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Solar Power Purchase Agreements (Solar PPAs)

solar-ppa

Installations of solar panels are not cheap. The costs involved include purchasing the solar panels and other components such as electrical work and installation. Homeowners pay around $2.96 for every watt in solar installations.

That implies that a homeowner will have to pay approximately $14,800 for a 5kW installation.

Not everyone will have this kind of cash readily available to finance the solar installation. That is why most homeowners will look for solar financing options to install solar systems in their homes.

Standard financing options include power purchase agreement (PPA), lease, or loan.

Here is a quick recap of the other two options before looking deeper into the power purchase agreement.

Loan: Loans are typical in almost every transaction or business venture. Solar loans are not any different from a home loan or auto loan. With this option, you approach a financial institution and borrow a loan to finance the solar system.

Depending on the agreed period, you will repay the loan after months or years with some interest.

Lease: The lease type of solar financing is just like any other lease agreement you already know. Just like a car lease, you will enjoy solar energy as you repay the lease monthly.

Power Purchase Agreement Defined

It is an agreement between energy sellers and buyers. These two parties will agree to sell or buy a given amount of energy generated through renewable means. It could happen through different renewable sources of energy such as wind or solar.

What is a Solar PPA?

It is an agreement whereby the solar company agrees to cover all the solar system installation costs. The company will only charge you the produced energy by the system. The entire idea of this kind of agreement is to help the homeowner install the system without paying upfront for it.

As seen earlier on, purchasing the solar system plus all installations is not cheap. With this agreement, the homeowner will still benefit from low utility bills. A typical power purchase agreement for residential homes lasts from 20 years to around 25 years.

The homeowner is at liberty to purchase the solar system in between the lease term. However, once the lease term agreement is over, the homeowner can renew the agreement, have the firm remove the entire system, or purchase the solar system.

Why PPAs Apply in Renewable Energy Projects?

Most governments want to promote renewable energy in the country. They will, therefore, give financial incentives for investments that utilize renewable sources of energy such as solar systems.

The incentives could be feed-in-premium or feed-in-tariffs. With the current developments in technology, renewable assets are becoming cheaper to obtain and build. That has led to a massive surge in renewable sources of energy investments.

Consequently, most governments seem to shy away from subsidy investment ventures. That could be because their financing is high, or the governments do not see why they should provide incentives in this sector.

Long-term Cheaper Electricity by Solar Systems

Research by the government shows that the average electricity prices are going up by around 5.04% every year. That technically means your electricity bill will double every 14 years.

Without ongoing fees or an upfront payment which is the case with solar PPA – means your business will make profits only since day one. You will continue accruing the benefits for the entire agreement period.

Once the agreement period is over, your business will still enjoy solar electricity if you decide to purchase the system.

Relevance of PPAs

Project Financing

Most renewables require another funding source like a bank or another financial institution. Not many third parties will lend homeowners money without security for the same.

The solar PPA provides this assurance when there is no government subsidy. The third-party lenders could be credit providers, lenders, or finance providers.

Since these solar systems cost a lot of money for purchases and installations, the credit provider chips in to finance the project.

The financier will require confidence that this is a viable project and they will get their money back.

The PPA provides this confidence to the financier. AS the lender, they have to assess whether the credit profile for the energy seller is vital in sustaining the project for around 10+ years.

COD Project Finance

Commercial Operation Date is the actual date when the renewable project gets connected to a grid, becomes fully operational, and starts giving out energy. In the power purchase agreement, COD is the date when the off-taker’s obligation begins.

For example, in the United States, the COD is when a portion of the project funding is released. That could either be potential additional fees, remaining construction costs, or tax equity.

For Hedging

PPAs give assurance that this renewable project will have a good ROI after completion by plunging the cash flow uncertainty. PPAs are at liberty to sell some portion of the future energy generation in the long run for the project to a buyer.

The parties involved will have to sign the PPA agreement before the project commences. Understand that investors are typical risk managers.

