Understanding Power Purchase Agreements (PPAs): the cornerstone of renewable project finance

They're a crucial part of a renewable energy provider's business case for future funding, with PPAs providing clarity on the contractual structures that anchor project revenues and underpin investment confidence.

There are several structures that PPAs can take, including physical, virtual, and sleeved, which vary depending on the level of flexibility required by the producer and the consumer. Other types of PPA include corporate PPAs and utility PPAs. We look at the different types of PPAs and their pros and cons.

What a PPA is and why it matters

A PPA is a long-term contract for the sale of renewable electricity. They are legally binding contracts that allow businesses to fix the price of the energy they consume over a long period, while enabling power providers to secure long-term financing for a renewable plant. 

The link between PPAs and financial bankability

The long-term bankability of PPAs benefits both contracting parties. The bankability of PPAs enables businesses procuring energy to plan their budgets and estimate future operational costs. It also gives the power producer peace of mind that capital will be available to finance the plant in the long term, making it a more attractive investment opportunity. A specific PPA type, known as a bankable PPA, has been introduced to address this risk. By implementing bankable PPAs, a power plant has a long-term income stream, lowering lenders' credit risk and opening up financial opportunities for potential renewable power plants. 

Duration, volume, and counterparty creditworthiness

PPAs will specify the length of any associated contracts, which tend to be longer-term, for example, 10 years. Too long, however, and it can be hard to negotiate a price that benefits both in the long term, as it is challenging to forecast pricing and inflation costs that far ahead. They'll also guarantee the agreed-upon amount of energy produced and procured, often with penalties if either participant fails to comply. The lender is usually involved in determining the creditworthiness of both contract participants, as its key interest is avoiding risk. They may assess creditworthiness using the consumer's credit rating and the producer's performance guarantees. Sometimes a third party is involved to balance the risk if the lender isn't satisfied.

Types of PPAs and key contract structures

Different participants and scenarios require different contractual agreements; luckily, PPAs meet most requirements. 

Utility vs. corporate vs. trader offtakes

A corporate PPA is usually directly between a power provider and a business and specifies a set price for power over a long period. A utility provider brings in a third party: itself. The utility company procures energy directly from the power plant and then supplies it to consumers. Traders set up PPAs on behalf of energy producers, with other businesses taking energy from the trader. 

Physical vs. virtual (synthetic) PPAs

Physical PPAs involve the actual exchange of energy, sometimes using an intermediary as a transmission host. These exchanges often occur in the same region. Virtual PPAs, on the other hand, are not actual changes of energy. They are frequently used to facilitate cross-border energy exchanges and to verify energy transfers through tools such as Guarantees of Origin, which use a Contract-for-Difference structure to set the price of the transferred energy. Companies sometimes use virtual PPAs to achieve Environmental, Social and Governance (ESG) goals. 

Sleeved PPAs through suppliers or aggregators

Utility providers are sometimes used as intermediaries between energy producers and consumers in a sleeved PPA. Aggregated PPAs, on the other hand, group together several off-takers and energy producers.

Pricing mechanisms and risk allocation

As with any long-term contract, there are elements of risk involved, many of which relate to how pricing may change and evolve over a more extended period. Hedging contracts can guard against price fluctuation or market volatility, potentially reducing risk. 

Fixed price, indexed, or floor/ceiling structures

One of the most common types of PPA you're likely to come across is a fixed-price PPA. These are drafted between a renewable power plant and an energy buyer and lock in the price of energy at a fixed fee over several years. More flexible PPAs, such as indexed PPAs, allow the cost of energy to rise and fall within reason. This makes a PPA contract more desirable in an environment where pricing and generation are more volatile, such as in renewable energy. 

Shape risk and imbalance exposure

Where the risk to the energy procurer is higher due to concerns about energy output, a lender can require a third party to mitigate the risk that it cannot deliver the energy amount quoted in the PPA. A third party can be selected to fill any gaps in energy outage during hour-to-hour generation affected by factors such as wind speed or non-operational days.

Termination and force majeure provisions

As with any contract, termination clauses must be negotiated to reduce risk to both parties. Issues arising from the early termination of the renewable energy plant include loan debt. In contrast, matters for the energy procurer may consist of a lack of market access after contract termination. A force that might be at play, entirely outside the plant's control and affecting its production, is known as a force majeure. When certain situations occur beyond a plant's control, the plant cannot be held responsible, and force majeure is often factored into a PPA. Therefore, it's crucial that all eventualities are considered and addressed in the PPA terms before signing, and all parties, including the lender, are satisfied.

Trends and innovations in corporate offtake

As the landscape of PPAs has evolved with the more widespread adoption of renewable energy, so have the complexities of the PPAs that service them. A hybrid PPA combines different types of energy pricing into a single PPA, enabling you to take advantage of both fixed- and variable-priced energy sources: a stable element and a concurrent element that rises or falls with market conditions. These renewable sources can be combined with energy storage systems to mitigate price volatility from energy spikes, potentially further stabilising the risk of this type of PPA. What's clear is that there are different types of PPAs for various business, lender and energy producer requirements. In the future, PPAs could become the backbone of renewable investment, turning uncertain markets into financeable opportunities.