Power Purchase Agreements – An important component of Europe’s Green Deal ambitions

Malta, April 2021 – In Europe the market for power purchase agreements (PPA) between renewable energy generators and large corporations has been growing steadily ever since 2015, surpassing a total energy capacity of 11 GW by late 2020 with about 73% of this coming from wind energy[1]. The expansion of the market is driven by opportunities from both the demand and the supply side.

Corporate clients are motivated by economical as well as reputational and sustainability considerations. They are keen to fix their energy needs at a stable and predictable price, hedge against market fluctuations and reduce or even neutralise their carbon footprint. On the supply side, the shift from a policy to a market driven expansion enables the developers of renewable energy to present to their lenders long-term revenue streams which are no longer reliant on feed-in tariffs or competitive auction processes.

Figure 1: Annual PPAs by country

By the end of 2020, 145 PPAs have been signed in 13 European markets. Recent large-scale PPAs demonstrate the commercial viability of a wind energy market solely based on market dynamics. According to the World Business Council for Sustainable Development (WBCSD), about half of the Fortune 500 companies have renewable energy procurement, energy efficiency or emissions reduction targets[2].

Figure 2: European corporate offsite PPA volumes, by technology[3]

In particular the large ICTs such as Google, Amazon, Apple, or Microsoft pioneered the PPA market, eager to power their energy-intensive data centres with renewable energy. In 2019 Amazon pledged to source 100% renewable energy by 2030, while Google announced its largest corporate renewable purchase in history, including nearly 800 MW of new renewable energy in Europe. In 2020 Microsoft followed suit with the announcement to exclusively power its European data center to be based in Sweden with renewable energy and to shift to a 100% renewable energy supply for all of its buildings and datacenters by 2025. However, in recent years other industries have entered into PPAs, for example, Mercedes-Benz signing six projects in Germany or aluminium manufacturer Norsk Hydro pioneering transactions in the Nordics.

While the US market is more mature, still representing about four fifths of the global renewable energy PPAs in 2019, the European market is quickly catching up. First transactions were inked in 2013 in Scandinavia. The Nordics remain Europe’s main market for corporate power purchase agreements (CPPA) due to plentiful wind resources and low power prices, a predictable and conducive regulatory environment, and the ability to transact power cross-border within the Nordpool power market of Sweden and Norway. The other European markets followed thereafter with the Netherlands, the UK, and Ireland ahead of the curve while Denmark, Germany, Spain and Poland joined as of 2018.

Figure 3: Wind energy CPPAs are booming[4]

The outlook provided is promising: According to a study by Re-Source among 1’200 corporate buyers of renewable energy from March 2020, 92% of interviewees are interested in PPAs to lower their energy cost.[5] Although buyers mention the reduction of their carbon footprint as an initial motivation, the ability to generate savings and to hedge the cost of their energy bill was cited as the main driver. In addition, CPPAs have the advantage to be negotiated between the generator and the offtaker with no need to participate in a government tender. Rather than engaging in an auction with an uncertain outcome, a PPA contract can be negotiated bilaterally on a schedule that suits all parties.

While the cost for renewable energy has steadily declined, and the overall demand for power has been rising, developers of renewable energy are keen to enter into long-term offtake contracts with rated buyers. They provide secure future income and enable equity or debt financing of a project as they assure lenders that their loans will be repaid. While the feed-in tariff-based fiscal incentives are phased out, PPAs improve the bankability of a project and replace the stable income that previously government support schemes guaranteed. As a result, wind power projects are an attractive alternative investment for institutional investors such as pension funds, provided they include a PPA with a large electricity consumer that guarantees stable cash flow at low risk. In fact, as the law firm Fieldfisher concluded in a survey conducted in late 2019, “CPPAs are becoming a ‘must have’ for some bank financing deals of renewables developments – a trend that is likely to strengthen as subsidy regimes are phased out. Corporate offtakes enable more projects to be built by providing financing, so increasing demand for clean energy is expected to foster more CPPAs.”[6]

In addition to these economic advantages, the European Union further liberalises its energy markets to increase its use of renewable energy to 32% by 2030 and to meet the ambitious targets of its Green Deal and of its member states in becoming carbon neutral by 2050. As a result, in December 2018 the Commission adopted the Renewable Energy Directive (RED II) which will further facilitate the uptake of PPAs across the EU.

Direct versus virtual PPA structures

Generally, corporate PPAs can be distinguished into two forms: a) the direct or physical PPAs (DPPA), which are often referred to as sleeved or corporate PPAs and b) the virtual or financial PPAs (VPPA), which also encompass synthesised or merchant PPAs. The former are mostly found in Europe, where offtakers have been eager to prove that the energy they are buying is renewable. The latter are more common in the US, where power can be sold virtually across markets and is thus less confined to a physical proximity between producer and consumer.

