POWER PURCHASE AGREEMENT TO PROMOTE RENEWABLE ENERGY RESOURCES

A  Power Purchase Agreement (PPA) is an agreement made to secure payment stream for a Build – Own Transfer (BOT), which is a financing arrangement in which a developer designs, builds and operate a complete project or facility, a power plant in this specific case , at little or no cost for the venture partner, which at specific concerted time  will take on the facility at a previously agreed price. 

Usually PPA are made between a state owned electricity purchaser and a private owned power producer and actually take the place of previously BOT or concessional agreement signed. In fact the PPA will also set out the output and the operation and maintenance specifications for the power plant, in addition of the obligations related to the sale and purchases of the power generated. So in the PPA it is firstly decided the “Sale of capacity and energy”, which includes the contracted capacity of energy to make available to the purchaser at a price defined in the “Charging Mechanism”. The final price charged for the power in the PPA is usually made up by an “availability charge”, made to cover the project’s company fixed costs, including a return on equity, and by a variable charge to cover variable costs. It is important to note that a PPA is a performance based arrangement, so that the purchaser pays only for what the power system produces. 

We can therefore link the two cost components to the specific capacity installed: the fist component relates to the availability of the power plant, whereas the second is calculated according to the quantity of power supplied. The PPA gives also the possibility of third party sales, which enhance the  financeability of the project and it can benefit the purchaser, in case revenues from sale to third parties are used to reduce purchaser’s monthly tariffs.  Purchasers though are not that willing to allow third party sales as they want to be sure that all capacity is always available to themselves, in this case in agreement there might be also an exclusionary clause, which sometimes has also been addressed as an impediment to future development of the energy market. With a PPA the purchaser is also guaranteed by a provision of sanction that might apply to the power producer in case it fails to deliver the power promised, or it does not perform as required or if the construction is not finished within a specific length of time. The agreement also need to include what happens at the termination of the contract: obligations of the power producer on hand-over of assets and the buyout price of the power plant if contemplated. 

The peculiarities just underlined of a PPA make its usage more appropriate in particular occasions, for example  when the projected revenues are uncertain and so some guarantees in relation to a secure supply  and price paid are required to make the project successful for both parties, or when the producer suffers a high level of competition. 

The appropriateness of a PPA is clear in case of solar power energy supply, so that the general PPA takes the name of Solar Power Purchase Agreement (SPPA), which define a financial agreement in which a third party developer owns, operates and maintains a photovoltaic system, and a “host customer” agrees to site the system on its roof or elsewhere on its property and purchases electricity from the solar system installed by the provider for a predetermined period. So we can think it as purchase of the service produced by the photovoltaic system rather than the purchase of the system itself. The main benefits for the solar services provider are stable income generation and tax credits. It is common that the solar service provider may form a special purpose entity with an investor providing the resources needed to install the system, in this case both investor and provider may benefit from tax credits. 

The host costumer benefits from no upfront capital cost, predictable, and possible stable and lower than market supply, energy price. Moreover there are some operating advantage, such no system performance risk, which is usually guaranteed by the provider, and there is the potential that the value of the property increases. Furthermore in specific case the host consumer may get renewable energy certification, according to Country specific laws, which are visible demonstrable environmental commitment. Some disadvantage might arise as well though. First the negotiations to conclude a SPPA, or more generally a PPA, might be complex and related transaction costs can increase. Then if the system does not cover the 100% of the electric load needed by the host costumer, he/she might encore in administrative costs of paying two separate electric bills.

The Solar Energy Industries Association underlines that a SPPA usually last up to 25 years and there are two main way to structure the costs for electricity for the duration of the agreement: the fixedescalation plan, under which the customer pays a price that rises at a predetermined rate, typically between 2% - 5%; the fixed price plan, on the other hand, maintains a constant price throughout the term of the SPPA, the starting electrical rate may be higher than the utility rate, but as energy costs rise, the average rate is expected to be lower.

SPPA have been lately more and more employed by federal agency in the United States, where increasing and unpredictable energy costs and further renewable energy goals push to find new solutions to meet budget and environmental requirements. The Energy Policy Act signed in 2005 mandate federal agencies to obtain at least 7,5% of their electricity from renewable energy sources, as solar power, that has become increasingly attractive because of diminishing costs and advances in technology so that pushed up demand for on-site solar system. Moreover solar developers wanted to build more projects: SPPA was seen the perfect financial tool to invest in a “community profitable project” that could also benefit employment in the solar power industry. Moreover a fixed escalation plan could benefit the federal agency budget as it provides predictability and relief from volatile electrical rate.

Power Purchase Agreement allows to design the financing mechanism most suitable for both provider and energy user thanks to the flexibility given by these type of contracts. Indeed it might be that SPPA help the further development of solar power energy utilization, as it provides not only more guarantees to costumers but it also allows providers to build more systems, therefore enhancing the quality of production. 

Author: Carlotta Galimberti