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What to Know Before Getting Started with Virtual PPAs for Renewable Energy

July 5, 2016

On the heels of last month’s Clean Energy Ministerial, leaders from some of the world’s most influential businesses received praise from the White House for their commitment to decarbonizing the electricity grid that powers their operations. And with good reason—renewable energy projects receiving support from corporate purchases have grown from 0.6 GW in 2009 to 8 GW this year. And there’s significant potential for growth in the corporate voice, as the majority of investment in large renewable energy projects through 2015 was driven by only 23 companies.

 

These influential corporations have the ability to shape policy and work with regulated utilities to increase investment in renewable energy through special tariffs like Duke Energy’s Green Source Rider in North Carolina and NV Energy’s recently expanded Green Energy Rider. In competitive markets, businesses can match their facilities’ power needs through direct contracts with wind and solar plants through power purchase agreements (PPAs). In rare cases, we’ve even seen large corporations like MGM Resorts and Wynn Resorts completely spurn their utility in favor of direct engagement with the wholesale market to source renewable power on their own terms. But for the majority of corporations that don’t intend to become power marketers, virtual power purchase agreements (VPPA) have been the weapon of choice for achieving big milestones toward their 100% renewable energy goals.

 

On the surface, a VPPA (alternatively referred to as a synthetic PPA, a contract for differences, which are actually a certain type of VPPA, or for those who tell it like it is, a fixed-for-floating swap) provides some compelling benefits over other sourcing models. As a relatively new model for corporations to pursue renewables, however, a VPPA introduces new risks and uncertainties that should  factor into your purchasing decisions.

 

VPPAs Hedge Against Long-Term Price Volatility, But Introduce Hourly Price Risk

First, the financial arrangement of a VPPA provides some protection against fluctuations in wholesale electricity rates, because the structure pays more if wholesale energy prices rise. With a VPPA, your firm will still have to purchase energy to physically power your facilities, and the prices you’ll pay for retail power are influenced by the same drivers of wholesale rates. Holding a long-term position in a VPPA can improve budget certainty around a historically volatile cost line item.

 

Most analyses of VPPA performance will show how the contract performs over time as the average market price of energy increases. However, since the VPPAs are settled on an hourly basis—that is, at each hour interval you’ll compare the fixed “strike price” against the real-time market price of energy, and net the difference—the arrangement could leave you exposed to fluctuations in real-time energy prices. For example, take a VPPA for a 50 MW wind plant at the ERCOT North Hub, with a fixed strike price near the annual average of $24/MWh, as seen in the charts below. Because energy is much more expensive in Texas during mid-day hours during the summer than it is during winter nights, this deal would have lost money during seven months last year. Unless your current energy procurement strategy provides similar exposure to market price, the VPPA could have a significant impact on quarterly budgets.

 

VPPAs Separate Renewable Investments from Energy Procurement, But Require Careful Consideration of Market Factors

Second, because the off-taker does not take physical delivery of the power, the VPPA allows corporations to invest in projects with the best economics, not necessarily those located closest to their load. Further, you won’t have to limit the size of your purchase or navigate the complexity of delivering power to your account, as in a traditional power-purchase agreement, which establishes the VPPA as a go-to lever for purchasing large chunks of power and quickly achieving renewable energy goals. You could conceivably meet a 100% renewable energy goal with one large purchase in Texas, even if your load is centered in Ohio—and  you’d certainly make headlines for it.

 

Despite the attractiveness of this kind of “big splash” approach, that kind of move would be a big gamble unless you’ve done the analysis to correlate wholesale market prices in Ohio with those in Texas. While underlying fundamentals like the price of natural gas play a role in guiding the prices in most US electricity markets, many other local factors contribute as well, such as grid rules, transmission and pipeline constraints, large plant retirements, and changes in the supply resources mix of coal, nuclear, natural gas, and renewables. Because these market correlations can change over the term of the VPPA, you should very carefully consider market risks for any investment in a generation facility that exceeds your load in the same market.

 

VPPAs Are a Good Way to Ensure Additionality—But Will They Always Be?

Finally, for organizations that require additionality in their approach to renewables, VPPAs provide a fixed rate of return for new wind and solar projects which would otherwise not get financed and built. As corporate renewable energy procurement pioneers like Google have stated, their position as a VPPA counterparty enables their projects to get off the ground, thus adding to the installed base of renewable energy on the grid near their facilities. This theme continues to resonate as organizations pursue their first large renewable power contracts.

 

But as sourcing renewables becomes more and more ubiquitous, and numerous buyers seek offtake from developers’ projects, it will become harder to prove the additionality caused by any single company’s actions.

 

The virtual PPA model has certainly been a boon to renewable energy projects in need of customers, and a useful structure for enterprises to secure clean energy. Last year, three out of four off-site wind and solar PPA deals announced by RMI’s BRC members were virtual. Together with a balanced portfolio of demand-side management, on-site generation, traditional PPAs, and ownership of off-site renewables (and, yes, renewable energy certificates), virtual PPAs will continue to allow corporations to achieve audacious renewable energy goals. But exactly how big of a role the virtual PPA should play in your organization’s strategy depends on your ability and desire to manage risk.