Author: Tyler Espinoza

Tyler Espinoza is a Director in the Energy & Climate Practice at 3Degrees and has been working in the renewable energy industry for over 10 years.

Four key accounting questions when considering a renewable energy PPA in Europe

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As we have previously discussed, the European PPA market for corporate buyers is witnessing a dramatic uptick in activity in 2020, and is poised for continued growth in the coming years.  U.S.-headquartered technology firms have been some of the first movers, but a variety of other buyers from different sectors and countries (spanning both the U.S. and Europe) are now beginning to transact. For any organization contemplating a PPA in Europe, there are some key accounting considerations to think through at the outset to help alignment across all of your stakeholders, including your finance and accounting teams.

Here are four key questions that corporate buyers need to ask themselves if they are evaluating a PPA in Europe. 

  1. Which accounting standard does your company report under: U.S. Generally Accepted Accounting Principles (GAAP) or IFRS (International Financial Reporting Standards)?

    By nature, financially settled “virtual” PPAs (VPPA) are financial instruments structured as Contracts-for-Differences (CFD) where a fixed price PPA is settled against a floating wholesale index price. The accounting standards differ slightly under U.S. GAAP versus IFRS. Derivative treatment and mark-to-market accounting are inevitable under IFRS, whereas U.S. GAAP rules are generally less strict.  This factor could influence an organization’s comfort and willingness to sign a VPPA in Europe, as PPAs with physical delivery do not require this treatment.  It is worth noting there are ongoing efforts between the governing bodies, IASB and FASB, to reconcile the differences between IFRS and U.S. GAAP respectively, so this will be an important area to monitor.

  2.  If your company is U.S.-based, do IFRS standards apply for a European VPPA?

    Not necessarily.  If your organization’s shares are listed only on a U.S. exchange, it is more than likely that your consolidated annual financial statements (i.e. SEC Form 10-K) are issued only under U.S. GAAP.  In situations where a company has dual listings on U.S. and European exchanges to raise capital in both markets, you may find yourself with added complexity to sort out when signing a VPPA in Europe, because your European business entity will be required to issue IFRS-compliant financial statements under European Union rules.  IFRS reporting may also apply for certain foreign subsidiaries owned by a U.S. company operating in a foreign country where IFRS use is mandatory.  

  3.  How will you value a VPPA over its term?

    In IFRS mark-to-market accounting, you need to periodically analyze and revalue the derivative on your books to reflect its economic substance and meet the disclosure objectives under applicable standards. It’s important to consider how your company will go about tackling this exercise. Finance professionals are often accustomed to mark-to-market accounting of various types of hedges (commodities, energy, interest rates, etc.), but the long-term lengths of VPPAs and the volatility of wholesale electricity markets may introduce new complexities. Supporting long-term PPAs is typically not a core function within organizations, so a strategy to support ongoing monitoring and forecasting may be required to satisfy periodic revaluation of the contract on the books.

  4.  Is your organization already comfortable with hedge accounting under IFRS?

    Many companies’ risk management practices already incorporate hedging activities. If this is the case for your organization, derivative or hedge accounting may be a routine activity for your finance and accounting teams. In this case, your challenge may simply be setting up the process to perform the periodic valuation of the VPPA.  

    Conversely, if your organization is new to hedges, it will have a steeper learning curve to overcome and you should plan accordingly in your procurement process. It can be helpful to work with an advisor who can perform post-execution monitoring services and understands typical needs when establishing these processes, ensuring end-to-end success in renewable energy procurements.

It’s exciting to witness the growth of PPAs in Europe, which can be a strategic option for companies looking to address their Scope 2 emissions in the region. However, this opportunity does not come without complexities and organizations that address these key accounting questions upfront will have a smoother experience executing these transactions. If your company needs assistance navigating these issues, please feel free to connect with us. We’d be happy to help.

Disclaimer: While 3Degrees is trusted commercial advisor for global renewable energy transactions, we are not a chartered accounting firm.  We recommend that our clients engage their technical accounting staff and an external accountancy and auditing firm to achieve clear, actionable guidance.

Observations from Orlando: Themes from the 2019 REBA Spring Member Summit

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Earlier this month, I had the pleasure of traveling with other team members to the land of Disney — Orlando, Florida — for the annual Renewable Energy Buyers Alliance (REBA) Spring Member Summit. For those not familiar with REBA, it’s an alliance of large clean energy buyers, developers, and service providers who are working together to lead a rapid transition to a zero-carbon energy future. As a member of REBA’s Leadership Circle, 3Degrees is very active in the organization and its bi-annual member summits are always highlights of our year — and the 2019 Spring Summit was true to form.

