Where should you start your risk mitigation strategy for corporate PPAs?
Caroline is Global Head of Instatrust, New Energy Ventures at DNV GL. She is leading the innovation cycle, development and launch of the Instatrust™ platform, a digital PPA platform that connects buyers and sellers of renewable energy.
DNV GL are platinum sponsor of our Financing Wind Europe conference on 31st October in London.
Corporate power purchase agreements are long-term contracts between a renewable energy producer and a corporate off-taker on the purchase of electricity.
Through a corporate PPA, renewable energy developers ensure stable long-term revenues while corporate buyers secure long-term energy costs and reach their sustainability targets. As such, a PPA is a contract allocating risks related to producing and consuming renewable energy between a seller and a buyer of energy.
However, risks are allocated and mitigated differently for each deal, due to the diversity of players and their capacity to absorb those risks and/or willingness to pay a third party to hedge those risks. A clear definition and understanding of risks emerging from a corporate PPA is the first step towards a good risk mitigation strategy.
What risks are specific to corporate PPAs and to whom should those be allocated?
The first types of risks are those related to variable generation patters: volume and shape (or profile) risks. The volume risk is due to the variability of the power output from the generation asset over a defined time-period, for example over a year. The shape (or profile) risk is linked to the hour-to-hour intermittent generation output profile deviating from both the generation forecast and the baseload demand of the corporate buyer.
While production forecast services offer an increased accuracy, weather conditions can largely deviate from expectations. For this reason, lenders will generally require that risks related to shape and volume are not allocated to the project developer. In non-corporate PPAs, the utility buying power can mitigate this risk by a diversified portfolio of projects from various technologies and different locations.
Moving to the model of a corporate PPA, this allocation of volume and shape risks has been transferred to the buyer. Thus, generators expect the corporate buyers to bear those volume and shape risks. If the PPA does not include volume commitment, the buyer would have to mitigate this risk. Most European PPAs have had a pay-as-produced structure, but firm volume is a solution with increasing corporate interest. However, a contractual solution where the seller fully manages shape is less common.
Is it acceptable and manageable for corporates buyers to carry volume and shape risks?
As most buyers have a steady electricity demand, if the production is too low, the buyer would need to purchase electricity from another source to meet its demand. The cost of managing volume and shape risk depends on the wholesale market conditions and the level of penetration of renewables. If price drivers are predictable, liquidity is high and prices are stable, it can be manageable for buyers.
However, if market conditions are highly volatile, the buyer can be exposed to prices spikes. High share of renewables in the grid would typically reinforce this risk as prices tend to be higher when renewable resource is low.
What are the risk mitigation options available for buyers?
If the consumption pattern of the buyer is flexible, deploying demand-side response devices to control the load to fit production is possible.
Another option is to combine renewables with dispatchable technologies such as energy storage, when economically feasible.
Additionally, the buyer could allocate the volume risk to the generator by including a firm or minimum volume guarantee in the PPA over a certain time period (i.e. a year). Sellers with generation output commitments can mitigate the risk of production shortfalls through mechanical availability commitments from construction or operations contractors, appropriate business interruption insurance and trading services offering risk management. Innovation in this field such as the Volume Firming Agreement enable a hedging of the volume risk. In all cases, the generator should ensure the volume requirement in the PPA is at a conservative level and aggregated over a sufficient period.
What other risks are corporate buyers exposed to?
Balancing risks are due to the exposure to power system costs arising when an asset’s forecasted generation is different from its actual generation. When an asset’s imbalance correlates to the power system imbalance, those costs would be higher. It is recommended that a third-party, such as a utility company (having the ability to include the asset within a large asset group to manage the balancing risk) bear this risk.
For fixed-price PPAs, high fluctuations of spot prices would impact either the buyer or seller in the form of price risks. More and more PPAs are thus structured on pricing options following market price’s fluctuations (such as cap and floor). Buyers would favour a pricing model that is fixed enough to predict energy costs over a certain time but flexible enough to reduce risks of decreased market prices.
Finally, the credit risks can materialise by a corporate defaulting and unable to pay. The higher this risk, the lower the bankability would be for a PPA. It can be mitigated by an aggregation of several buyers or others form of credit’s support.
New products such as the proxy revenue swap are emerging. This is a hedging solution for volume risk where the hedge provider pays the seller a pre-agreed fixed annual price reflecting a long-term price and wind resource assessment. The actual payment is the difference between the pre-agreed price and the floating reference price of the project (market price). Hence, the hedge provider is taking both volume risk and price risk, against a fee.
In conclusion, it can be anticipated that the offer for innovative risks mitigation products for PPA specific risks will grow and diversify to meet various needs.