17th January 2018
A power purchase agreement (PPA) is a contract between an electricity generator and the party who is purchasing the power (the offtaker) which incorporates the commercial terms for the sale and purchase of electricity for a project. Where the purchase is not a licensed supplier of electricity, it is typically referred to as a ‘private wire’ PPA.
The key benefit of a private wire PPA is, for both the generator and offtaker, the opportunity to share savings in avoiding grid charges and policy costs applied to electricity imported from the grid. Provided that the project falls under one of the exemptions in Schedule 4 of the Electricity (Class Exemptions from the Requirement for a Licence) Order 2001, there is no need for a licenced supplier, which allows significant savings to be made.
The decline in availability of many of the renewable energy subsidies – the Renewables Obligation scheme is closed to new projects and the Contracts for Difference scheme does not currently support onshore wind or solar – means that such savings may be critical to the financial viability of renewable energy projects given.
It is likely that one or both of the parties will also require a physical connection to a distribution or transmission grid network. The offtaker is likely to require back-up grid supply, either because of the intermittent nature of some renewable supply, to hedge against the risk of the supplier not meeting demand at peak times, or for reassurance that it can still get power during shut downs or service failure. Depending on the arrangement between the parties, it may alternatively be the case that the generator is required to have its own grid connection to supply the offtaker with a certain amount of power at all times, regardless of whether its plant is generating. The generator is also likely to want a grid connection for the sale of surplus power, in the event that the offtaker does not require some or all of the power generated.
The contractual arrangements are likely to be such that the generator will be obliged to supply all of its power to the offtaker in the first instance, and will only be permitted to export surplus to the grid. The offtaker may be required to offtake all the power generated by the generator and only be entitled to import power required over and above that supplied by the generator. If the offtaker already has a direct connection to the local distribution network the generator may require that the offtaker’s connection is two-way, so that surplus power can be exported on to the local distribution network.
When assessing the merits of a private wire deal, additional costs associated with the installation and maintenance of the private wire infrastructure should be factored in; for example responsibility for the physical interface between the generator’s plant and the offtaker’s facility, and for insuring the private wire against damage. The additional complexity and risks associated with the legal and contractual arrangements underpinning the private wire supply deal will also need careful consideration.
Private wire PPAs present an opportunity for both parties to hedge against volatility of energy prices. A cap and floor mechanism allows corporate buyers protection against the cost of purchasing electricity from a licenced supplier and rising power prices, while ensuring they don’t miss out on decreasing power prices. For generators, the private wire PPA model can provide an alternative route to market with long term revenue certainty from a credit-worthy counterparty, improving its ability to raise more debt finance or secure more favourable debt terms. Careful consideration should therefore be given by both parties to the pricing mechanism to ensure maximum benefit is obtained from this alternative energy sale and purchase arrangement, e.g. fixed price or a cap and floor mechanism. Where surplus energy is exported to the grid, the parties will also have to agree the price payable for exported power.
A key requirement for generators is finding an offtaker with sufficient covenant strength to guarantee revenue certainty. The generator would typically require the offtaker to guarantee to take a high proportion of the plant’s generation for the full term of the PPA or otherwise pays compensation to the generator to cover expected revenues over the project term. Clearly this will depend on the bargaining power of the entities – a generator would prefer an uncapped indemnity for any losses it suffers as a result of the offtaker’s breach whereas the offtaker may require a range of limitations on its liability.
Parties should consider carefully the consequences of the PPA’s early termination, for example due to breach or insolvency. The generator will require the ability to continue operating and exporting to the grid post-termination, and/or flexibility to negotiate a replacement private wire deal following termination of the original agreement. The offtaker will want flexibility to obtain energy elsewhere post-termination, either from another PPA or from the grid if the generator falls away. If shared or offtaker-controlled grid network connections are required by the generator after termination (for example if the generator is using the offtaker’s local distribution network connection to export surplus power), the generator will need the rights to continue to use the connection after termination of the PPA. Although the parties may need to negotiate a new arrangement with the DNO post completion for the offtake of power, they should ensure the original deal provides for sufficient land and access rights to the private wire infrastructure in the event of an early termination.
Private wire PPAs are driven by generators seeking price certainty in a market of reduced subsidies and corporate end-users who will hedge their exposure to the electricity market and strengthen their corporate social responsibility credentials. The transition towards a subsidy-free renewables market opens the opportunity for projects which can achieve savings elsewhere, and private wire PPAs could be the answer in many scenarios. Deals should be negotiated carefully to ensure that risk is apportioned appropriately to deliver a robust and deliverable deal.
For energy users in energy intensive sectors, such as food and drink and other manufacturing sectors, private PPAs could provide a real opportunity to achieve a range of financial, environmental and corporate responsibility goals.