DPPAs are struck between the buyer and the renewable energy generator and oblige the generator to sell the electricity generated of a given facility directly to the end user ‘sleeved’ either through transmission lines or the national grid.

VPPAs by contrast are financial contracts, which require no physical exchange of energy. Instead, the generator ‘virtually’ sells the power to the corporate at a strike price. Both parties will trade the defined quantities of electricity on the spot markets. If the spot market price differs from the reference or strike price, either party will compensate the other.[7]

Figure 4: Two fundamental models of PPAs

Timely completion is an essential prerequisite of wind energy PPAs

PPAs bring along risks that were traditionally assumed by utilities in Europe because of their deep understanding of the long-term risks in energy markets and their ability to diversify these risks across their large portfolios. As corporates are increasingly interested in signing long-term PPAs, they may take on risks such as developmental, construction or execution risks, operational, market or pricing risks as well as contractual, legal and regulatory risks.

To MX Underwriting the risks which apply to the completion of a renewable power plant are the major concern. Typically, developmental risks are among the most significant ones and include those that a plant is not consented, permitted or constructed on a timely basis, as agreed by the developer and the corporate. However, a timely delivery – or even worse – the risk that a project is cancelled, for instance, due to a challenge to a permit – is of fundamental importance to the buyer as usually the contracted power will be an essential precondition for other operations of the end user. Thus, PPAs often include closely defined start dates that bind the supplier to deliver the power from an agreed date onwards and the supplier will be liable that this date is met.

In Europe permit challenges are one of the most frequent causes for the delay of a wind energy project. According to MX Underwriting up to 50% of permits for wind energy projects in Europe are challenged, which can result into a delay of up to three years until a judicial review has passed through all possible legal instances. In the worst case, a permit is revoked or cancelled – frequently because the developer cannot complete the project in time or under the conditions defined in the permit.

Permit challenge insurance can reduce the uncertainty posed by permit challenges, enabling projects to progress in parallel with the management of all-to-frequent challenges. Furthermore, the cover enhances a project’s bankability for investors and lenders, underpinning a developer’s ability to service debt in the event of unforeseen interruption to construction or operations.

Malta, April 2021 – In Europe the market for power purchase agreements (PPA) between renewable energy generators and large corporations has been growing steadily ever since 2015, surpassing a total energy capacity of 11 GW by late 2020 with about 73% of this coming from wind energy[1]. The expansion of the market is driven by opportunities from both the demand and the supply side.

Corporate clients are motivated by economical as well as reputational and sustainability considerations. They are keen to fix their energy needs at a stable and predictable price, hedge against market fluctuations and reduce or even neutralise their carbon footprint. On the supply side, the shift from a policy to a market driven expansion enables the developers of renewable energy to present to their lenders long-term revenue streams which are no longer reliant on feed-in tariffs or competitive auction processes.

Figure 1: Annual PPAs by country

By the end of 2020, 145 PPAs have been signed in 13 European markets. Recent large-scale PPAs demonstrate the commercial viability of a wind energy market solely based on market dynamics. According to the World Business Council for Sustainable Development (WBCSD), about half of the Fortune 500 companies have renewable energy procurement, energy efficiency or emissions reduction targets[2].

Figure 2: European corporate offsite PPA volumes, by technology[3]

In particular the large ICTs such as Google, Amazon, Apple, or Microsoft pioneered the PPA market, eager to power their energy-intensive data centres with renewable energy. In 2019 Amazon pledged to source 100% renewable energy by 2030, while Google announced its largest corporate renewable purchase in history, including nearly 800 MW of new renewable energy in Europe. In 2020 Microsoft followed suit with the announcement to exclusively power its European data center to be based in Sweden with renewable energy and to shift to a 100% renewable energy supply for all of its buildings and datacenters by 2025. However, in recent years other industries have entered into PPAs, for example, Mercedes-Benz signing six projects in Germany or aluminium manufacturer Norsk Hydro pioneering transactions in the Nordics.

While the US market is more mature, still representing about four fifths of the global renewable energy PPAs in 2019, the European market is quickly catching up. First transactions were inked in 2013 in Scandinavia. The Nordics remain Europe’s main market for corporate power purchase agreements (CPPA) due to plentiful wind resources and low power prices, a predictable and conducive regulatory environment, and the ability to transact power cross-border within the Nordpool power market of Sweden and Norway. The other European markets followed thereafter with the Netherlands, the UK, and Ireland ahead of the curve while Denmark, Germany, Spain and Poland joined as of 2018.