These people look to optimize their return/risk ratio. Entering into a PPA agreement is a way to control the volatility risk.

risk-return

Power market prices are very volatile and could be changing very frequently. In this type of contract, the offtaker gives a fixed price for the long run.

With that, they are guaranteed an appealing ROI in the foreseeable future and minimum risk on the revenues expected.

For price predictability in future

Electricity prices are expected to fluctuate frequently and massively at times. Power purchase agreements involve the consent to sell a given amount of MWh from the renewable project to an energy buyer at a specific price.

This agreement ensures the seller has a secured future stream of profits, and the buyer is assured a given amount of energy for a defined cost.

Why Choose a PPA?

You may be wondering, why should I go for a power project agreement? Here are the benefits of PPA:

Benefits for the renewable project owner

  • The PPA allows solar energy companies to boost their revenue certainty. This concept is impossible in fluctuating energy markets, more so if there is no government incentive.
  • Reduce risks by spreading them to the contractual parties. The project owner is not directly involved in the project alone as other parties share the risk.
  • Enable renewable projects financing by third-party lenders. They do not incur the installation and purchasing costs alone.

Benefits for the businesses

Zero upfront cost

the commercial solar system is funded by the lender and the project owner. You save some cash right from the first day.

Saves on electricity bills

Solar electricity is much cheaper than most of the other sources of energy.

Eco-friendly

With solar electricity, you boost your firm’s environmental responsibility and enhance your connection with customers who are always going green.

No insurance or maintenance costs

The project owner manages the system as per the agreement. In case of any maintenance, the owner takes care of it. The insurance cover is also not up to you.

Fully transferable

PPAs can be transferred to other occupants of the house if the initial owner decides to vacate the premises.

Long-term forecasting and protection

This solar electricity system does not rise and fall as frequently as the other forms of energy. Unit price only rises with the Retail Price Index meaning your budget will likely be lower.

Benefits for the lender

  • PPAs will allow the lender to have a claim on the renewable project for their contribution.
  • The agreement offers some revenue certainty. That is from energy sold at a specific price in advance.

Who is PPA good for?

Energy Buyers

Those firms that purchase energy could benefit a lot from PPAs to get renewable sources of energy. Such firms also attain their green energy goals in the process.

Corporates are firms that consume large amounts of energy needed across various platforms. These are companies like Amazon, Nike, and Google. They will purchase power from renewable sources to manage their carbon footprint.

Utilities are energy providers like Vattenfall (Sweden), Axpo (Switzerland), and Holaluz (Spain). These firms have generating assets but still, need additional energy for supplies to the customers. Using solar energy via PPAs enables these companies to regulate their carbon print and work under the required obligations.

Industrials are companies that also require vast amounts of energy for their manufacturing endeavors. An example is a mining company. Such firms will agree to a PPA to cater to long-term energy needs.

Energy Sellers

These are technically renewable asset owners. They fall into different categories, but they are generally known as sellers:

  • Renewable energy project managers
  • Independent electricity producers
  • Investment companies on infrastructure
  • Energy and utility companies that want to create their renewable assets
  • Infrastructure funds that invest in renewable energy

How PPAs Work?

1. Initial stages

The entire process starts with:

  • An existing renewable project that requires financing
  • A new renewable project needs to be set up. The project already has a location, size, and an agreed connection to an electricity grid.

2. Optimal Hedging Strategy

PPA Forms

These agreement contracts come in diverse forms. Probably you have already come across the virtual and physical PPAs. PPAs can also come in other states or forms.

Physical PPA

It is an agreement where you purchase the energy where the meter point is situated. That is the reception point.

A utility will supply solar power to its customers via existing transmission lines. With this PPA, the customer gets physical delivery of energy via the grid.

What is meant by financial PPA?

It is also known as synthetic PPA or virtual PPA. This agreement allows a firm to purchase renewable energy without being physically present. With this agreement, the company does not own physical energy.

