Do PPAs still offer the best deal for wind?

WORLDWIDE: Signing a power purchase agreement used to be the best way to secure finance for wind projects across the globe, but in today's uncertain climate their long duration and fixed costs can damage suppliers' credit ratings.

Low prices… Unique conditions in Brazil have pushed PPA prices down (pic: Impsa)
Low prices… Unique conditions in Brazil have pushed PPA prices down (pic: Impsa)

Power purchase agreements (PPAs) for wind-generated electricity are an important support mechanism in many global markets. The basic idea is to agree a price for the electricity for a fixed number of years with an energy or other company, giving the wind-farm operator a steady source of income on which to base a business case for project finance.

If only it were that simple. Looking at some examples from around the world, the complexities of PPAs seems to rank them as a commercial and legal "art form" of their own. In countries such as Brazil and South Africa, PPA counterparties are part or fully owned by the state, giving considerable contractual security. In Europe, PPA players are more diverse. And PPAs do not always deliver expected results, with some utilities receiving a reduced credit rating after locking in to a fixed price for energy.

In-built flexibility

In Brazil, PPA prices for wind-generated electricity are low enough to raise eyebrows. But the country's PPAs have some unique characteristics that may help explain how these prices came about. The contracts with energy company Eletrobras (which is 52% owned by the state) run for 20 years and are divided into four-year periods in which fluctuations in annual output can be smoothed. If output in one year reaches only 90% of the agreed amount, the wind-farm operator still receives 100% of payment and can make up the difference in any of the three ensuing years, Mauricio Tolmasquim, chairman of the Brazilian Energy Agency, explained at the European Wind Energy Association (EWEA) conference in March.

Flanking the PPA, tax incentives are provided for wind-farm construction and production of the equipment used. BNDES, Brazil's national development bank, provides good lending rates, allowing wind projects to be financed on a 20% equity and 80% debt basis.

Generators pay network costs in Brazil, but wind farms of less than 30MW only pay half of these transmission costs, so projects tend to be split into units smaller than 30MW. These conditions have helped to reduce the PPA price resulting from auctions to just EUR 37/MWh in 2013, said Tolmasquim.

Competitive bidding

Like Brazil, South Africa has no electricity spot market and purchase contracts for wind energy are allocated by competitive bidding. Under the rules set out in the renewable energy independent power producer procurement programme (REIPPPP), the allocation decision is based to 70% on the price bid and to 30% on socio-economic factors such as local ownership and control, job creation, community development and strong local-content requirement.

PPAs are clinched with state-owned power company Eskom and run for 20 years. In the first auction, the average levelised price was equivalent to EUR 0.10/kWh, indexed to inflation. The second and third auctions achieved prices of EUR 0.075/kWh and EUR 0.055/kWh, taking into account the currency rates of the time.

The bidding process involves extensive documentation, however, with players required to provide seven copies of a 5,000-page document, involving large sums in bid preparation. "This is a game needing very trustworthy players, but is also very expensive. We are working on ways to get smaller wind parks involved and for South African players to stay in the game," Johann van den Berg, head of the South Africa Wind Energy Association, said earlier this year.

Small players lose out

In the already well-developed electricity markets in Europe, PPAs are of a different nature, and they also seem to work best for major energy-sector players rather than small community or municipal developments as, for instance, are currently widely found in Germany.

A PPA needs to provide a project with a degree of protection against wholesale electricity price risk by guaranteeing a minimum price, according to a study by specialist consultancy Redpoint Energy for the UK Department of Energy and Climate Change, released in July 2013. Ideally, it needs to have a tenor of 12-15 years following commissioning, a length of time that should cover the debt repayment period plus a buffer to cover downside scenarios. Also banks will require a PPA counterparty (the company buying the electricity) with a strong balance sheet and a minimum credit rating of BBB-, the study concluded.

The European Commission's draft guidelines on state aid for environmental protection and energy 2014-2020 say aid schemes will only be authorised for a maximum period of ten years, however, the aid having to be re-notified if it is to be continued.

The ten years of renewables support thus does not fit with the bankability needed for a 12-15 year PPA with minimum price guarantee. Such incompatibility means independent, and often small companies wishing to finance a wind-energy project with income earned from a PPA may have difficulty getting such an agreement structured.

Balancing costs

Another issue is the cost of providing balancing power when forecasts of wind generation are too high or too low, and the electricity offtake company (the buyer side of the PPA) has to balance out the difference in the intraday market or, as a last resort, have the job done by the transmission system operator and pay the higher price involved.

The cost of pricing this imbalance risk over the 12-15 years of a PPA needs to be factored into the support price paid for the renewables electricity. Opinions differ on what price should be put on the imbalance risk. In Germany, the draft Renewable Energy Act factors in EUR 4/MWh for wind and solar, equivalent to 2% of the current price paid for offshore wind of EUR 190/MWh.

