Drastic changes to energy markets from COVID-19 have highlighted the market risks for corporate buyers considering virtual power purchase agreements (VPPAs). A combination of decreased electricity demand and all-time low natural gas prices has led to a noteworthy decline in wholesale electricity prices in some markets, which is bad news for VPPA offtakers. Corporate buyers that are not hedged against these price swings are seeing dismal contract financial performance so far in 2020, but there is reason for optimism.
Assessing 1H 2020 damage
In some markets, wholesale power prices have dropped by over 20% since February 2020 compared to the two year average. ERCOT has fared better than others, such as PJM. In spite of the rough start this year, prices in May and June rebounded slightly as businesses reopen and summer demand increases, but this good news may be short-lived if there is a resurgence in COVID-19 infection rates. The charts below illustrate how 2020 has compared to with 2016-2019 in ERCOT and PJM.
Let’s look at the impact of the first half of 2020 on existing projects. 3Degrees examined the year-to-date performance of active projects in popular VPPA areas such as ERCOT North and PJM Dominion. A key (and expected) observation was a steep reduction in realized electricity prices, which has no doubt been painful for corporate buyers expecting greater revenue. When compared to 3Degrees’ pessimistic forecasts, we found that the realized prices fell between our “downside” and “black swan” scenarios. 3Degrees’ consulting practice helps clients and their finance teams manage VPPA expectations with a conservative, data-driven approach to electricity price forecasting, which has proven highly valuable in the COVID-19 era.
3Degrees takes a conservative, data-driven approach to VPPA financial analysis using market-based forecasts and custom scenarios. Our ‘Black Swan’ scenario has so far proven to be a reasonable worst case estimate for corporate buyers weathering extreme events, such as COVID-19.
Expectations for future corporate PPA performance
Despite the underperformance of active projects this year, new-build projects in some markets are still projected to see cost-neutral to positive contract values over the long-term. Even if the COVID-19 rebound is drawn out until 2023, our adjusted downside scenario, which accounts for two years of “black swan” impact, estimates a drop in contract values of only $1-2 per MWh compared to pre-COVID estimates. The chart below shows our projections under several forecasts with differing views on the duration of depressed market prices.
Seeking potential opportunities amid uncertainty
Lengthy renewable energy procurement and project development timelines limit opportunities for buyers who want to act quickly. The current market turbulence has created unique prospects for those that are nimble and opportunistic. First, buyers may benefit from lower PPA prices in the near term. For some sellers, low interest rates are reducing financing costs thereby enabling lower PPA prices, while others may be forced to reduce margins in response to reduced corporate PPA demand and fierce competition amongst developers. Another opportunity for buyers may be shortened transaction timelines. Nervous buyers may cancel or pause procurements and leave competitive, well-vetted projects on the table, providing a potential opening for nimble buyers to seize great projects that are “back on the market.”
Given the long-term nature of VPPA transactions, it is likely that at least one market shock will occur during a contract term. Discussions around risk can help buyers anticipate and plan for worst-case scenarios. As the energy market impact of COVID-19 is likely limited to the near-term, corporate buyers who are just now considering or beginning their procurement are well positioned to benefit from the market rebound and better understand the downside risks.
Corporate buyers who are just now considering or beginning a VPPA procurement are well positioned to benefit from the market rebound and better understand the downside risks. Contact our consulting team to explore current corporate PPA opportunities.