What is a power purchase agreement (PPA) and why use one?
Understanding what is a PPA: A Guide to power purchase agreements
Renewable energy strategies at your fingertips
Make sure you don’t miss out on U.S., Europe and APAC renewable market insights.
As more companies strive to reach corporate sustainability goals like net-zero emissions or align with Science-Based Targets Initiative (SBTi) standards, the need for renewable energy solutions grows. However, on-site renewable energy projects typically require significant upfront capital and often only account for a fraction of total electricity needs. To solve this problem and potentially reduce their scope 2 emissions, many organizations are turning to power purchase agreements (PPAs). PPAs can help companies manage their electricity consumption and support their sustainability goals by enabling access to electricity generated from renewable sources such as wind and solar.
PPAs — which can be either physical or virtual, as we’ll examine in this article — enable companies to procure renewable electricity and reduce pricing volatility. PPAs often provide a fixed price or fixed cost for electricity, ensuring predictable expenses for buyers and helping to hedge against market fluctuations. That helps companies further their financial, environmental, and marketing goals, although PPAs do typically require strategic project selection and the help of a trusted advisor to minimize risks.
In this power purchase agreement guide, we’ll take a closer look at key areas such as:
- What is a PPA?
- PPA benefits
- PPA risks
- Differences between a VPPA and a PPA
- Importance of working with trusted PPA advisors
What is a power purchase agreement (PPA)?
In a broad sense, a power purchase agreement (PPA) is a contract between two parties for the sale of electricity. Typically, however, this term is used in the context of renewable electricity, where a renewable energy developer—who may own or operate renewable assets such as a wind farm or solar farms—agrees to sell electricity from a particular project and the associated energy attribute certificates (EACs) to a buyer, often a corporation. These renewable energy projects can include various types of power plants and renewable assets. These contracts typically last around 10-20 years.
Consumer-focused PPAs also exist, such as solar PPAs that involve a homeowner hosting solar panels on their property, but rather than owning the system and paying for it upfront, the developer maintains control, and the homeowner pays the developer a set rate for the solar power the system generates. These solar PPAs often source renewable energy from solar farms, which are key facilities in the production of green electricity.
For the purposes of this article, however, we’ll focus on corporate PPAs. These agreements provide developers with reliable financing to develop their renewable energy projects, while corporations get the benefit of procuring renewable electricity at a contracted price, without the capital outlay or physical requirements of on-site power generation. The project company is often responsible for developing and operating the power plant or generating assets, and the utility company may act as the buyer in some cases.
Definition of a PPA
The definition of a PPA depends on which type you’re referring to. PPAs come in two main forms, known as physical and virtual PPAs:
- Physical PPAs, which are contracts for the actual energy and EACs from a project to be delivered directly to the buyer, involving physical delivery of electricity from the project to the buyer at a specific utility meter point.
- Virtual PPAs, which serve as financial contracts that enable the developer to sell renewable electricity into the grid at a contracted price, with market price differences settled with the buyer, and the buyer receives the associated EACs. A virtual power purchase agreement is also known as a synthetic PPA; synthetic PPAs are financial arrangements that do not involve physical delivery of electricity.
While the most common type of PPAs has typically been physical PPAs, they are not always practical for all companies, given the complexity and often regulatory requirements needed to take possession of the electricity from a particular project.
In the U.S., physical PPAs also require the buyer — or a third-party scheduler — as well as the seller to obtain a license from the Federal Energy Regulatory Commission (FERC), given that a physical PPA gives legal title of the electricity to the buyer and then requires moving and scheduling the electricity to the company’s load or selling the electricity into the wholesale power market while keeping the renewable energy certificates (RECs).
Given this complexity, physical PPAs are usually purchased by utilities, although some large companies have found success using PPAs for sites requiring large, concentrated loads, such as manufacturing plants or data centers.
In other cases, however, companies may prefer to use virtual PPAs (VPPAs), which do not involve taking physical possession of electricity. Instead, a VPPA is a contract for difference (CfD), where the two parties settle the differences between market prices and a previously agreed-upon rate. Synthetic PPAs (or synthetic PPAs) are commonly used in deregulated electricity markets.
Explanation of contract for difference (CfD)
A CfD involves two parties settling the difference between current contracted pricing and future pricing.
With a VPPA, the buyer/offtaker continues to procure electricity from its local utility, while the developer sends electricity into its local grid. If the market prices result in the developer selling into the grid below the contracted price, the offtaker covers the shortfall. If the developer sells its electricity for more than the contracted price, it would send the extra money to the offtaker. That’s what makes these contracts CfDs, which in financial markets are generally considered to be derivative contracts. The amount of electricity covered by the agreement is typically measured in megawatt hours (MWh).
