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What is a fair price for a PPA?

Corporate power purchase agreements (PPAs) are an increasingly common tool for funding renewable energy. For the buyer, they bring predictability in outlay plus a means for achieving their corporate environmental goals. For the project developer, they ensure a secure, bankable revenue stream. But the true value of a PPA relies on achieving a pricing model that works for all parties. And that is an increasingly complex problem.

There are many steps to go through in negotiating a PPA contract. Pricing is certainly not the first, but the price structure and level are often a major part of discussions before finalizing the transaction. The result needs to strike a balance between the financial needs of the buyer and the seller. If either party is significantly short-changed, then the long-term viability of the PPA will be put at risk.

Typically, PPA pricing has been based on average monthly or yearly prices derived from forecasts for relevant market. While this approach has worked well in the past, when renewable energy was a relatively small part of the energy mix, it became obsolete with the significant uptake in renewables. In particular, it ignores several dynamic risks that are present in markets with a high proportion of renewables. And over the relatively long lifetime of a typical corporate PPA, these merchant risks can have a major impact on the business case.

A complex risk landscape

For example, increased penetration of renewable energy can lead to greater weather-related volatility in spot prices. This is exacerbated by cannibalization effects that impact the capture price for specific technologies (e.g. when there is a lot of solar power being produced, the market value of solar power can drop). This latter factor is, of course, greatly influenced by the specific generation mix in the local market.

Moreover, the risk of differences between predicted and actual output of a given power plant is significant for long-term hedging structures like PPAs. For physical PPAs, who takes on this imbalance risk and how they are compensated are key parts of defining the pricing model. Similarly, the rise of cross-border PPAs – where electricity is generated and consumed in different market zones – also brings additional risks due to potential price differences in the different markets. Again, the financials of handling this risk must be incorporated into the pricing structure. 

Accommodating these risks is driving diversity in PPA pricing. There is a strong trend away from fixed pricing towards more market-based structures. And many corporate buyers are looking for innovative pricing structures that give them more possibilities for hedging – such as the collar which sets maximum and minimum price guarantees, providing higher contract settlement certainty for the buyer but also protection for the seller.

Understanding a dynamic market clearly

This diversity gives more flexibility to find a fair pricing structure. But more choice also makes deciding on the best structure more complicated. Therefore, before agreeing on a PPA pricing structure, stakeholders need to consider the type of generation technology involved and the local energy mix. They need to think about how risks will be distributed and compensated among the parties involved in the contract. And they need to understand the dynamics and risks of the market(s) where the contract will be realized.

Achieving that understanding requires a long-term dynamic market risk analysis that goes beyond the standard power price forecast. For parties in Europe, DNV can provide such a PPA pricing analysis by combining historical market data with our future outlooks in a powerful stochastic calculation to obtain accurate price, profile and imbalance risk. The analysis can be tailored to individual locations and assets to identify any site-specific variations from overall trends.

Leveraging DNV’s unique expertise in risk assessment and renewable energy technologies, our green energy procurement services support corporate energy buyers in achieving impactful green power procurement quickly, easily and transparently. Besides connecting renewable energy buyers and sellers, we offer support in risk assessment and allocation for corporate PPAs. For more information, please contact us today for more information.

10/1/2020 9:00:00 AM

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Jakub Pilc

Jakub Pilc

Principal Consultant - Green Energy Procurement