What is a PPA (Power Purchase Agreement)?
As businesses continue to reduce their carbon footprint, the acronym PPA (Power Purchase Agreement) has been popping up more frequently – but what is it? And what does it actually mean?
A Power Purchase Agreement (PPA) is a contract between a renewable energy generator and an electricity buyer.
We explore PPAs in more detail and answer those burning questions.
What is a PPA (Power Purchase Agreement)?
A Power Purchase Agreement (PPA) is a contract between a renewable energy generator and an electricity buyer, typically a utility company.
The PPA sets out the terms under which the generator will sell the electricity a renewables project will generate to the buyer for an agreed period.
Under the terms of the PPA, the generator agrees to deliver a certain amount of renewable electricity to the buyer, while the buyer agrees to purchase and take delivery of that electricity.
PPAs are commonly used in the UK to support the development of renewable energy projects. They provide a stable revenue stream for generators and help reduce the financial risks of building and operating renewable energy projects.
PPAs also help to ensure a consistent supply of clean energy to the grid, which helps to reduce carbon emissions and support the UK’s transition to a low-carbon economy.
How does a power purchase agreement work?
The Power Purchase Agreement is the contractual agreement between two parties, typically a power producer and a customer.
It works by setting out the terms of the agreement, including the price, quantity, and duration of the contract. The electricity buyer will typically pay a fixed business electricity price per kWh, which may be lower than the retail price they can currently buy electricity from the national grid.
What energy sources are available for a Power Purchase Agreement
Solar and wind energy are the two most common energy sources when entering a PPA, but here are all the possible renewable generator projects used in Britain:
- Solar Power. Solar energy is harnessed through photovoltaic panels that convert sunlight into electricity.
- Wind Power. Wind turbines generate electricity by converting the wind’s kinetic energy into electrical energy.
- Hydro Power. Hydroelectric power is generated using water flowing through turbines converting the potential energy of water into electrical energy.
- Biomass. Biomass energy is produced from organic matter, such as wood chips, agricultural waste, and municipal solid waste, which is burned to generate electricity.
- Geothermal Power. Geothermal energy is generated using heat from the earth’s core to produce steam and driving a turbine to generate electricity.
Power Purchase Agreements – Risk vs Reward
Here, we explore the benefits a large business may receive in purchasing electricity through a PPA.
The benefits of a power purchase agreement
PPAs are becoming increasingly popular in the UK as more businesses look to reduce their energy bills and carbon footprint and source their electricity from renewable sources.
A power purchase agreement’s benefits are as follows:
- Cost savings – These can offer financial protection for businesses by providing a stable, predictable price for electricity over a long-term period, often lower than the cost of grid electricity.
- Price stability – PPAs typically involve long-term fixed pricing, which can help businesses better forecast their business electricity rates and manage their budgets.
- Reduced carbon footprint – By purchasing renewable energy through a PPA, businesses can reduce their carbon footprint and demonstrate their commitment to sustainability.
- Long-term energy security – PPAs provide long-term energy security by guaranteeing a source of electricity for a specified period, reducing the risk of price volatility and supply disruptions.
- Improved reputation – By sourcing their electricity from renewable sources, businesses can improve their reputation by demonstrating their commitment to sustainability and environmental responsibility.
- Regulatory compliance – PPAs can help businesses comply with regulatory requirements related to sustainability and carbon reduction.
- Energy independence – Off-gird businesses can use a PPA as a direct alternative to a business energy supply from the national electricity and gas networks.
What are the risks associated with power purchase agreements?
While PPAs provide benefits for both parties, there are also risks. Understanding the risks associated with PPAs can be crucial for electricity buyers looking to participate in this growing sector.
In this question, we will explore the potential risks related to power purchase agreements in the UK and how they can be managed.
- Price risk – The buyer may end up paying more than they would have if they had purchased electricity from the open market if the price of electricity falls below the agreed-upon price in the PPA.
- The generator fails to produce the agreed amount of energy – The generator may not be able to produce the agreed-upon volume of electricity, forcing the buyer to purchase electricity from another source at a higher price.
- Regulatory risk – Changes in government policies and regulations can impact the profitability of the PPA for the buyer. This will significantly impact the ability to secure a reliable supply of electricity.
- Performance risk – The generator may not perform as expected – leading to the buyer not receiving the agreed-upon amount of electricity.
- Contractual risk – There is a risk that the terms of the PPA may not be properly understood or enforced, leading to disputes between the two parties.
What are the different types of power purchase agreements for buyers?
Here are the common Power Purchase Agreements for electricity buyers, explained in more detail below:
In a fixed-price PPA, the buyer agrees to purchase electricity from the renewable energy generator at a fixed price over a specific period of time. This provides the generator with a guaranteed revenue stream and can help the buyer to manage their energy costs.
Variable price PPA
A Variable Price Power Purchase Agreement is a type of agreement that allows the price of electricity to fluctuate over time based on market conditions.
Under this arrangement, the buyer agrees to purchase electricity from the generator at a price that varies based on an agreed-upon index that tracks the wholesale price of energy.
Other PPAs to consider:
- Indexed PPA. An indexed PPA is similar to a fixed price PPA, but the price of electricity is linked to an index, such as the Consumer Price Index (CPI).
