Power purchase agreement

A power purchase agreement (PPA), or electricity power agreement, is a contract between two parties, one which generates electricity (the seller) and one which is looking to purchase electricity (the buyer). The PPA defines all of the commercial terms for the sale of electricity between the two parties, including when the project will begin commercial operation, schedule for delivery of electricity, penalties for under delivery, payment terms, and termination. A PPA is the principal agreement that defines the revenue and credit quality of a generating project and is thus a key instrument of project finance. There are many forms of PPA in use today and they vary according to the needs of buyer, seller, and financing counter parties.[1][2]

Background

A power purchase agreement (PPA) is a legal contract between an electricity generator (provider) and a power purchaser (buyer, typically a utility or large power buyer/trader). Contractual terms may last anywhere between 5 and 20 years, during which time the power purchaser buys energy, and sometimes also capacity and/or ancillary services, from the electricity generator. Such agreements play a key role in the financing of independently owned (i.e. not owned by a utility) electricity generating assets. The seller under the PPA is typically an independent power producer, or "IPP."

In the case of distributed generation (where the generator is located on a building site and energy is sold to the building occupant), commercial PPAs have evolved as a variant that enables businesses, schools, and governments to purchase electricity directly from the generator rather than from the utility. This approach facilitates the financing of distributed generation assets such as photovoltaic, micro-turbines, reciprocating engines, and fuel cells.

Parties involved

The seller

Under a PPA, the seller is the entity that owns the project. In most cases, the seller is organized as a special purpose entity whose main purpose is to facilitate non-recourse project financing.

The buyer

Under a PPA, the buyer is typically a utility or a company that purchases the electricity to meet its customers' needs. In the case of distributed generation involving a commercial PPA variant, the buyer may be the occupant of the building—a business, school, or government for example. Electricity traders may also enter into PPA with the Seller.

Regulation in the United States

In the United States, PPAs are typically subject to regulation by the Federal Energy Regulatory Commission (FERC). FERC determines which facilities are applicable for PPAs under the Energy Policy Act of 2005.[3] PPAs facilitate the financing of distributed generation assets such as photovoltaic, microturbines, reciprocating engines, and fuel cells.

PPAs are typically subject to regulation at the state and federal level to varying degrees depending on the nature of the PPA and the extent to which the sale of electricity is regulated where the project is sited. In the U.S., FERC determines which facilities are considered to be exempt wholesale generators (EWG) or qualifying facilities and are applicable for PPAs under the Energy Policy Act of 2005.[3]

Where appropriate

Power purchase agreements (PPAs) may be appropriate where:[4]

  • the projected revenue of the project is uncertain and so some guarantees as to quantities purchased and price paid are required to make the project viable;
  • protection from cheaper or subsidized domestic or international competition (e.g., where a neighboring power plant is producing cheaper power) is desired;
  • there is one or a few major customers that will be taking the bulk of the product - for example, a government may be purchasing the power generated by a power plant - the government will want to understand how much it will be paying for its power and that it has the first call on that power, the project company will want certainty of revenue;
  • purchaser wishes to secure security of supply.
  • with solar power projects in non-profit companies in order to reduce costs for installation of the solar energy system[5]

Financing

The PPA is often regarded as the central document in the development of independent electricity generating assets (power plants). Because it defines the revenue terms for the project and credit quality, it is key to obtaining non-recourse project financing.

One of the key benefits of the PPA is that by clearly defining the output of the generating assets (such as a solar electric system) and the credit of its associated revenue streams, a PPA can be used by the PPA provider to raise non-recourse financing[6] from a bank[7] or other financing counterparty.[8]

Contract timeline

Effective date

The PPA is considered contractually binding on the date that it is signed, also known as the effective date. Once the project has been built, the effective date ensures that the purchaser will buy the electricity that will be generated and that the supplier will not sell its output to anyone else except the purchaser.[9]

Commercial operation

Before the seller can sell electricity to the buyer, the project must be fully tested and commissioned to ensure reliability and comply with established commercial practices. The commercial operation date is defined as the date after which all testing and commissioning has been completed and is the initiation date to which the seller can start producing electricity for sale (i.e. when the project has been substantially completed). The commercial operation date also specifies the period of operation, including an end date that is contractually agreed upon.[9]

Preemptive termination date

Typically, termination of a PPA ends on the agreed upon commercial operation period. A PPA may be terminated if abnormal events occur or circumstances result that fail to meet contractual guidelines. The seller has the right to curtail the delivery of energy if such abnormal circumstances arise, including natural disasters and uncontrolled events. The PPA may also allow the buyer to curtail energy in circumstances where the after-tax value of electricity changes.[9] When energy is curtailed, it is usually because one of the parties involved was at fault, which results in paid damages to the other party. This may be excused in extraordinary circumstances such as natural disasters and the party responsible for repairing the project is liable for such damages. In situations where liability is not defined properly in the contract, the parties may negotiate force majeure to resolve these issues.[9]