Settling the difference between the market price and contracted price means that VPPAs serve as hedges, albeit imperfect ones. The idea is that if wholesale electricity rises, the developer would be able to sell into the grid at higher prices than the VPPA contracted rate, and settling the difference would help offset the higher prices the offtaker faces when purchasing from its own utility. However, the magnitude of these increases, or even the direction, may differ between the offtaker’s and developer’s markets. PPAs are designed to provide long term revenue certainty and stable cash flows for both buyers and developers.
Where are PPAs available?
Physical PPAs are location-dependent and generally require a buyer’s site to be located in close proximity to the project site to facilitate the electricity transfer. This process also means that physical PPAs are generally accessible in competitive retail markets or direct access energy markets, where buyers have flexibility to choose their energy supplier. The structure of the electricity market influences the availability and structuring of physical PPAs, as certain electricity markets provide more options for contract terms and project development. That said, it’s possible but far more difficult to use a physical PPA in a regulated market.
Virtual PPAs typically have more availability, given that the electricity generation and delivery are not tied together. However, the project developer still needs to be able to sell its electricity into the grid, so VPPAs are typically used in organized electricity markets, such as a regional transmission organization (RTO) or independent system operator (ISO), which use a transparent pricing index. Organized electricity markets facilitate the use of VPPAs, but it is important to assess and manage market risks, as market volatility and fluctuating energy prices can impact the financial outcomes of these agreements. In contrast, selling into a vertically integrated market may not be possible.
What are the benefits of a PPA?
A PPA can provide several benefits to buyers, across areas such as: such agreements help make a renewable energy project financially viable by providing guaranteed demand and stable, long-term revenue certainty.
Whether a PPA is physical or virtual, it can provide insulation from electricity price volatility, given that the two parties agree on a rate for the duration of the contract. Generally, this rate is fixed, but even with a variable-rate PPA, there are generally more parameters around pricing that can reduce risk, such as having a floor and ceiling on prices.
Meanwhile, PPAs enable organizations to scale renewable energy procurement without requiring upfront investment to build out on-site generation.
Both types of PPAs come with associated EACs, thereby giving buyers the benefit of renewable energy procurement that can reduce scope 2 emissions if replacing non-renewable energy, based on the Greenhouse Gas (GHG) Protocol scope 2 market-based reporting methodology. While PPAs address scope 2 emissions, organizations interested in reducing their scope 1 emissions can also explore Gas Purchase Agreements (GPAs) as a strategic approach. PPAs enable organizations to source green energy and clean energy, supporting their environmental goals.
These long-term contracts also provide stability to project developers and give them the financing necessary for building out a new renewable energy source. Without these contracts, this zero-emission electricity source would not be added to the grid, which is why PPAs are said to provide “additionality,” a key criterion for PPA buyers.
The environmental benefits of PPAs also extend into corporate marketing benefits. The additionality created via these agreements, where a company not only reduces their scope 2 emissions but helps add a renewable energy source to the grid, can provide a boost to the buyer’s brand image. Many studies show that the majority of employees and consumers care about a company’s climate efforts, and entering into a PPA provides a clear example of a company’s commitment to sustainability.
Curious about PPA markets?
Subscribe to get access to 3Degrees’ Global Market Report to keep track of market trends and their effects on the energy and PPA market landscape globally.
What are the considerations for a PPA?
Beyond PPAs several advantages, they also require careful consideration. In particular, market risks—such as price volatility and regulatory changes. PPA considerations to be mindful of:
The long-term nature of PPAs may reduce exposure to market price volatility, but that also leads to a risk of locking in a more expensive rate. For example, if electricity rates spike leading up to the start of a physical PPA, the buyer might be agreeing to a higher rate than what they would pay if they continued paying market prices.
PPAs carry counterparty risk, because whether it’s a physical or virtual agreement, the buyer depends on the developer to deliver the electricity. The financing from the agreement, including the purchase of the EACs, is meant to support the project’s development, but sometimes projects do not get completed as planned. Thus, potential PPA buyers should carefully consider project maturity and a developer’s background to increase the likelihood of choosing a successful project.
PPAs are specific types of contracts that often carry significant complexity, especially VPPAs, which add a financial layer. That means that creating a PPA requires guidance from multiple departments, such as finance, legal, and operations, in order to come to an agreement that is compliant, financially sound, and provides the desired operational and environmental advantages.
