Introduction to Virtual Power Purchase Agreements for Corporations
March 13, 2019 · By Zach Starsia
Virtual power purchase agreements (VPPAs) are becoming an increasingly popular way for corporations to achieve their renewable energy goals. Here’s the 101 on VPPAs for anyone who is exploring this option on behalf of their company for the first time.
First of all, what is a power purchase agreement?
A power purchase agreement (PPA) is a contract between an energy buyer and the developer of a renewable energy project that hasn’t been built yet. In the contract, the buyer guarantees that the developer will receive a fixed price for their energy, and in exchange the buyer receives renewable energy credits (RECs) for every megawatt hour of clean energy that is generated and sold. PPAs are long-term contracts, typically spanning 12-20 years, enabling the project developer to secure long-term financing and build the project.
What are the benefits of a power purchase agreement?
Corporations enter into PPAs for a variety of reasons. PPAs enable a corporation to:
- Reduce Scope II Emissions – These are carbon dioxide emissions that are a result of the corporation’s electricity use.
- Make Renewable Energy Claims – With a PPA, a corporation can claim that all or part of its operations are “powered by renewable energy.”
- Contribute to Decarbonizing the Grid – PPAs result in the generation of clean energy that would not have been possible if it weren’t for the agreement; this is known as “additionality,” and is important to many stakeholders.
- Hedge Energy Costs – PPAs can act as a hedge against rising energy prices (read on for more info).
What is a virtual power purchase agreement?
When a company decides to pursue a PPA, the two most common options are a physical PPA or a virtual PPA. 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 virtual PPA, the energy doesn’t physically flow from the project to the buyer. It is merely a financial contract, which is why it’s often referred to as a “financial PPA.” In a VPPA, the energy is sold on the wholesale electricity market at a defined settlement location (node, trading hub or load zone). The buyer continues to get their electricity from their utility company at their utility’s rate. For more information on the differences between a physical and virtual PPA, check out “4 Questions to Ask Before Choosing a Physical or Virtual Power Purchase Agreement.”
A VPPA is settled financially as a fixed-for-floating swap or contract-for-differences. The buyer and developer will agree on a settlement period, typically every month or quarter. During that time, the developer will sell energy on the wholesale market, at the floating market price. At a pre-determined interval (typically every hour), the developer will calculate the difference between the floating market price and the fixed VPPA price. At the end of the settlement period, they’ll add up the differences. If the total is positive, the developer will pay the buyer the difference. If the total is negative, the buyer pays the developer the difference, thereby guaranteeing that the project always receives the agreed upon VPPA price for each megawatt hour.
How does a virtual power purchase agreement work?
There are two players that come to the table in a VPPA: the corporate buyer, and the developer of the renewable energy project. Corporate buyers want to achieve their renewable energy goals by procuring bundled RECs and bringing new clean generation projects to fruition (referred to as “additionality”). Developers are trying to sell their energy at a price that will enable them to reach their internal rate of return. If the developer can find a buyer who will guarantee that they get that price for 10+ years, they can get the financing they need to build the project.
Here are the general steps in the process:
- The developer begins development of the project (site control, permitting, interconnection, etc.)
- The buyer and developer sign the VPPA, which defines the terms of the contract and the transfer of RECs.
- The developer gets financing and begins construction of the project.
- Once the project is operational, the developer sells the energy on the wholesale power market in their area, at whatever the price is at the time (the floating price).
- At the end of the settlement period, the floating market price vs. fixed VPPA price will be calculated, and the developer or the buyer will pay the difference, depending on whether it was higher or lower than the VPPA price.
- The developer receives one REC for every megawatt hour sold. Under most VPPAs, the RECs are immediately transferred to the buyer.
In addition to receiving RECs, a corporation has an opportunity to hedge energy costs through a VPPA. If energy prices rise where the buyer uses energy AND where the project sells energy, the buyer will have a higher utility bill, but (if the average wholesale market price rises above the VPPA price), they’ll also receive a payment from the developer. If energy prices decrease, they’ll have a lower utility bill, but they’ll also have to pay the developer at settlement (if the average wholesale market price is below the VPPA price). For this reason, hedges are more effective if the buyer uses most of their energy in the same electricity market as the project.
Where can virtual power purchase agreements take place?
With a VPPA, the project does not need to be located in the same wholesale electricity market as the company’s facilities. However, the project must able to deliver its energy to a deregulated (retail choice) electricity market that is run by one of the seven Regional Transmission Operators (RTOs) or Independent System Operators (ISOs) in the U.S.
Even though the corporation does not need to operate in the same wholesale market as the project, there are a few benefits to doing so:
- Projects located in the same ISO will have a stronger correlation between the energy market price at the project location and the energy price the corporation pays on its utility bills. A stronger correlation between these prices has the potential to create a more effective long-term hedge on energy costs.
- It may be important to corporate stakeholders to work with a project that is close to where it uses the most energy, so that the environmental benefits are in the same region as the corporations’ operations.
What type of corporations can participate in a virtual power purchase agreement?
VPPAs are now an option for a wide variety of corporations, universities and other institutions. But that wasn’t always the case.
To get financing for a project, developers need to first find a buyer for the majority of energy the project will generate. Historically, developers would find a utility or a large corporation to purchase the majority of energy, and then – if there was any energy left over – they’d sign a PPA with a smaller corporation. This made it extremely challenging for a smaller corporation to find a developer willing to sell them just the right amount of energy.
Now, project developers are slicing up a project and selling the pieces to multiple buyers. This is referred to as “aggregation” – and it has the potential to transform the industry. With aggregation, a developer doesn’t have to find a utility or large corporation first; multiple buyers can collectively purchase the majority of energy the project will produce, allowing the developer to get financing. By slicing up the project, buyers who don’t need extremely large volumes of energy are now able to participate in PPAs. For more information on aggregation, check out “What is Energy Aggregation? – A Primer.”
While aggregation is great in theory, it’s complicated to execute. To sell to multiple buyers, a developer has to knock on a lot of doors, convince multiple buyers to work with them, and find enough buyers to purchase the perfect amount of energy– not too much, not too little. On the flip side, before corporations can collaborate to purchase power from a project, they first have to find each other, coordinate their extensive list of internal stakeholders, and jointly navigate tricky timing issues and contract negotiations in order to get a deal over the finish line.
LevelTen Energy developed its Dynamic Matching Engine to solve this problem. The Engine analyzes all of the data in the LevelTen Marketplace – a comprehensive database of more than 1,600 renewable energy projects across North America – to identify optimal projects (or portfolios) based on each buyer’s needs. Through the power of data science, LevelTen Energy can uncover a project that meets a corporations’ needs in terms of size, price, risk, timing, location and other factors, whether they work alone, or with other buyers.
By bringing buyers and sellers together, and matching them in optimal ways, LevelTen is able to open the world of renewable energy VPPAs to thousands of corporations who were previously sitting on the sidelines. For more information about working with LevelTen, visit www.leveltenenergy.com.