With hundreds of members in attendance, the gathering in Orlando was chock-full of engaging conversations about the continued evolution of our industry and our collective efforts to make progress in the fight against climate change. As I listened to the sessions and the participants’ dialogue that week, I observed three distinct themes.

 

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New buyers are entering the market and many are interested in aggregation

2018 was the biggest year yet for corporate renewable energy deals with more than 6,000 MW signed. This growth is driven, in part, by energy buyers from new industries entering the market. While early adopter technology companies continue to play a sizeable role in renewable energy procurement, companies from sectors such as consumer goods and food & beverage are also participating, which I find to be an encouraging trend.

Over the course of the summit, a term that I heard frequently from both experienced and new buyers was renewable energy aggregation. While just a few years ago aggregation was relatively new on the scene, it is now a much more well-known concept. Multiple sessions were dedicated to the topic, including one led by 3Degrees VP, Energy and Climate Practice, Erin Craig, who guided a discussion on whether an aggregated energy procurement process could help educate and engage a company’s internal stakeholders and, ultimately, help them feel more comfortable about executing a long-term transaction.

From leveraging the purchasing power of multiple buyers, to shared resources and opportunities to learn together and, yes, helping to validate the decision with internal stakeholders and achieve buy-in, aggregation has multiple advantages for companies of all sizes. Buyers also noted the benefits gained from the cross-sharing of best practices (namely, time savings). However, while a great option for many buyers, aggregation is not the right fit for everyone. And several participants noted that there are still plenty of opportunities to streamline the process and make it more efficient for the buying group.

*If you’re interested in learning more about how to convene a group of buyers for an aggregation, check out 3Degrees’ recent blog and video on this very topic.

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Product innovation is expanding options and opening doors

The next theme that I observed was around product innovation, a topic that was discussed at length. While utilities have historically supported renewable energy programs and products to varying degrees, there has been a noticeable expansion of green tariff options from many utilities, such as Georgia Power who has now applied for their second one, and Portland General Electric. Many companies are encouraged by this trend and expect to take advantage of these offerings where they are cost effective. That said, there are still plenty of challenges with green tariffs, which are perceived to be overly complex, fairly costly, and not transparent enough. All of these factors present hurdles for prospective participants, as evidenced by the fact that of the 25 green tariffs currently available, only 15 have been used to date.

In addition to green tariffs, product innovation is also alive and well in competitive retail markets, such as Texas, Illinois, Maryland and other Mid-Atlantic and Northeastern states. In these regions, we see a wide range of opportunities that come packaged as project-specific energy delivery with volume firming agreements. Suppliers execute long-term power purchase agreements (PPA) and pass the energy through to retail customers, which can be done at a fixed term and rate, or a split-term with a combination of fixed and indexed rates. Additionally, buyers often have the option to keep the project RECs or execute a REC swap for a lower price.  It’s exciting to see this influx of creative thinking around the end goal of expanding renewable options for corporate buyers.

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Market risk exposure is still at the forefront of buyers’ minds

Risk mitigation was another topic that seemed to be on a lot of people’s minds at the summit. Risk is always top of mind with PPAs, but now that early PPAs are beginning to come online and their performance is being monitored, early adopters are re-evaluating their risk mitigation strategies. These buyers are exploring additional risk mitigation mechanisms, such as financial products, collar pricing, and hedging strategies. For example, companies that are concerned about market prices staying low over the next 10+ years can work with financial institutions to trade their potential upside for protection against downside risk.

During the several discussion sessions on this topic, it was noted that advisors can be extremely helpful in this area, because many of these risks can be addressed contractually early on in the procurement process. Advisors are adept at helping buyers navigate through appropriate market/project selection, layering risk mitigation measures into PPA contracts, and pursuing the best-fit contract structure.  

 

Though aggregation, product innovation, and risk mitigation may seem like distinct themes, there is actually a common connection: a desire to deliver custom, best-fit products that allow buyers to build portfolios that balance risk and reward, or pay a bit more for a lower risk profile. That said, despite the market risk involved, PPA transactions have never been more popular and remain a great option for many buyers, if executed correctly.  

If I had to connect all of the conversations that took place at the REBA Spring Member Summit into one headline, it would be this: the options for organizations to support renewable energy continue to expand and there is literally something for everyone out there. And this is great news… for buyers, suppliers, and — most of all — the environment.