What are the differences between a PPA and a VPPA?
A PPA is the overarching category of power purchase agreements that can either be physical or virtual agreements. PPA contracts can be structured as either physical or virtual agreements, each offering distinct features and benefits for project financing and risk management. However, given the rise in popularity of VPPAs, the term PPA often refers to the physical type.
As mentioned, the differences between these two types of PPAs — physical and virtual — are that physical PPAs involve the direct purchase and delivery of electricity and EACs, while a VPPA is a financial agreement that still gives the buyer the associated EACs but does not involve direct receipt of the electricity. Instead, the developer sells its electricity into the grid, the offtaker still purchases from its local utility, and the two parties settle the difference between their virtual PPA price and the market price the developer receives.
The role of energy suppliers in PPAs
Energy suppliers are a vital link in the success of power purchase agreements (PPAs), especially when it comes to renewable energy projects. In these agreements, the energy supplier acts as the bridge between the power producer—who generates renewable energy from sources like wind farms or solar panels—and the electricity consumer, such as a corporation or large facility. The energy supplier is responsible for ensuring that the renewable energy generated by the power producer is reliably delivered to the consumer’s site, whether through a physical connection or via the broader electricity grid.
Beyond simply transmitting electricity, energy suppliers manage the grid connection, oversee the metering of energy generated and consumed, and handle billing for the renewable energy supplied. Their expertise ensures that the renewable energy flows seamlessly from the power producer to the end user, supporting the consumer’s sustainability goals and helping to reduce their carbon footprint. By facilitating the delivery and management of renewable energy, energy suppliers play a crucial role in making power purchase agreements work for all parties involved.
Responsibilities and requirements of suppliers
Energy suppliers involved in power purchase agreements take on a range of responsibilities to ensure the smooth operation of renewable energy delivery. Their primary duty is to guarantee the reliable and consistent supply of renewable energy to the consumer, managing the technical aspects of grid connection and ensuring that the energy generated by the power producer reaches its destination efficiently.
Suppliers are also tasked with installing and maintaining metering systems that accurately track the amount of renewable energy delivered. This data is essential for billing, settlement, and the allocation of renewable energy credits. To fulfill these roles, energy suppliers must comply with all relevant regulatory requirements and industry standards for renewable energy trading and distribution.
In addition to these core functions, many energy suppliers offer value-added services such as energy storage solutions, demand response programs, and energy efficiency consulting. These services help consumers optimize their use of renewable energy and further support their sustainability objectives. To meet these demands, energy suppliers need robust infrastructure, advanced technical capabilities, and a deep understanding of the renewable energy market.
The PPA process: From initiation to negotiation
Securing a power purchase agreement (PPA) for renewable energy involves a structured process that brings together the power producer and the energy consumer to create a mutually beneficial arrangement. The journey begins with a thorough assessment of the consumer’s energy needs and the power producer’s ability to generate renewable energy, ensuring that both parties are aligned on their goals and capabilities.
Throughout the process, open communication and careful planning are essential. The power producer must demonstrate their capacity to deliver the required amount of renewable energy, while the consumer evaluates how the agreement will support their energy transition and sustainability targets. By following a clear process, both parties can negotiate a PPA that delivers predictable revenue streams for the producer and long-term renewable energy supply for the consumer.
Key steps in securing a PPA
The process of securing a power purchase agreement for renewable energy typically includes the following key steps:
- Initial assessment: The energy consumer and power producer evaluate the consumer’s energy requirements and the producer’s renewable energy generation capacity to determine if a PPA is feasible.
- Proposal and term sheet: The power producer presents a proposal and a term sheet that outlines the main terms and conditions of the potential PPA, including the type of renewable energy, expected quantities, and preliminary pricing.
- Due diligence: The consumer conducts a thorough review of the power producer’s financial stability, track record, and ability to deliver the promised renewable energy, ensuring the project is viable and reliable.
- Negotiation: Both parties negotiate the details of the PPA contract, including the agreed PPA price, the volume of energy to be supplied, contract duration, and any additional terms such as renewable energy credits or guarantees of origin.
- Contract signing: Once all terms are agreed upon, the consumer and power producer sign the PPA contract, formalizing their commitment to the renewable energy agreement.
- Implementation: The power producer, often in collaboration with the energy supplier, puts the agreement into action by generating and delivering renewable energy to the consumer, supported by robust metering and billing systems.
