4 Questions to Ask Before Choosing a Physical or Virtual Power Purchase Agreement

Energy Procurement · PPA Risk Management

4 Questions to Ask Before Choosing a Physical or Virtual Power Purchase Agreement

January 30, 2019

There are many compelling reasons why corporations are flocking toward offsite power purchase agreements (PPAs) as a way to achieve their sustainability commitments, contribute to the construction of more renewable energy projects, and manage unpredictable energy budgets. Unlike distributed/on-site power generation (e.g. rooftop solar panels), offsite PPAs are not limited by availability of suitable rooftop space, grid interconnection opportunities, or other constraints at a corporation’s location.

When a company decides to pursue an offsite power purchase agreement, the two most common options are a physical PPA or a virtual PPA (VPPA). VPPAs can also be referred to as a financial PPA, contract for differences, or fixed-for-floating swap. With either option, the company agrees to pay a fixed price for every megawatt-hour of clean energy that is generated, plus the associated renewable energy certificate (REC) that is created as a result of that power generation.

Although a physical PPA and VPPA may sound similar, in practice they are different. With a physical PPA, – as the name implies – the corporation, or a designated third party, takes title to the physical energy at a specified delivery point on the electric grid. The physical energy can then be transmitted from that specified delivery point to the corporation’s energy account or meter.

With a VPPA, energy from the project flows onto the grid without a specific destination and the corporation does not physically receive the electrons. A VPPA is a financial contract for the underlying value of energy, not the energy itself. Often times in a VPPA, the only commodity exchanging hands between the project and the corporation are the RECs.

Before a company can decide which type of PPA to pursue, it should answer these four questions:

1. Where do we use most of our energy?

With a physical PPA, a corporation chooses to buy a portion of its power needs from a renewable energy project rather than its local utility or retail electric supplier. The project transfers legal title to the energy at a designated delivery point on the electric grid. Then the corporation, often with the help of third-party service providers called power marketers, can physically deliver the energy to another point on the electric grid, such as the corporation’s meter. This arrangement isn’t possible everywhere.

Physical PPAs are limited to states with “retail electricity choice,” where energy consumers are allowed to buy power competitively on the retail level from an entity other than the local utility (see image below for a map of states that allow retail electricity choice, via EPA.gov).

Retail Electricity Choice Map

In addition, the project must be located within the same wholesale electricity market as the corporation. For example, if a corporation wants the power delivered to a location within the PJM wholesale market that covers the Mid-Atlantic and parts of the Midwest, it would have to contract with a renewable energy project that is interconnected with and delivers to PJM. Below is a map of the seven wholesale markets in the U.S.

Just as in many forms of trade and commerce, the greater the distance the power must travel, the greater the cost. For this reason, with a physical PPA, it is best if a company chooses a project that is located close to where it will consume the clean energy, like a headquarters or data center.

Physical PPAs are ideal for corporations that use most of their energy within a wholesale market that has retail electric choice (for example, a technology company with a large data center in Maryland). If the corporation uses energy at many locations (for example, a national coffee chain with stores in every city), a VPPA may be more practical.

With a VPPA, the corporation can be located anywhere, however it is easiest to facilitate if the project is located in one of the competitive wholesale electricity markets, which are run by Independent System Operators (ISOs). There are seven ISOs in the United States (see map above). These ISOs have sufficient market depth and liquidity at large trading hubs to allow a financial contract like a VPPA to be structured.

Though not necessary, there can be benefits to signing a VPPA with a project in the same ISO market as the corporation’s energy consumption. For one, some corporations want to contract with a project that is electrically connected to the same grid as their consumption. In addition, projects located in the same ISO as the corporation’s consumption will have a stronger correlation between the energy market price at the project location and the energy price the corporation is paying on its utility bills. A stronger correlation between these prices has the potential to create a more effective long-term hedge on the corporation’s overall energy budget. For corporations looking to manage volatility in energy budgets, this correlation is an important consideration.

When choosing between a physical or virtual PPA, location matters. A corporation choosing a physical PPA must be located in both a) the same ISO as the project and b) a state with retail electricity choice. On the other hand, a corporation choosing a VPPA can be located anywhere, though the project must able to deliver its energy to an ISO market. While VPPAs offer more geographic flexibility, corporations must still take care when evaluating their procurement options.

