Assuming two identical PPAs, the final criteria to decide upon is the credit quality of the off-taking counterparty. In many transactions, parties need to come up with a structure and specific sizing of additional guarantees to secure future cash flows both from settlement and replacement risks.
We will discuss here how to assess the optimal guarantee size from the viewpoint of the equity owner and only taking into account the energy risk exposure.
Such calculation should take into account the following features and assumptions:
- Forward Price curve at the signing of PPA
- Risk premium paid to off-taker, defined as the discount of the net PPA price to the market price on baseload basis
- Outstanding Volume to be delivered by the producer to the off-taker
- Typical price volatility observed in the market
- A continuous increase in price volatility over time (“the risk of lower/higher prices occurring increases over time)
Plotting the inputs, in many cases will result in a shape of the energy risk exposure as outlined below. Assuming no credit value in the balance sheet of the off-taker, that would then be one to one the required minimal guarantee levels for the replacement risk.
The exposure is first increasing due to the increase in price volatility while then gradually decreasing over time with the contractually agreed deliveries of volumes.
To complete all credit risks, a fixed sum shall be added to cover settlement risks which determination is relatively straightforward if the energy yield of the project and payment conditions are known.