Operation and metering

Maintenance and operation of a generation project is the responsibility of the seller. This includes regular inspection and repair, if necessary, to ensure prudent practices. Liquidated damages will be applied if the seller fails to meet these circumstances. Typically, the seller is also responsible for installing and maintaining a meter to determine the quantity of output that will be sold. Under this circumstance, the seller must also provide real-time data at the request of the buyer, including atmospheric data relevant to the type of technology installed.[9]

Sales

Delivery point

The PPA will distinguish where the sale of electricity takes place in relation to the location of the buyer and seller. If the electricity is delivered in a "busbar" sale, the delivery point is located on the high side of the transformer adjacent to the project. In this type of transaction, the buyer is responsible for transmission of the energy from the seller. Otherwise, the PPA will distinguish another delivery point that was contractually agreed on by both parties.[9]

Pricing

Electricity rates are agreed upon as the basis for a PPA. Prices may be flat, escalate over time, or be negotiated in any other way as long as both parties agree to the negotiation. In a regulated environment, an Electricity Regulator will regulate the price. A PPA will often specify how much energy the supplier is expected to produce each year and any excess energy produced will have a negative impact on the sales rate of electricity that the buyer will be purchasing.[9] This system is intended to provide an incentive for the seller to properly estimate the amount of energy that will be produced in a given period of time.

Billing and payments

The PPA will also describe how invoices are prepared and the time period of response to those invoices. This also includes how to handle late payments and how to deal with invoices that became final after periods of inactivity regarding challenging the invoice. The buyer also has the authority to audit those records produced by the supplier in any circumstance.[9] There is a defined timeline when PPA Provider has to send an invoice to the Generator or vice versa and if that timeline is not met then it has its own consequences, which varies from one PPA Provider to another.

Performance terms

The buyer will typically require the seller to guarantee that the project will meet certain performance standards. Performance guarantees let the buyer plan accordingly when developing new facilities or when trying to meet demand schedules, which also encourages the seller to maintain adequate records. In circumstances where the output from the supplier fails to meet the contractual energy demand by the buyer, the seller is responsible for retributing such costs. Other guarantees may be contractually agreed upon, including availability guarantees and power-curve guarantees. These two types of guarantees are more applicable in regions where the energy harnessed by the renewable technology is more volatile.[9]

Example contracts

A basic sample PPA between the Bonneville Power Administration and a wind power generating entity was developed as a reference for future PPAs.[10] Solar PPAs are now being successfully utilized in the California Solar Initiative's Multifamily Affordable Solar Housing (MASH) program.[11] This aspect of the successful CSI program was just recently opened for applications.

PPAs can be managed in the European market by service providers. The legal agreements between the statewide power sectors(seller) and the trader(buyer/who buys large quantity of power) will be treated as the PPA in power sector.

Data center owners Amazon, Google, and Microsoft have used PPAs to offset the emissions and power usage of cloud computing. Some manufacturers with heavy carbon emission footprints and energy usage such as Anheuser-Busch InBev have also shown interest in PPAs. In 2017, Anheuser-Busch InBev agreed to purchase using a PPA from the utility company Iberdrola in Mexico for 220 MW of new wind farm energy.[12]

Recently, a new form of PPA was proposed to commercialize electric vehicle charging stations through a bi-lateral form of power purchase agreement.

See also

References
  1. Albert Thumann, Eric A. Woodroof Energy Project Financing: Resources and Strategies for Success - 2009- Page 93 "WHAT IS A POWER PURCHASE AGREEMENT (PPA)? A power purchase agreement is a long-term agreement to buy power from a company that produces electricity. A third-party financier will provide the capital to build, operate, and ..."
  2. D. R. Carmichael, Paul H. Rosenfield Accountants' Handbook, Special Industries and Special Topics 2003 Page 38 "The fact that an agreement is labeled a “power purchase agreement” is not conclusive. If a contract “conveys the right to use property, plant and equipment,” the contract should be accounted for as a lease. Other power purchase contracts.."
  3. "FERC." FERC.gov. Web. 30 Nov. 2010.
  4. PPPIRC. "PPP in Infrastructure Resource Center".
  5. "Convert Your HOA to Solar Power with These Four Steps - Educational Community for Homeowners (ECHO)". www.echo-ca.org.
  6. "Free Online Dictionary: Non-Recourse Finance." TheFreeDictionary.com. Web. 30 Nov. 2010.
  7. "Financial Glossary." People.hbs.edu. Web. 30 Nov. 2010.
  8. "Free Online Dictionary: Counterparty." TheFreeDictionary.com. Web. 30 Nov. 2010.
  9. "AGMRC." AGMRC.org. Web. 30 Nov. 2010.
  10. "USDOE & BPA PPA Archived 2017-05-01 at the Wayback Machine." BPA.gov. Web. 30 Nov. 2010.
  11. "MASH Archived 2010-11-13 at the Wayback Machine." CPUC.CA.gov. Web. 30 Nov. 2010.
  12. "Big business sees the promise of clean energy". The Economist. Retrieved 2017-06-25.
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