By following these steps, organizations can secure a PPA that supports their renewable energy goals, provides financial stability, and contributes to a cleaner energy future.
Operation and metering in PPAs
The operation and metering of power purchase agreements are essential to ensuring that the renewable energy generated is accurately tracked and credited to the consumer. Effective operation involves the seamless coordination between the power producer, energy supplier, and consumer to deliver the agreed quantities of renewable energy. Metering systems play a critical role in this process, providing transparent and verifiable data on the energy generated and consumed.
Accurate metering not only supports reliable billing and settlement but also underpins the allocation of renewable energy credits or certificates, which are key to demonstrating the environmental benefits of the PPA. By maintaining high standards in operation and metering, all parties can be confident in the integrity of the renewable energy supplied and the impact it has on reducing carbon emissions.
How renewable electricity production is measured and verified
Electricity production under a power purchase agreement is measured and verified using advanced metering systems installed at the point of generation. These systems continuously monitor the amount of renewable energy generated by the power producer, capturing real-time data that is essential for both operational and financial purposes.
The energy supplier is responsible for ensuring that the metering equipment meets industry standards and complies with regulatory requirements. This includes regular maintenance and calibration to guarantee accurate measurement of the renewable energy generated. The data collected from these meters is used to calculate the amount of renewable energy credits (RECs) or guarantees of origin (GOs) that the consumer is entitled to claim, providing transparent proof of their renewable energy consumption.
By leveraging precise metering and verification processes, power purchase agreements deliver confidence to all parties that the renewable energy generated is accurately accounted for, supporting both sustainability reporting and the transition to a cleaner energy system.
Importance of working with advisors for PPA procurement
Given the complexity of PPAs and the strategic advantages they can provide an organization, it is prudent to work with an experienced advisor.
The right partner can help you in several areas, such as:
- Understanding what to watch out for when buying PPAs for the first time
- Executing a PPA aggregation that combines multiple buyers into one contract for a large-scale project to take advantage of economies of scale
- Assessing PPA feasibility across different geographies and markets for a multinational corporation with different energy needs in different areas, where understanding the power sector in each region is crucial for successful PPA procurement
- Modeling the financial and emissions impact of a PPA
- Structuring contracts that align with your financial, environmental, and operational goals
- Guiding you through regulatory, legal, and accounting nuances
Ready to see how a power purchase agreement can help your organization’s utility solutions? Reach out to us today.
*Due to legal and regulatory restrictions in certain jurisdictions, this material is only intended to be accessed in those jurisdictions where to do so would not constitute a violation of the local marketing laws. This material is provided as general information only. It does not constitute an offer to sell or the solicitation of an offer to buy any investment. Nor does it constitute the giving of investment advice. For more information. For more information, click here.
FAQs about PPAs
Want some quick answers to frequently asked questions about power purchase agreements?
PPAs can be used for a wide range of renewable projects, including wind farms, solar power plants, and other renewable energy installations. These contractual arrangements help facilitate the financing and development of large-scale renewable assets by providing standardized agreements and market-oriented structures.
A PPA is typically a long-term contract of around 10-20 years, depending on what the developer and offtaker agree to.
While there are a few different types of PPAs, these contracts often refer to renewable energy agreements between project developers and corporations. In that context, there are two main types of PPAs: physical PPAs, which involve the direct transfer of electricity and EACs, and virtual PPAs, where the actual electricity is not directly transferred but is instead settled financially, while the EACs are still transferred.
3Degrees Group, Inc. (“3Degrees”) is a Commodity Trading Advisor registered with the United States National Futures Association. These materials are provided as general information only. Nothing contained in the material constitutes investment, legal, tax or other advice. Any projections, market outlooks or estimates contained in this material constitute forward-looking statements, and are based on certain assumptions and subject to certain known and unknown risks. Accordingly, such forward-looking statements should not be relied upon as being indicative of future performance or events–past performance is not indicative of future results. 3Degrees encourages you to carefully consider whether a transaction is suitable for you based upon your particular circumstances.
The information contained herein has been given in good faith and every effort has been made to ensure its accuracy. Therefore, carefully consider whether such trading is suitable for you in light of your financial condition. 3Degrees accepts no responsibility for any losses, whether sounded in tort, contract, negligence, or otherwise, directly or indirectly resulting from any reliance placed on any part of the contents of these materials and disclaims any liability for its accuracy or correctness, including as to any errors or omissions in any materials provided by 3Degrees. Swaps, futures and options trading involve significant risk of loss and may not be suitable for everyone.