- Collar PPA. A collar PPA sets both a floor and a ceiling price for the electricity sold under the agreement.
- Sleeved PPA. Sleeved PPAs involve a third party, such as an energy supplier, who acts as an intermediary between the generator and the buyer. The third party buys the electricity from the generator and then sells it to the buyer at a fixed or indexed price.
- Virtual PPA. A virtual PPA is a financial agreement where the buyer purchases the Renewable Energy Certificates (RECs) associated with a specific renewable energy project without taking physical delivery of the electricity generated by the project.
Power Purchase Agreement – FAQs
Here are some frequently asked questions surrounding Power Purchase Agreements.
What is the difference between a power purchase agreement and a feed-in tariff?
A power purchase agreement and a feed-in tariff are both schemes to support renewable energy generation. There are some key differences between the two.
A PPA is a contract between a renewable energy generator and an electricity buyer, such as a business or utility. The PPA sets out the terms for the sale of electricity, including the agreement’s price, quantity, and duration.
The price for electricity is typically based on the wholesale market price for electricity. But it may include additional charges to cover the generator’s costs and provide a profit. PPAs are usually used for large-scale renewable energy projects like wind farms or solar power plants.
In comparison, a feed-in tariff was* a government scheme paying small-scale renewable energy generators for their electricity.
The scheme was introduced to encourage the adoption of local renewable energy projects. Such as solar panels on residential homes or small wind turbines.
Under the scheme, the generator receives a fixed payment for each unit of unused electricity but does not obligate the generator to produce an agreed amount of electricity.
*The feed-in tariff closed in April 2019 and was replaced with the smart export guarantee.
The key differences between PPA and FIT:
One of the main differences between a PPA and a FIT is who sets the price for the electricity. In a PPA, the price is negotiated between the generator and the electricity buyer. In a FIT, the government typically sets the price higher than the wholesale market price for electricity to encourage investment.
This means that generators can profit from their electricity, even if they do not sell it to the grid.
Another difference is the scale of the projects that each scheme is designed to support.
- PPAs are typically used for large-scale renewable energy projects;
- whereas FITs were designed for smaller-scale projects, such as residential solar panels.
How are power purchase agreements negotiated?
In the UK, Power Purchase Agreements are typically negotiated between the developer of a renewable energy project and the purchaser of the electricity. Here are the general steps involved in negotiating a PPA in the UK.
What are the steps taken when negotiating a PPA?
When negotiating PPAs, several common steps are taken when negotiating a Power Purchase Agreement:
- Expression of interest – A renewable energy project developer will typically request expressions of interest from potential purchasers of electricity. This may be done through a competitive tender process or directly approaching potential purchasers.
- Term sheet negotiation – Once a purchaser has expressed interest, the parties will typically enter into negotiations to agree on the basic terms of the PPA. This may involve discussing issues such as the duration of the contract, the price to be paid for the electricity, the terms for delivery and payment, and any other relevant commercial terms.
- Due diligence – After the parties have agreed on the basic terms, the purchaser will typically conduct due diligence on the renewable energy project to assess its technical, financial, and legal feasibility.
- PPA negotiation – Based on the outcome of the due diligence, the parties will then finalise the terms of the PPA. This will involve negotiating the specific provisions of the agreement, including the terms for delivery and payment, the duration of the contract, the price to be paid for the electricity, and any other relevant commercial terms.
- Signing and execution – Once the parties have agreed on the final terms of the PPA, the agreement will be signed and executed.
How long do power purchase agreements typically last?
The duration of a Power Purchase Agreement can vary depending on the type of energy source, the size of the project, and the specific terms negotiated between the parties.
The typical duration of a PPA for renewable energy projects in the UK is between 10 and 15 years.
For instance, the UK government’s Contracts for Difference scheme, which supports renewable energy projects, offers fixed-price contracts for up to 15 years for wind and solar projects and up to 10 years for other renewable technologies such as biomass, geothermal, and tidal power.
How do renewable energy companies use Power Purchase Agreements?
Renewable energy companies in the UK use Power Purchase Agreements to sell their electricity to buyers, such as commercial or industrial entities, business energy suppliers, or utilities.
PPAs allow renewable energy companies to secure long-term contracts to sell their electricity, providing them with a stable source of revenue and helping them finance new projects.
Why do companies purchase Virtual Power Purchase Agreements?
A Virtual Power Purchase Agreement is a financial agreement between a renewable energy generator and a buyer. The buyer agrees to purchase renewable energy certificates (RECs) for a specific project.
As well as securing energy, businesses will use a Virtual Power Purchase Agreement to benefit from the following:
- Meeting sustainability goals – Companies that have set targets to reduce their greenhouse gas emissions or to increase their use of renewable energy may use virtual PPAs to demonstrate their commitment to sustainability. By purchasing RECs from a specific renewable energy project, they can claim the project’s environmental benefits without building or operating their own renewable energy infrastructure.
- Saving money – In some cases, virtual PPAs can provide cost savings for companies, compared to purchasing green electricity from the grid. This is because the price of RECs may be lower than that of traditional grid electricity, especially if the renewable energy project is located in an area with strong renewable resources.
- Corporate social responsibility – Companies can use virtual PPAs for their broader corporate social responsibility efforts. They demonstrate their commitment to sustainability and responsible business practices.