Virtual power purchase agreements (PPAs)

An Overview Of Virtual PPAs

Home Mexico Energy Insights An Overview Of Virtual PPAs

Virtual power purchase agreements (PPAs) are creating new ways to reduce price volatility and expand the market for clean energy

For many years, the market for clean energy was limited by unstable prices. Energy prices are generally difficult to predict, but clean energy adds to the uncertainty of new technologies and the weather. Within a small area, spot prices for wind power can literally go whichever way the wind blows.

Virtual PPAs dramatically expand opportunities to buy and produce clean power. In many cases, price volatility was too high for firms to buy clean power. Virtual PPA contracts for differences (CFD) eliminate most price fluctuation issues. It was also too difficult to connect buyers and sellers. Firms wanting to purchase clean energy had to find producers within a limited area. They often had to deal with running new lines, installing new equipment, complying with regulations, and other technical issues. Virtual PPAs allow clean energy producers to handle most of the details without buyer involvement.

The Growing Use of PPAs and The Need for Predictable Prices

Power purchase agreements have been proliferating rapidly during the last decade. U.S. corporate renewable energy PPAs went from less than 150 MW in 2013 to over 3,000 MW by 2018. Global corporate power purchase agreements increased by 44% during 2019, and growth in Latin America was even higher. Furthermore, over 80% of U.S. power purchase agreements in 2019 were virtual PPAs.
Companies across the board such as accounting giant Ernst and Young, Mexican cement producer Grupo Cementos, Estée Lauder, Microsoft, and McDonald’s have all signed PPAs in the last few years.

A Contract for Differences

Many virtual PPAs work via an arrangement that those in the financial industry may recognize as a contract for differences (CFD). If the market price falls below the agreed-upon price, the company buying the energy must pay the difference to the clean energy provider. When the market price rises above the agreed price, the green energy producer pays the difference to the energy buyer.

Efficiently Reducing Emissions

With a virtual PPA, there is no need to run new power lines to buyers. In fact, clean energy producers and virtual PPA buyers do not even have to be in the same geographical region. The buyer usually starts out paying a price difference for the clean energy, while the producer generates power at the most feasible location. No energy directly changes hands, but the overall reduction in emissions is the same as if it had. Naturally, virtual PPAs count toward clean energy certificates in most jurisdictions.

Controlling Risks and Improving Profitability

While there are risks involved with virtual PPAs, they are the same as for other CFDs and lower than most other clean power arrangements. Counterparty risk is inherent in any contract for differences. If the producer of clean energy goes bankrupt, its virtual PPA customers will be forced to look for another supplier. In many cases, they will have to pay more money. However, bankruptcy risk is much lower than with physical clean power delivery.

With a traditional PPA, new lines and meters might have to be installed by a different green power producer at a considerable cost. Also, the overall amount at risk can be lower when the buyer only agrees to pay the difference rather than buy power.

Virtual PPAs Provide Fast Payback and High ROI

While transitioning to clean energy has historically cost money, virtual power purchase agreements can improve cash flows right from the beginning. Firstly, virtual PPAs eliminate many of the high startup costs associated with buying clean power directly. Secondly, technological advances are rapidly reducing the cost of clean energy.

Solar energy prices declined 74% between 2011 and 2018, while onshore wind power prices dropped 30%. Because prices are falling, it is often possible to get lower prices today with long-term contracts. The flexibility of contracts for differences also allows firms to pay more for the contract upfront to secure lower prices in the future.