Companies can now focus their efforts on green impact and can receive renewable energy without owning the asset. The virtual PPA has no impact on the energy source consumed by the company buying the energy.

Underlying Structure of PPAs

Despite having different contractual forms, PPAs will also have diverse underlying structures and varying hedging forms.

These various hedging forms distribute the energy risks between seller and buyer. Typical forms of the PPA structure include annual, monthly or pay-as-produced baseload.

3. Sourcing

The project owner has to request a quotation or proposal (RFP/RFQ) to receive purchasing offers. Companies that are interested in purchasing energy will then make their offers.

However, it is prudent to understand that established buyers like Google do not follow this process. The company will launch auctions or private tenders and invite pre-selected parties. These parties should bid against one another severally.

4. Compare PFA Offers

The first offers do not have all the details of the agreement. They only contain the core commercial conditions called Term Sheets which includes a PPA structure, a tenor, and a price.

Offers can vary from one buyer to another because of different underlying structures, price area basis, or inclusion costs. Comparing the proposals is not an easy task.

5. Negotiation

Buyers and sellers can conclude on the approximate price at an early stage. However, the contract details could take up to 12 months for the negotiation. There are several crucial points that both parties should discuss and agree on.

Negotiating and comparison are the most critical parts of this entire process. After completing the PPA process and both parties sign, the existing or new project has better chances of re-finance or finance. Construction can then commence for the Commercial Operation Date.

6. Signing the contract

After all the agreements are complete, and every party is satisfied, you can now sign the PPA contract.

7. What next after signing

Even though the PPAs guarantee a future sale of energy and purchase at a specific price, selling an energy asset needs managing all the time. Though the contract agreed maybe for ten years, this asset could have a lifespan of over 30 years.

PPA Drawbacks

  • It is not possible to move houses. Even though categorically it is possible, you have to understand that these PPAs are more than 20 years old. So, once the house’s current occupant vacates, the solar system will have to belong to the house’s new owner.
  • The solar company takes all benefits of financial incentives such as solar tax credits. However, it may not be a significant drawback to the buyer since you will still save some cash on your energy bill.
  • This PPA contract bears a price escalator that boosts the price you pay every year. A standard escalator is marked at a 3% increase each year. Even with this increase in yearly costs, you will still pay less than you would pay to an electricity provider.

Understand Energy Risks

When negotiating the PPA, you need to understand the level of energy risks in play. It is essential for the success of the negotiation. Here are five crucial energy risks to assess:

Price Risk

Here the significant risk is the probability of adverse movement of price in the market. This risk can only be mitigated but cannot be avoided.

Volume Risk

The yearly energy production of a renewable energy project is an estimate. How the parties arrive at this estimate is via assessment and calculations based on long-term meteorological data.

In case the renewable asset hedges a fixed volume at a specific price, there is a risk. Some volume is not produced and requires procuring. In such a case, the producer will buy the missing volume of energy at market prices.

They may find the market prices higher than the original price, which is risky to them. Optimization of the volume risk is vital. You can use insurance guarantees or use some PPA structures that reduce this risk.

Profile Risk

This risk comes about due to changing nature of renewable sources of energy. Markets with high renewable energy influence and high production times mean a drop in the power price and revenue.

However, that is dependent on the type of renewable energy and the location of the facility. You can easily manage this risk by selecting some specific PPA structures.

Liquidity Risk

A market is liquid if both the seller and buyer can easily transact large volumes without affecting the market price. As a buyer, you can mitigate this risk depending on the PPA structure you choose.

You can achieve this by securing a validity period or aggregating a given formula to calculate the prices. Both parties could decide to specify a PPA price closure that will be referencing the publicly available prices.

Balancing Risk

Balancing risk is the difference between the actual energy production and the scheduled estimates. You can mitigate this risk by using intraday trading or discussing the imbalance cost and agreeing on managing it.

Final Thoughts

Solar PPAs are ideal since they save you a lot of money and time. With this financing option for your solar system, you do not have to worry about maintenance and those sorts of things. The provider company takes care of that.