You know you want a Corporate PPA and all the perks that come with it. You issue a tender and receive plenty of bids. Do you know how to read the numbers? We created a guide to explain the main drivers behind Corporate PPA pricing in simple terms.
What is a Corporate PPA?
A Corporate PPA is a bi-laterally negotiated contract between an energy seller and a corporate entity looking to buy energy for own consumption. It’s a tailor made arrangement defining the duration, the volume, the price and the risk allocation between the two parties. The tenor of a PPA is usually long-term (≥10 years), but there are also shorter arrangements which are getting more popular.
Corporates can buy either straight from the asset owner (developer) or through a utility/trader which needs to manage its position. Both options can serve the purpose of a corporate PPA. Some corporates want to have close contact with the asset they are buying from, so for additionality reasons they would prefer to sign a contract with the asset owner. It’s worth noting that often utilities own generation assets as well.
What determines Corporate PPA pricing?
PPAs take a long time to negotiate, although deal-making becomes quicker as the market matures. One of the most strategically important elements to agree upon is the price. The PPA price is not an independent, standalone element of the negotiation but a result of multiple negotiation points.
Pricing a PPA is dependent on some elements:
LCOE of the project – When project owners start establishing the negotiation range of the price they are willing to sell their hard-generated MWh, the very floor they will set is their Levelised Cost of Energy (LCOE) to cover their basic costs and calculate the desired profit accordingly.
LCOE is not just the project owner’s consideration. Many buyers who wish to enable new projects to get financed, built and come online (additionality) want to make sure that the PPA price they are offering achieves this goal. LCOE costs coming down over the years is a primary driver of more buyers having the ability to agree on competitive prices.
In the past, LCOE costs were significantly higher and green energy would come with a premium. Even though renewables achieved a steep decline in their costs, LCOE levels change depending on a number of factors.
- Supply chain ease, especially when materials need to be imported from abroad
- Costs of materials, which are dependant on the price of multiple commodities such as metals
- Development costs based on elements such the amount of bureaucracy or the price of land, or the valuation of ready-to-build projects often acquired by players not taking development risk
- Grid connection costs
Even though corporates signing a PPA with utilities sometimes don’t have a link to a specific project (except if the utility owns the project), LCOE is already incorporated in the utility’s price for the energy from the renewable project.
Corporates starting a negotiation for a PPA backing a new project need to ask as much as possible about how LCOE costs are evolving. Costs often change, resulting in requests from the seller to re-negotiate the initially offered PPA price.
Market-based fair value of the energy – Electricity is a particularly volatile commodity. Prices change based on market circumstances, and electricity’s fair value changes at each point in time. For example, today’s market value of electricity can be seen on the spot markets.
But PPAs are long-term contracts, so the parties need to review how much buyers pay today for electricity delivered in the future. One of the main tools to assess the long-term market value of electricity is futures and forward markets; the main elements of what is commonly referred to as the forward curve.
Daily evolution of PEXA Euro Composite, December 2018- October 2022
The forward curve is a core element of Pexapark’s benchmark PPA prices model, which is back-tested with market evidence of transacted deals pricing. Our signature PEXA Euro Composite illustrates the average PPA prices across all European markets, for all technologies, for a 10-year Pay-as-Produced (PAP) PPA starting one year ahead. Although the Index does not represent benchmark prices, it does illustrate a trend.
As pricing information for futures transactions is obtained daily from exchanges, benchmark PPA prices indicating the fair value of each PPA product are updated accordingly.
Electricity is the most volatile commodity. Day-to-day percentage price changes have reached up to 230%. However, not all periods are the same – and this is where market circumstances come into play. Realised volatility is significantly higher in a turmoil period than in a relatively stable period.
Electricity, and therefore energy, is a global game. Innumerous actors are impacting pricing on a daily basis. Therefore, the timing of when buyers and sellers sign the agreed PPA price is important.
Risk allocation and discounts – A PPA is a game of risk allocation. Every risk has a price, and depending on who’s assuming it, the PPA price evolves accordingly.
For example, the fair market value of a PPA changes depending on the volume structure.
In a Pay-as-Produced (PAP) PPA, the buyer will offtake any MWh produced at any time of the day. This means that profile risk sits with the buyer. The corporate will need to buy energy from the market during the hours that the plant is not producing.
In an Annual Baseload PPA (BLA), the producer has to deliver a determined amount of energy every hour of the year. This means that profile is mostly with the seller. Because if the plant is not producing the required amount of energy, they will have to buy from the spot markets to honour the agreement with the buyer.
Finland onshore wind 10-year PPA, PAP and BLA pricing comparison
Source: PexaQuote Note: Values hidden to protect customer value
Baseload PPAs come with a price premium because of the seller’s additional risks. Similarly, PAP is a cheaper option for the buyer, because of the profile discount applied on the buy side.
Profile risk is only one of the major risk components, and based on readily available tools such as PexaQuote can be calculated in seconds. There are major risk components such as price risk, volume risk and capture risk that also need to be reflected in the price – and this is where the negotiation game begins. The secret sauce is the ability to fairly quantify the ‘cost’ of each risk.
For example, when a corporate launches a tender and receives bids from various sellers, these will typically look fairly different. That’s because they carry different risks, and are also priced based on the seller’s appetite. A corporate needs to be in a position to learn to read the numbers between the lines.
Tenor of the PPA – To a certain extent, the length of a PPA reflects the price risk. How much does a corporate ‘charge’ the uncertainty of agreeing on a long-term fixed price? Typically, the longer the tenor, the lower the price because of the price risk discounts applied.
The tenor of a PPA is an increasing concern amid market turmoil periods, where uncertainty is high. For example, a high-pricing environment in the spot markets also results in increases in the forward curve, ‘transferring’ the potentially temporary high prices to the long term. In such occasions, some corporates may pay a higher price for a shorter-term PPA, in exchange of the limited price risk appetite they demonstrate.
German PAP solar PPA, 10-year and 5-year tenor comparison
Source: PexaQuote Note: Values hidden to protect customer value
Are corporate PPAs fixed-price?
Most corporate PPAs are fixed-price, but this doesn’t mean there are not diverse configurations. Ideally, buyers and sellers want cash flow certainty, so fixed-price serves both parties. In fixed pricing, both parties take pricing risk. The seller agrees on a price no matter whether prices could increase in the future, and the buyer takes the risk of prices decreasing over the tenor of the PPA.
Other pricing structures include configurations that have a bigger linkage to the movement of prices. It could be a floating price arrangement, where the PPA price mirrors movements in the spot markets; a floor price where the seller sets a minimum price no matter how much prices fall; or a collar price with both a floor and a ceiling.
Is there a difference when pricing a virtual PPA and a physical PPA?
No, there shouldn’t be. The only time that attention needs to be paid on the price is when the point of consumption is different to the point of production. This can happen when a country has different pricing zones or cross-border PPAs. You can find out more about the topic in our dedicated guide on cross-border PPAs.
You can discuss more on corporate PPAs with our in-house experts Alex Fels, Senior PPA Origination Manager, and Jorge Seabra, PPA Originator! Feel free to reach out to firstname.lastname@example.org for a coffee!