Over the past decade, corporations and municipalities have sought to increase their control over the long term cost of energy by contracting directly with project developers for the purchase of renewable energy, bypassing the traditional sources – the local utility.
But several issues have limited the growth opportunities for these transactions:
- physical delivery is often both impractical and cost-inefficient
- owning renewable projects requires more land or rooftop space than is typically available on or near corporate locations in order to solve their energy need
- a single project may generate more energy than is required to meet the energy needs of any one location
- corporate locations may lack the solar radiation or wind patterns necessary to generate the optimal amount of energy
- physical delivery of power is difficult both because of lack of adequate transmission and because regulatory approval under state and federal laws is often required
- Ownership of renewable energy facility requires a commitment of capital that might be better employed in their businesses.
The solution has been the development of the synthetic PPA, also known as a “contract for differences”
- this is a contractual arrangement between a seller (the project owner) and a buyer (the corporate off-taker of the power) where the buyer does not take physical delivery of power but pays for the power under a long term, fixed rate contract.
- in that connection, a financial hedge (the contract) for the energy produced by a renewable energy project is structured
- This contract for differences specifies the following:
(i) the project owner sells the power into the local wholesale electricity market to either the local utility or another buyer at the current market rate for power for that locality for resale to meet the energy needs of that reseller's customers
(ii) The corporate off-taker purchase an equivalent amount of power from its local utility at the then current market rate for power for that locality
(iii) at the end of each month, the project owner calculates the total revenues received from the sale of power from its renewable energy project, calculated at the various floating price payments received during that period. The corporate off-taker calculates the total costs paid for the purchase of power from the local utility, calculated at the various floating price payments made during the month. If the total revenues received by the project owner exceeds the (total) revenues for the quantity of power delivered at the fixed price for the power specified in the synthetic PPA, then the project owner pays the excess to the corporate off-taker.
(iv) if the total costs paid by the corporate off-taker during the month are less than the total costs for the quantity of power delivered at the fixed price for the power specified in the synthetic PPA, then the corporate off-taker will pay over to the project owner the difference.
Benefits
- the synthetic PPA functions as a price hedge for the corporate off-taker's energy use purchased from the project owner.
- corporate off-takers can lock in cost savings if energy prices increase over the life of the synthetic PPA.
- fixing energy costs over rhe term of the synthetic PPA aids in budget planning. These benefits are key for those companies whose energy costs represent a large share of operating costs
Challenges
- if energy prices decline over the term of the synthetic PPA, the corporate off-takers will have locked energy costs at too high of a rate
- the hedge is not perfect; there is basis risk if the project owner sells power at a different market hub than where the corporate off-taker’s energy use is priced. This risk is generally borne by the project owner.
- this is best mitigated by selecting a settlement hub near where the corporate off-taker is purchasing its energy. The project owner takes the basis risk if that differs from the hub where the project owner sells the energy.