What is a VPPA and what are the benefits?
Key VPPA considerations for organizations seeking scalable, cost-effective renewable energy procurement.
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To achieve ambitious climate goals, such as fulfilling the RE100 commitment of consuming 100% renewable electricity by 2050, companies must identify effective strategies to scale their renewable energy procurement efficiently.
While investing in on-site renewable energy projects can be part of the solution, they typically account for only 5-10% of the load, which is insufficient, especially for companies with very large loads that need hundreds of thousands of megawatt-hours (MWh) of electricity per year.
To that end, companies can secure a large, long-term supply of renewable electricity without having to invest significant upfront capital by entering into power purchase agreements (PPAs).
In particular, a virtual power purchase agreement (VPPA)* offers many businesses a compelling renewable energy procurement solution. A virtual PPA can be particularly attractive because it is the only truly scalable solution with the ability to be cost-neutral or better from a financial perspective, in addition to providing the environmental and marketing benefits that come with using renewable energy.
In this guide to VPPAs, we’ll take a closer look at key areas such as:
- What is a VPPA?
- Pros and cons of VPPAs
- Differences between a VPPA and a PPA
- Importance of working with VPPA advisors
What is a virtual power purchase agreement (VPPA)?
A virtual power purchase agreement (VPPA), also a financial contract, is a renewable energy procurement mechanism that allows organizations to receive the energy attribute certificates (EACs) generated by a particular project, without having to take physical delivery of the electricity, meaning that the organization does not need to have facilities located in the vicinity of the renewable energy project.
Here, we’ll take a closer look at the meaning of a VPPA:
Definition of a virtual PPA
A virtual PPA is a contract between a renewable electricity project (the seller/developer) and an electricity consumer (the buyer/offtaker). The contract sets a price at which the offtaker agrees to purchase electricity and the associated EACs from the renewable electricity project, typically for a term of around 10-20 years. Yet rather than delivering the electricity to the offtaker, as is the case with physical PPAs, a VPPA involves the developer selling the energy into the grid at the market price, while the offtaker continues to purchase electricity as usual from its regular utility provider.
The developer and offtaker then settle the difference between the fixed PPA price and the market price. If the developer sells its electricity for more than the VPPA contract price, the offtaker receives the difference. If the market price is less than the contract price, then the offtaker pays the difference to the developer.
Explanation of contract for difference (CfD)
A VPPA is a type of contract for difference (CfD). A CfD is a contract where two parties agree to settle the difference between a current agreed-upon price and the price at a specific time in the future.
Depending on how the offtaker purchases the electricity used at its facilities, these differences in the VPPA settlements may offset changes to the price of the purchased electricity, also known as an imperfect hedge. Since the offtaker continues to purchase from its utility provider throughout the arrangement, the idea is that if wholesale electricity prices increase, the developer would also pay the offtaker more, thereby helping to offset higher utility prices. The amounts would not line up perfectly, though, as pricing and how it is set in the offtaker’s region would typically differ from that in the project’s area.
Where are VPPAs available?
While physical PPAs are location-dependent and typically only used in competitive retail markets or direct access energy markets, virtual PPAs have more widespread availability, since the electricity is not actually delivered to the buyer. Still, VPPAs are often available in organized retail markets, such as within a regional transmission organization (RTO) or independent system operator (ISO).
This is because the renewable project developer needs to be able to sell its electricity directly to the grid in a market with a transparent pricing index, both of which exist in RTO/ISO regions, but is not necessarily the case in markets with vertically integrated electricity generation, transmission, and distribution.
What are the benefits of a VPPA?
Procuring electricity via a VPPA can provide benefits in three main areas:
The financial attractiveness of a VPPA is that it is typically the most cost-effective option for renewable energy procurement that is also highly scalable for organizations with large, distributed electricity usage. In some markets, VPPAs have a projected positive net present value (NPV), meaning that over the contract term, the offtaker would earn revenue based on forecasted future electricity pricing in comparison to the fixed PPA rate.