In the Netherlands, the mechanism used for calculating the contract-for-difference prices assumes the cost of balancing at about 9% of the price paid for wind power. "In real life about 7-8% is paid, although the actual costs are more like 9-10% or some EUR5.5/MWh. The German estimate of EUR4/MWh could thus be optimistic," says Albert Jochems, managing director of Green Giraffe Energy Bankers.

Credit rating

Another difficulty is the impact of long-term PPAs on credit rating. Although the Netherlands' contract-for-difference system has been running since 2011, the 195MW NOP Agrowind project was the first to reach financial close in February this year, with the involvement of several international banks and a PPA with energy company Eneco.

"Part of the problem is that long-running PPAs, as done in this case with Eneco, are factored in as an obligation described as imputed debt that rating agencies view negatively," says Niels Jongste, Netherlands managing director of Green Giraffe Energy Bankers.

The financial risk inherent in signing a long-term PPA is measured by the credit-rating agencies and imputed on to a utility's balance sheet for the purposes of assessing the company's creditworthiness, said the Redpoint report. "The impact seems to be most acute when a supplier has entered a PPA where it has committed to pay a fixed or minimum price per megawatt hour of output for a period beyond the forward curve of electricity trading, which runs for about three years ahead."

This issue may dissuade energy companies from signing PPAs, as they prefer to invest in renewable capacity off their balance sheets, potentially leaving independent renewable-energy project owners without a route to market.

New generation

New avenues may be opening up, however. A novel type of PPA, between a project owner and a corporate customer, has been signed by insurance giant Allianz and internet company Google. The ten-year PPA is Allianz's first with an end-user of the electricity and takes out some of the price risk," David Jones, head of renewable energy at Allianz Capital Partners in the UK, said in March. "It is priced in euro in a non-euro market, Sweden," he added. Allianz receives green certificates that are allocated to wind power in Sweden.

Francois Sterin, Google's director of global infrastructure, said his company, which has been carbon neutral since 2007, committed to buy electricity at a fixed price for ten years from 2015, from the 72MW wind project owned by Allianz and developer O2, and a 59MW project owned by Eolus Vind, both located in Sweden.

An electricity trader has yet to be signed up who will trade the wind power on the wholesale market. The aim will be for the electricity volume generated by the Swedish wind farms to more or less match the needs of Google's data centre in Finland, but taken over the whole year. On an optimistic note, Sterin said: "There is growing interest in long-term offtake agreements for renewables electricity as developers and investors prepare for a post-subsidy world and the direct involvement of corporations in renewables sourcing is increasing very fast."


- Tolling agreement The independent generator is paid an agreed fee for making the generation plant available to the off-taker for electricity generation

- Fixed price/floor price The independent generator agrees to supply all power generated and the off-taker agrees to buy that power and pay a fixed price or a minimum price per unit of output

- Route to market The independent generator agrees to supply all of the power generated and the off-taker agrees to buy the power and pay the prevailing market price (less a trading fee) for each unit of output

- Trading style The PPA provider agrees to manage and sell the power produced by the independent generator and to allow the generator to hedge the price risk by contracting future positions

Source: Redpoint Energy/Decc


Wind power capacity additions have largely been backed up by long-term power purchase agreements (PPAs) in North America, although policy uncertainty in the US in particular is driving developers to look for new ways to lock in enough revenue certainty to drive projects forward.

At least 60 PPAs for 8GW of wind capacity were signed last year, says the American Wind Energy Association (AWEA). Make Consulting's recently released North America Wind Power Outlook notes that of the 19.1GW of wind under active development in the US, about 9.5GW has announced PPAs.

"Definitely some utilities are looking to diversify their supply mix, some are looking for a hedge against natural gas prices, some have to meet renewable portfolio standards. But some of it is just competitively priced. We've heard of PPAs under $20/MWh," says Luke Lewandowski, the firm's lead analyst for North America.

Historically, says AWEA, about 64% of wind energy in the US has been procured by utilities, and in recent years by corporate buyers, through long-term PPAs with independent power producers. Another 14% is owned directly by utilities. The remainder is being sold into short-term spot markets, usually using some type of hedge contract to help smooth the revenues. Generally, it involves the hedge provider paying the generator if prices drop below a floor value and taking any upside if rates rise above a set ceiling.

Make estimates that about 7.4GW of projects moved ahead last year without an off-take agreement in place as project developers raced to start construction before the $0.023/kWh production tax credit (PTC) expired at the end of 2013.

It is a model that appears to be on the rise as the opportunities for new PPAs are dwindling due to continuing uncertainty over the PTC, a lack of significant demand growth and the fact that many states with renewable energy mandates have reached their near-term targets.

The challenge they face, says Lewandowski, is that there are few alternative financing options available for projects without PPAs. The financial institutions and power traders that will provide hedges are only able to handle about 2-3GW of projects. "I have to think some of these projects are going to disappear," he says.

Offering security in Canada

In Canada PPAs are the norm and the fact that most are with government-owned utilities or agencies provide security to developer and financiers. Alberta's competitive power market, with no renewable mandates to drive long-term contracting, is the exception.


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