy buying when procured by a business. These emissions are attributed directly to the business that procures them. VPPAs feed into a business' Scope 2 emissions reduction strategy by reducing the overall emissions added to its carbon footprint by buying power from a renewable energy plant and receiving a guarantee of origin, other ways of reducing Scope 2 emissions may be opting to not to business with a company that generates a lot of emissions from heating and cooling operations.  

2. Enable long-term renewable energy support without on-site infrastructure 

One of the positives of investing in renewable energy via VPPAs is that there is no requirement to situate renewable power facilities on the purchaser's site. This comes with a host of benefits; for example, the renewable power facility can be located in a location that is better suited to that type of energy production, such as environments more appropriate to wind or solar generation. The procurer also doesn't have to be concerned with legal roadblocks such as planning or site restrictions, as the project owner will handle these elements. Financial benefits also include a lack of financial responsibility, such as upfront costs, operating costs, and maintenance or leasing costs associated with setting up a renewable energy plant.  

3. Offer financial and reputational benefits for organisations 

Investing in renewables via VPPAs can also help improve a business's brand reputation. Environmental, Social, or Governance (ESG) goals are personal targets set by businesses to position their sustainability and ethical goals. In some cases, publicising ESG goals may attract more desirable employees with similar ESG goals or attract business from more sustainably minded companies, resulting in financial benefit for businesses.  

Challenges and considerations in VPPA contracts 

As with all financial instruments, a VPPA is not a silver bullet and must be considered from all angles before investing. As renewable energy is an unpredictable and unstable energy source compared to fossil alternatives, the energy market can experience volatility, which can impact pricing, meaning businesses could spend more money than anticipated on carbon reduction efforts, and other methods may make more sense. All power purchase agreements involve transactions that the legal council should approach, but VPPAs feature even more complex contract structures, requiring expert analysis. 

Its also important to make sure VPPAs are aligned with wider sustainability goals. While VPPAs offer an opportunity to invest in renewable energy without having to consume it, the question should be asked, why are you not consuming it? While some businesses are already consuming or generating their renewable energy and use VPPAs to reduce a carbon footprint further, some may use the tool to reduce carbon footprints without reducing their own output, which is at odds with the sentiment of the green energy transition. 

VPPAs offer a flexible path to clean energy support, but require careful planning to align with sustainability goals and manage market complexities.