Renewable Energy Buying Trends: Virtual Power Purchase Agreements

Across the country and across all sectors of the economy, more and more organizations are joining the renewable energy movement. As we discussed in last month’s Customer Insights, there are many avenues to accessing renewable energy. In this edition we explore virtual power purchase agreements (vPPAs), which are scalable structures that unlock many possibilities for customers interested in green energy.

How does a PPA differ from a vPPA?
First let’s briefly talk about a basic power purchase agreement (PPA). Conventional PPAs are well-established commercial structures commonly used across the electricity industry.
There are three main parties involved in a PPA:

• The developer: The developer is responsible for building the power plant.
• The owner: The owner will own and maintain the power plant once it’s in service.
• The customer: The customer, often referred to as an offtaker, will pay for the power. The customer can be a single corporation or organization, utility, municipal power authority or co-operative.

A vPPA looks a lot like conventional PPA at first glance, but there is a key difference – a vPPA is entirely a financial transaction. Unlike a PPA, where the customer takes title to the physical power produced by the renewable energy asset, the customer does not take title to the power generated under a vPPA. The power generated under a vPPA is simply sold into its local
Regional Transmission Organization (RTO) market.

vPPAs are often called “fixed-for-floating” swap transactions, meaning the customer pays the owner a fixed rate ($/kWh) for all the power generated and in turn the owner remits the value of the power sold to the customer. The market value of these payments is specified in the deal between the customer and owner and is typically a variable Locational Marginal Price (LMP) at a highly visible trading hub within the RTO.

Since vPPAs are not necessarily bound by proximity to the location of the customer, these projects have been sited and developed where the wind blows, land is cheap and interconnections to the transmission grid are available. To date, most vPPA activity has been in the Electric Reliability Council of Texas (ERCOT) and the Southwest Power Pool (SPP) in the Great Plains. Over the last decade vPPAs have mostly been wind farms. However, recently as solar prices have continued to drop, solar activity in this arena has increased. Many in the industry forecast that solar will become the dominant generation technology for vPPAs in the 2020s.

With either wind or solar renewable generation technology, it is important that the renewable energy asset be located in an RTO with a visible spot market for electricity where the generation can be sold. The map below outlines the various RTOs and Independent System Operators (ISOs) across the United States.

Factors to be aware of when considering a vPPA
The concentration of vPPA developments in north and west Texas and the central Plains have produced very low prices, as low as the $15 to $25/MWh range, but have also created some potential pitfalls for customers. When considering a renewable energy project under a vPPA, here are a few important dynamics to be aware of:

First, consider the viability of the project and whether it truly meets your sustainability goals. It’s easy to become fixated on the lowest sticker price and overlook important components of the agreement. Customers can be set back years by signing strictly on a low price from a developer who is unable to deliver in the end. Large-scale renewable energy development is complicated. Projects like this encompass a multi-year process with regulatory, permitting, engineering, construction and financial risks before completion. It is essential you seek an experienced developer and take time for proper due diligence prior to signing.

Second, although a vPPA may seem obvious on the surface to meeting your organization’s sustainability goals, it’s important to examine the agreement closely. The industry buzzword today is “additionality” which has been used to describe new renewable energy that has been added to the grid. A vPPA will meet this criterion if a project is built because the customer signs an agreement. However, an increasingly common set of criteria involves regionality and carbon displacement. For example, a customer in Illinois may not meet their sustainability goals with a Texas-based renewable energy asset vPPA. This is because the project has no impact on the mix of electricity generated on the grid that serves the customer in Illinois. Secondly, they have not reduced the carbon intensity of their physical energy supply.

Finally, customers who elect vPPAs because of the low price may not fully appreciate the work that remains on their own energy supply. vPPA contracts typically stipulate that the customer is buying the entire project’s Renewable Energy Certificates (RECs) output for the duration of the term. Since the renewable energy asset may not match your facility’s usage down to the exact megawatt-hour (MWh), you will need a plan to manage this REC position as it comes in over or under relative to your load. Additionally, when it comes to energy procurement for customers in deregulated states, a vPPA only takes care of RECs. Other than RECs, the complex work of entering into a vPPA has no impact on the complex work of traditional energy procurement.

What to know about a financial transaction?
It is important to emphasize the fact that vPPAs are financial transactions. The “fixed-for-floating” swap transaction nature of the deal means that vPPA customers have taken a long-term position in power markets. There is potential for a gain or loss on the position, depending on how spot markets trend over the coming decade. There are also important accounting implications that any organization considering a vPPA needs to understand. While many larger companies are very comfortable with this sort of transaction and incorporate financial hedges into their electricity commodity procurement strategies, other organizations may desire a more secure transaction when considering renewable energy strategies.

What does the future hold?
As we look to the upcoming decade, we expect the momentum behind vPPA development to continue. Early on, there are a few important dynamics we are keeping a close eye on. Here’s what you should be aware of.

• The Production Tax Credit (PTC) for wind and the Investment Tax Credit (ITC) for solar, are set to begin stepping down in 2021. These credits have a significant impact on the overall price. Our experts forecast that the expiration of the credits may result in at least a 20% increase in project costs in the near term. There is wide speculation that the incoming Biden Administration would seek to extend these tax credits, which would benefit development.

• Other factors being monitored include grid infrastructure development, energy storage trends, carbon pricing and other policy measures and consumer sentiment around the impact of various renewable energy commercial structures. Storage and transmission investment, coupled with
decreases in generation technology costs, could alter the vPPA landscape, making more markets competitive.

• On the policy and sentiment side, there is a chance that vPPAs could become outdated if the industry moves on from the REC and offset construct toward more direct physical renewable energy structures. Either way, the core of the vPPA structure will likely prove flexible and may adapt to meet changing needs.

Interested in learning more?
If you are interested in learning more about the renewable energy landscape or how your organization might take advantage of low renewable energy costs, click HERE. If you are already working with an AEP Energy Sales Representative, they will happily provide more information.

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