2. Do we want to pay for energy management services?

Because the buyer of a physical PPA takes title to energy, these contracts require additional energy management services, which corporations often outsource to experienced third party providers called power marketers. Power marketers are licensed entities that move power through and around the ISO markets on behalf of buyers and sellers. Depending on where the corporation actually takes title to the energy, the corporation may also be subject to additional wholesale market participation requirements that are well outside the scope of their core business. In this way, physical PPAs may add an undesirable level of complexity (and cost) that a VPPA does not incur.

However, there are new emerging models for physical PPAs that may be appealing to some buyers. Some retail energy providers now offer physically delivered renewable energy products that can be wrapped seamlessly into monthly energy bills. These are called “retail sleeved PPAs.” The retail energy provider manages all aspects of power marketing and other required services, while still delivering the buyer benefits associated with a PPA.

With a VPPA, the company simply pays for electricity from its energy provider(s) and conducts business as usual; no changes are required to the way it receives or manages energy. A VPPA does not impact how an energy consumer buys electricity to power its day-to-day operations. The buyer still sources all electricity needs through the local utility or preferred retail electric supplier, with the VPPA contract existing as a completely separate contract. In many cases, the buyer’s utility or retail electric supplier is not aware of the VPPA.

3. Are we prepared to handle regulatory and accounting issues?

Physical PPAs and VPPAs have different regulatory obligations to which the buyer must adhere.

As mentioned previously, physical PPAs require a licensed power marketer to facilitate the delivery of physical energy from the project to the buyer’s account. If the buyer elects to perform this service without the assistance of a third-party expert, there are significant certifications required (e.g. FERC licensing). Very few non-utility, corporate buyers have pursued a physical PPA without the assistance of a third-party due to these complexities.

VPPAs can trigger different accounting treatment and derivative reporting requirements than physical PPAs. Buyers should be aware of these requirements so they can avoid undesirable regulatory complexities. As a ‘swap’ (i.e. fixed-for-floating swap) agreement, VPPAs trigger reporting, record-keeping, and registration requirements for the buyer and seller under the Dodd-Frank Wall Street Reform and Consumer Protection Act. While these requirements are easily manageable, buyers should seek the proper commercial and legal guidance for how to fully understand them prior to executing a VPPA contract.

In addition, buyers must be attentive to provisions in VPPAs that have the potential to trigger derivative accounting, something corporate accounting teams prefer to avoid. One of the most common derivative accounting triggers is the creation of a minimum, guaranteed, or ‘notional’ amount of production (e.g. a certain number of MWhs per year) from the renewable energy project. Rather than guaranteeing a number of MWhs per year, buyers should ask for a guaranteed percentage of time the project is available, which avoids derivative accounting because it cannot be translated to a MWh guarantee. Fortunately, there is now enough precedent in the industry that the big four accounting firms now routinely opine on these tricky accounting issues.

4. Do we want to sign a PPA with more than one project?

Signing a PPA (whether physical or virtual) with more than one project can be a way to mitigate risks. Given the restrictions on location and the cost of energy management services, participation in physical PPAs is limited, with projects that are located near the corporation’s facilities. With VPPAs, it is easier for a corporation to purchase energy from a diverse array of projects, in multiple states and/or wholesale markets. For example, a company could purchase energy from a wind farm in ERCOT, a solar farm in PJM, and geothermal plant in CAISO.

Few corporations have the resources to gather data on hundreds of projects under development, analyze all of that information, and create a portfolio of PPAs that will maximize value and minimize risk. That’s where LevelTen Energy can help. Using our Dynamic Matching Engine, LevelTen can analyze a massive amount of data on clean energy projects under development to find which ones best match a corporation’s needs in terms of location, value, risk and other factors. Once a shortlist of optimal projects is identified, LevelTen can help the corporation enter into a power purchase agreement with the project developers.

Still reading? Let’s talk. LevelTen can help companies of any size determine the best way to meet their renewable energy goals, whether that’s a physical PPA, VPPA, or other option.

About Rob Collier – Vice President of Developer Relations, LevelTen Energy

Rob leads LevelTen’s engagement with project developers. Prior to joining LevelTen, Rob worked for utility-scale solar developer OneEnergy Renewables in various capacities, most recently as director of development.