Solar Power Purchase Agreements (Solar PPAs)
Solar panel installations can be costly, with homeowners typically spending around $2.96 per watt, which equates to about $14,800 for a 5kW system.
Since not everyone has the necessary funds, solar financing options like power purchase agreements (PPAs), leases, and loans are gaining popularity.
A solar loan resembles other loans, where money is borrowed from a financial institution to finance the solar system, and repaid with interest over a set period.
In contrast, a solar lease functions like a car lease, allowing homeowners to use solar energy while making monthly payments.
A power purchase agreement (PPA) is another type of solar financing option, involving an agreement between energy sellers and buyers to trade a specific amount of energy produced through renewable sources such as solar or wind.
In a solar PPA, the solar company bears the installation costs and charges homeowners only for the energy generated, eliminating upfront expenses.
PPAs typically last 20 to 25 years, during which homeowners may purchase the solar system, renew the agreement, have the system removed, or buy it after the contract expires.
Government incentives like feed-in-premiums or feed-in-tariffs encourage renewable energy investments, making PPAs a relevant option in this sector.
By assuring third-party lenders of a project's viability, PPAs can help finance renewable projects.
PPAs can take various forms, including physical or financial/virtual, and employ diverse structures and hedging mechanisms that distribute energy risks between the seller and buyer.
Although PPAs provide benefits such as no initial costs, long-term electricity bill savings, and eco-friendliness, drawbacks like price escalators and limited mobility for homeowners who may relocate exist.
Before signing a PPA contract, it is crucial to comprehend the energy risks and negotiate accordingly.
What is a Solar PPA?
A Solar PPA is a contract between energy sellers and buyers, in which they agree to trade a specific amount of renewable energy, generated through sources like wind or solar.
In this agreement, the solar company bears all installation costs, and the homeowner pays only for the energy generated by the system.
This setup benefits the homeowner, as it allows system installation without upfront costs, which can be pricey.
Typically, residential power purchase agreements last 20 to 25 years, during which homeowners enjoy reduced utility bills and may opt to purchase the solar system.
Upon the agreement's conclusion, homeowners can choose to renew the contract, request the company to remove the system or buy the solar system.
Why PPAs Apply to Renewable Energy Projects?
Governments worldwide are increasingly supporting renewable energy sources. As a result, they offer financial incentives, such as feed-in-premiums or feed-in-tariffs, to encourage investments in renewable energy, including solar systems.
Advancements in technology have made renewable energy assets more affordable, leading to a significant rise in investments in these sources.
However, some governments hesitate to subsidize investment ventures in this sector, possibly due to high financing costs or a perceived lack of need for incentives.
In conclusion, most governments promote renewable energy usage, providing financial incentives like feed-in-premiums or feed-in-tariffs to encourage investments. While some governments may be reluctant to subsidize renewable energy ventures, the overall trend is moving toward a more sustainable future.
Long-term Cheaper Electricity by Solar Systems
Government research indicates that average electricity prices increase by about 5.04% annually, causing electric bills to double every 14 years.
Solar Power Purchase Agreements (PPAs) allow businesses to counter rising electricity costs without upfront or ongoing fees. By utilizing solar PPAs, businesses can start saving money immediately and enjoy the benefits throughout the agreement's duration.
Once the agreement ends, businesses have the option to purchase the solar system, continuing to benefit from solar energy. This approach not only reduces electricity expenses but also lowers their carbon footprint, contributing to a more sustainable future.
Relevance of PPAs
Renewable energy projects often require funding from sources like banks or financial institutions. Many third parties hesitate to lend money without security.
Solar PPAs provide assurance in the absence of government subsidies, attracting credit providers, lenders, or finance providers.
Given the high costs of solar system purchases and installations, credit providers contribute to project financing.
Financiers need confidence in the project's viability and assurance of repayment.
PPAs offer this confidence, as lenders assess the energy seller's credit profile to determine if the project can be sustained for 10+ years.
COD Project Finance
Commercial Operation Date (COD) is the date when a renewable project connects to the grid, becomes fully operational, and starts generating energy. In a power purchase agreement, the off-takers obligation begins on the COD.
In the United States, for example, the COD is when a portion of project funding is released, covering potential additional fees, remaining construction costs, or tax equity.
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.
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.
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.
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?
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.
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
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.
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.
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.
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.
- 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:
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.
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.
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.
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 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.
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.