However, this potential upside is not the typical selling point for VPPAs, and organizations should be wary of developers or intermediaries promoting high returns. Rather, companies should consider the range of possible financial outcomes and be comfortable with downside scenarios in addition to the overall market risk that these contracts entail.
Because a VPPA comes with the EACs generated by the project, buyers gain the benefit of a scope 2 emissions reduction (if replacing a non-renewable source) based on the Greenhouse Gas (GHG) Protocol scope 2 market-based reporting methodology.
In addition, through the buyer entering into a long-term contract at a fixed PPA price, the developer is able to get the project financed and built, thereby potentially adding a new zero-emission electricity source to the grid. This concept of adding new renewable generation to the grid is what is referred to as “additionality,” which is a criteria that many VPPA buyers are looking to satisfy with their renewable energy procurement.
Tied to the environmental benefits of VPPAs, organizations can gain marketing benefits from being able to promote their Scope 2 emission reduction through a procurement mechanism that also has additionality, which signals a higher level of impact than simply purchasing unbundled EACs, for example. Stakeholders such as customers and suppliers may be more likely to work with your organization if they know you’re supporting the transition to clean energy, and the stories behind the specific projects you have entered into VPPAs with can provide strong marketing narratives.
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What are the risks of a VPPA?
While VPPAs can be advantageous in many ways, these are not contracts to enter into lightly. Consider potential risks across areas such as:
Although VPPAs can provide financial benefits, such as potentially having a projected positive NPV, there is still market pricing risk that can cause VPPAs to be more expensive than direct electricity purchases. Specifically, in some months or years, you may pay significant settlements to developers if wholesale electricity pricing falls in their regions. At the same time, local utility prices may not fall at the same rate, which effectively increases VPPA costs. In other words, highly variable market pricing can lead to net savings in some periods or net higher costs in other periods.
VPPAs also involve counterparty risk in the sense that the contract can only function if the project gets built and successfully delivers electricity to the grid. Potential buyers should consider the development maturity of projects they are considering to minimize development risk, as well as the track record of the developer to help ensure they are able to build and operate the project as contracted.
VPPAs are complex contracts, and depending on what accounting standard a company uses, they may be treated as a derivative. As such, putting together a VPPA requires the input and expertise of a variety of stakeholders, across domains such as finance, legal, and risk management. It is very important to understand the full terms of the contract and ensure that not only does it meet relevant compliance requirements but also that it provides the financial and environmental benefits your organization is looking for.
What are the differences between a VPPA and a PPA?
A VPPA is a type of PPA. In many cases, though, a PPA refers to a physical PPA, where the actual electrons of electricity from the project developer are delivered to the offtaker’s facilities alongside the associated EACs for a fixed price.
In contrast, a VPPA does not involve the offtaker taking physical delivery of the electricity, but rather it’s a financial contract for difference that provides the developer with a guaranteed price for selling its electricity into the grid, while the offtaker continues to purchase electricity from its utility. The developer then sends the associated EACs and settles the difference between the contract price and the market price with the buyer.
Importance of working with advisors for VPPA procurement
While virtual PPAs are a powerful corporate renewable energy procurement solution, they are also complex. An experienced advisor can help you understand what to look for when procuring VPPAs, along with helping you tailor unique solutions like PPA aggregations that best meet your energy and financial needs.
Some examples of how an advisor can help you with VPPAs include:
- Assessing feasibility across geographies and markets
- Modeling financial and emissions impact
- Structuring contracts aligned with your financial and environmental goals
- Navigating regulatory, legal, and accounting nuances
Want to learn more about how a virtual power purchase agreement can help your organization? Contact us today.
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FAQs about VPPAs
Want some quick answers to frequently asked questions about virtual power purchase agreements?
A VPPA contract is typically 10-20 years, but it can vary based on the preferences of the developer and offtaker.
The strike price is the guaranteed price that the VPPA parties agree the seller will receive for its electricity. For example, if the strike price is $40/MWh, but the seller can only get $30/MWh when selling into the market, then the buyer agrees to pay the difference between the strike price and market price — $10/MWh in this case.
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