What are Power Purchase Contracts?

Power Purchase Contracts, or Power Purchase Agreements (PPAs) refer to long-term, renewable energy contracts between a power producer, typically a renewable energy generator, and a power purchaser, which can be a utility company or a larger corporation. These contracts outline the terms and conditions for buying and selling a specific amount of electricity over a predetermined period. By directly agreeing with a power producer, companies can have a much clearer, direct impact on stimulating more renewable electricity supply. It also provides more price stability for the buyer as they are entering into a long-term contract with a predefined price for the supply of electricity.

How Do Power Purchase Contracts Work?

The PPA outlines key terms, including price, contract duration, and energy volume. The buyer agrees to purchase electricity at a fixed or negotiated price, typically lower than retail rates. The seller assumes responsibility for producing and delivering the agreed-upon amount of energy. After drafting, the PPA must be submitted to the relevant regulatory authority for approval.

Benefits & Challenges Associated with Power Purchase Contracts

Benefits

A Contract for Difference Power Purchase Agreement (CfD) is a financial instrument that mitigates price risk for renewable energy generators. It involves agreeing on a predetermined "strike price" for electricity with a counterparty. If the market price falls below the strike price, the generator receives a top-up payment; if it exceeds the strike price, the generator pays the difference. This ensures a stable and predictable revenue stream for the generator, regardless of market fluctuations.

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Power Purchase Agreement Contracts establish a foundation by securing a buyer for the electricity, providing an initial shield against market uncertainty. By layering a CfD on top, any residual exposure to price fluctuations is mitigated, resulting in a stable and predictable income stream for the generator. This combination of PPA and CfD enhances project financeability by reducing risk and attracting investors, particularly crucial for large-scale renewable projects that require significant upfront investment.

Risks

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PPAs offer greater control and potential cost savings compared to green tariffs but require higher levels of involvement from the energy buyer. Below are some other PPA risks to take note of.

1. Volumetric risk

Volumetric risk in PPAs refers to the uncertainty and potential financial impact arising from the difference between the projected and actual volume of electricity generated and consumed. As PPAs tend to include intermittent renewable energy sources like weather-dependent wind and solar, this can lead to significant variability in the amount of electricity generated compared to the contracted amount.

If the actual generation differs from the expected volume, the financial outcomes are influenced by the prevailing market prices at the time of the mismatch, which can cause market price risks to occur.​ Price risk arises from fluctuations in electricity market costs. For PPAs, this risk is magnified if there is a mismatch between contracted electricity volumes and actual generation. When the renewable energy asset underperforms, the off-taker must purchase additional electricity from the wholesale market to meet consumption demands. This exposes them to financial risks. Higher market prices amplify losses during underproduction, while lower prices reduce potential savings during overproduction.

Although PPAs often guarantee electricity production volumes, producers may need to purchase additional EACs to fulfill contract obligations in case of underperformance. An underperforming PPA indicates insufficient renewable energy generation to fulfill contractual obligations. To solve this, organizations must make an effort to closely monitor actual electricity production against contract specifications and ensure the correct number of EACs are received. 

2. Shape risk

Shape risk is the risk that is associated with the hourly mismatch between supply and demand, and the resulting additional procurement costs that arise from this

3. Regulatory and policy risk

Power Purchase Contracts operate within a complex regulatory and market environment. Changes in policies like renewable energy subsidies, emissions regulations, or even grid infrastructure can significantly influence the economics and risk profile of these contracts. An example of this would be the introduction of carbon pricing mechanisms or stricter renewable portfolio standards. Both scenarios can alter the value of Renewable Energy Certificates (RECs), impacting PPA pricing and contract terms.

4. Credit risk

Credit risk in this context refers to the potential financial loss incurred if one party fails to fulfill its contractual obligations. For instance, if a corporate buyer signs a contract with a renewable energy project to purchase renewable energy before it's even completed. There is always a risk that the project might experience delays, underperform, or fail, leaving the buyer without the energy already paid for. Conversely, if the buyer defaults on payment obligations, the project's financial viability is compromised. To mitigate this, parties can incorporate guarantees, letters of credit, or other financial instruments into PPAs.

How to Avoid Risks Associated with Power Purchase Contracts

1. Contractual clauses

Include specific clauses in the PPA contract that address data availability and accessibility, performance guarantees, and curtailment conditions. Access to real-time data allows you to monitor your contract performance and identify your exposure to volumetric PPA risks. These clauses ensure that both parties are aware of their obligations and the mechanisms in place to handle deviations from expected volumes​. 

2. Real-time data monitoring

Implementing monitoring systems can help track the performance of the PPA asset and detect volumetric risks early. Having access to the data you need to track volumetric risk, allows you to monitor your contract performance and identify your exposure to volumetric risks. Flexidao's platform provides high-resolution intelligence for tracking the performance of clean energy contracts and certificates by effectively calculating, monitoring, and forecasting key operational, financial, and risk metrics.

3. Shape Risk 

Matching electricity supply and demand is crucial for mitigating PPA risks. Renewable energy's intermittent nature can create challenges, as sellers prioritize immediate offtake while buyers often seek flexible delivery options. By monitoring the alignment between generation and consumption, businesses can identify potential mismatches and implement strategies to address them. This includes exploring options like energy storage or demand response to bridge the gap between supply and demand.

4. Monitor electricity generation against contract terms 

To effectively manage a PPA, organizations need to monitor electricity generation against contract terms. A good rule of thumb for ensuring compliance with contractual terms is to validate hourly generation volumes and identify inexcusable outage periods. This includes tracking plant performance, comparing actual output to projected volumes, and verifying the accuracy of REC issuance. Flexidao simplifies this process by providing insight into hourly generation data so organizations can calculate availability performance metrics and understand if and when outage reasons are justified.

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5. Leverage technology for financial performance

Reporting financial outcomes of virtual PPAs and managing liquidity needs are both necessary for estimating near and long-term cash-flow commitments. However, these calculations can be complex, requiring many data sets from various sources. This is where solutions like Flexidao’s come in. The platform enables a deeper understanding of an organization’s past financial performance and forecast financial outcomes of virtual PPAs by providing greater visibility of what is going on under the hood via data visualizations like cash flow performance overview or quantitative cash flow forecast.

Learn How To Manage Your Power Purchase Agreement Contracts Better with Flexidao

1. Avoid costly invoicing errors with deeper oversight

Streamline accounting for Power Purchase Agreement Contracts with timely and accurate invoice validation and tracking of financial settlements. Gain critical insights into the historical and projected financial performance of your PPA and effectively manage liquidity risk.

2. Save valuable time in periodic data collection and processing

Eliminate time-consuming manual tasks with automated collection, processing and consolidation of high-granularity production, consumption, and carbon data. Optimize your reporting process by tracking and updating portfolio balances of Energy Attribute Certificates (EACs) issued by your contracts.

3. Ensure contract performance by enforcing availability guarantees

Monitor project operational performance and automate availability calculations to assess whether availability guarantees and contractual performance clauses are being met. Gain deep insights into historical hourly generation, price values, and outage reports to ensure your expected generation volumes are met.

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Speak with our experts today to simplify the management of your PPA contract, certificates, and emissions data.