Figure 3: Wind energy CPPAs are booming[4]

The outlook provided is promising: According to a study by Re-Source among 1’200 corporate buyers of renewable energy from March 2020, 92% of interviewees are interested in PPAs to lower their energy cost.[5] Although buyers mention the reduction of their carbon footprint as an initial motivation, the ability to generate savings and to hedge the cost of their energy bill was cited as the main driver. In addition, CPPAs have the advantage to be negotiated between the generator and the offtaker with no need to participate in a government tender. Rather than engaging in an auction with an uncertain outcome, a PPA contract can be negotiated bilaterally on a schedule that suits all parties.

While the cost for renewable energy has steadily declined, and the overall demand for power has been rising, developers of renewable energy are keen to enter into long-term offtake contracts with rated buyers. They provide secure future income and enable equity or debt financing of a project as they assure lenders that their loans will be repaid. While the feed-in tariff-based fiscal incentives are phased out, PPAs improve the bankability of a project and replace the stable income that previously government support schemes guaranteed. As a result, wind power projects are an attractive alternative investment for institutional investors such as pension funds, provided they include a PPA with a large electricity consumer that guarantees stable cash flow at low risk. In fact, as the law firm Fieldfisher concluded in a survey conducted in late 2019, “CPPAs are becoming a ‘must have’ for some bank financing deals of renewables developments – a trend that is likely to strengthen as subsidy regimes are phased out. Corporate offtakes enable more projects to be built by providing financing, so increasing demand for clean energy is expected to foster more CPPAs.”[6]

In addition to these economic advantages, the European Union further liberalises its energy markets to increase its use of renewable energy to 32% by 2030 and to meet the ambitious targets of its Green Deal and of its member states in becoming carbon neutral by 2050. As a result, in December 2018 the Commission adopted the Renewable Energy Directive (RED II) which will further facilitate the uptake of PPAs across the EU.

Direct versus virtual PPA structures

Generally, corporate PPAs can be distinguished into two forms: a) the direct or physical PPAs (DPPA), which are often referred to as sleeved or corporate PPAs and b) the virtual or financial PPAs (VPPA), which also encompass synthesised or merchant PPAs. The former are mostly found in Europe, where offtakers have been eager to prove that the energy they are buying is renewable. The latter are more common in the US, where power can be sold virtually across markets and is thus less confined to a physical proximity between producer and consumer.

DPPAs are struck between the buyer and the renewable energy generator and oblige the generator to sell the electricity generated of a given facility directly to the end user ‘sleeved’ either through transmission lines or the national grid.

VPPAs by contrast are financial contracts, which require no physical exchange of energy. Instead, the generator ‘virtually’ sells the power to the corporate at a strike price. Both parties will trade the defined quantities of electricity on the spot markets. If the spot market price differs from the reference or strike price, either party will compensate the other.[7]

Figure 4: Two fundamental models of PPAs

Timely completion is an essential prerequisite of wind energy PPAs

PPAs bring along risks that were traditionally assumed by utilities in Europe because of their deep understanding of the long-term risks in energy markets and their ability to diversify these risks across their large portfolios. As corporates are increasingly interested in signing long-term PPAs, they may take on risks such as developmental, construction or execution risks, operational, market or pricing risks as well as contractual, legal and regulatory risks.

To MX Underwriting the risks which apply to the completion of a renewable power plant are the major concern. Typically, developmental risks are among the most significant ones and include those that a plant is not consented, permitted or constructed on a timely basis, as agreed by the developer and the corporate. However, a timely delivery – or even worse – the risk that a project is cancelled, for instance, due to a challenge to a permit – is of fundamental importance to the buyer as usually the contracted power will be an essential precondition for other operations of the end user. Thus, PPAs often include closely defined start dates that bind the supplier to deliver the power from an agreed date onwards and the supplier will be liable that this date is met.

In Europe permit challenges are one of the most frequent causes for the delay of a wind energy project. According to MX Underwriting up to 50% of permits for wind energy projects in Europe are challenged, which can result into a delay of up to three years until a judicial review has passed through all possible legal instances. In the worst case, a permit is revoked or cancelled – frequently because the developer cannot complete the project in time or under the conditions defined in the permit.

Permit challenge insurance can reduce the uncertainty posed by permit challenges, enabling projects to progress in parallel with the management of all-to-frequent challenges. Furthermore, the cover enhances a project’s bankability for investors and lenders, underpinning a developer’s ability to service debt in the event of unforeseen interruption to construction or operations.