November 22, 2021

All about Power purchase agreements (PPAs): Who creates one, What they do, and When they are necessary

by PowerHub Editor

Power purchase agreements, which are typically referred to as ‘PPAs,’ are an old concept in electricity markets — but as a lot of things do, like Hollywood remakes, they’ve been making a comeback in recent years, especially in the corporate world!

Unfortunately, the phrase “power purchase agreement,” while quite literal in its definition, still fosters a lot of confusion. Because of this, we think it’s a good idea to explore a few power purchase agreement-related topics like what is a PPA? Who has the responsibility for developing them? When are they required? And what the advantages are of using them?

What exactly is a “power purchase agreement?”

While it’s easy to get bogged down in the details on this topic, you definitely don’t have to!

To keep it simple, you can think of a power purchase agreement as an arrangement where an electricity producer supplies power to a consumer or trader. As the name suggests, one party (the consumer or electricity trader) is purchasing power, through an agreement. See? We said the definition was literal!

If an electricity producer (picture a solar farm, it makes it easier) sells its power to a company that plans to consume it, the agreement is referred to as a “corporate PPA”.

On the other hand, if the contract is with an electricity trader (a company that plans to resell the electricity, rather than consume it itself), it’s a merchant PPA. A power purchase agreement, then, is just a contract that defines the conditions of an electricity arrangement!

The topic doesn’t need to get much more complicated than that.

Power purchase agreements are incredibly flexible documents — like, gymnast-level flexibility. They can be designed to meet specific needs of any kind. So, just like snowflakes — or fingerprints for that matter — every power purchase agreement is different.

Though, admittedly, there has been a noticeable (and growing) trend towards standardizing PPA terms and formats. Using repetitive, copy/paste language is referred to as “boilerplate,” or generic copy, and yes, it’s as boring to produce as it sounds! But… the benefit of writing PPAs using standard terms is that it’s faster and saves money, if not your attention span!

Different kinds of power purchase agreements

While the details of a PPA will vary based on the specific situation and parties involved, there are two broad kinds of agreements: physical and virtual (also called synthetic). A physical PPA customer receives paid-for renewable energy through their local grid.

Because the electricity is delivered through local transmission lines, however, both parties in a physical PPA have to share the same power grid. I guess our high school teachers were right after all; geography is important! Without sharing the same grid, the electricity delivery would go absolutely nowhere… which, you know, kind of defeats the purpose of setting up a PPA, to begin with.

Virtual PPAs represent the other half of the power purchase agreement equation. These contracts differ from physical PPAs as the parties involved (the electricity producer and consumer) don’t have to exist near each other.

This is because there is no actual delivery of the produced electricity (hence the name virtual PPA). Instead, these agreements decouple the physical flow of electricity from the financial flow. That’s a mouthful — we know — but all it means is that a virtual PPA is purely a financial agreement.

Renewable energy can therefore be produced far away from where it’s being purchased (including across borders), giving companies more freedom to procure clean power from various renewable energy sources. And no one ever complained about too much freedom before, so this is obviously a good thing!

Who develops a power purchase agreement?

Writing up a power purchase agreement tends to fall squarely on the shoulders of fancy lawyers, as the documents are quite complex. It’s important that before signing on to a PPA, every aspect of the contract is understood. Additionally, you’ll want to keep strictly to what’s in writing.

Don’t make any promises that aren’t reflected in the formal arrangement! The long-term nature of these agreements means it’s easy to forget small details — after all, some last for 30 years!

After the initial PPA writeup, all that’s left is the ongoing invoicing process. This tends to get (begrudgingly) handled by renewable energy asset managers in a burdensome and time-consuming manner. To their delight, however, invoicing is increasingly being automated using AI software platforms like Powerhub.
When are power purchase agreements necessary? Are there any risks to them?

PPAs offer companies long-term price security, and it’s hard to emphasize just how important that is, especially as the world grapples with volatile energy prices once more. The International Energy Agency blames post-COVID-19 economic growth, a colder-than-normal winter forecast, and weaker than expected energy supply increases on the surging prices.

Yet, businesses that are locked into power purchase agreements don’t have to be concerned with this at all! They may still have 99 problems, but at least energy prices aren’t one!

Instead, these companies enjoy the benefit of knowing that they pay a consistent amount for electricity over the long term. Not only does the stability of a PPA open more investment opportunities, but it’ll also help keep peace of mind among staff thanks to added job security. And hey, maybe more peaceful sleep at night will translate into efficiencies on the job! Sleep is an underrated asset, so you never know!

The primary downside of power purchase agreements (besides having to gruel through painful lawyer-speak, let’s be honest) is that, occasionally, quantities of agreed-upon electricity may not be available. The most likely culprit of this would be an unexpected downturn in sunlight or wind (impacting solar and wind, respectively).

In this case, the supplier of electricity must provide compensation. Alternatively, they could outsource the remainder of the supply to a third-party electricity trader. What we’re trying to say is that it’s not particularly challenging — like, at all — to overcome any issues that arise throughout a PPA contract.

Power purchase agreements represent a fundamental part of the modern energy market — and that’s a fantastic thing, as they offer a myriad of benefits to renewable energy producers and consumers. While there’s a tendency to view PPA’s as something really complex — that’s not the case! We promise — it just has a fancy-sounding name.

Sure, the actual contract language would never be considered layman’s terms (obviously, they’re written by lawyers!), but that doesn’t matter. Instead, what’s important is understanding what power purchase agreements are — and the kind of advantages they can offer. And, with the added benefit of automated technology, such as the Powerhub platform, week-to-week PPA management is easier than ever before!

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