Frequently Asked Questions About Power Purchase Agreements

February 27, 2020

 

What is a power purchase agreement (PPA)?

A power purchase agreement sets out the terms of a bi-lateral agreement in which one organization buys energy from another. The main elements of a power purchase agreement include the price for capacity, the price for energy (basically, the marginal cost of electricity), and the number of years that it will last.

Both parties benefit from PPAs. Developers reduce risk in projects through stable cash flow from the PPA, while consumers, usually large industries, benefit from 1) locking in power prices at a discounted rate, 2) protection from price fluctuations and volatile operating costs, and 3) showing government regulators that they have a long-term commitment to renewable energy and/or are in compliance with renewable energy policies.

How are PPAs different in Mexico?

In Mexico, many power purchase agreements are between businesses. For example, a private producer of clean energy may sell it to an automobile manufacturer. In much of the world, the most common arrangement is for a private power plant to sell electricity to a state-owned utility. The market is much more flexible in Mexico. For example, a subsidiary of the state-owned utility company sells power to private companies. Power purchase agreements in Mexico also frequently involve sustainable energy.

Why are Mexican PPAs important?

Given rising tariffs and other issues in China, Mexico plays an increasingly vital role in manufacturing. Power purchase agreements allow manufacturers, with plants of all sizes, to lock in lower electricity rates.

What are the typical cost savings from using PPAs?

In our experience, PPAs can save companies between 15% and 40% on their monthly power bills, depending on the source and tenor of the agreement. Generally, more money can be saved by locking in rates over the long term and by using renewables which eliminates the cost of the clean energy certificates.

Are there any other notable benefits?

There are additional advantages to PPAs involving renewable energy. Using renewables can improve a company’s image with the public. More importantly, the Mexican government set specific targets for renewable energy usage. Helping the government to meet its clean power targets can contribute to better relations with regulators.

How is the “Spot Market” Clearing Price Set?

Market participants can buy energy through via the wholesale market at spot price. Prices are calculated in real time and what’s known as “day ahead” prices. The Mexican system operator, National Center for Energy Control (CENACE) takes bids from producers and then dispatches the least expensive plants first. This proceeds on to the higher-cost dispatch until the domestic power demand is met. The kWh price paid is fixed at the value of the last kWh dispatched.

Prices fluctuate depending on several factors such as supply, demand, oil prices, maintenance, plant state, among others. This pricing mechanism is advantageous for consumers because it forces power producers to constantly focus on lowering operating costs. As producers lower operating expenses, they can bid lower prices, and thus have more of their bids accepted.

Which companies are involved in PPAs?

Several sizable European energy firms participate in Mexican power purchase agreements. The Italian firm Enel is one of the leaders, particularly in renewables. Enel has a dedicated subsidiary for the Mexican market, Enel Green Power México (EGPM). ENGIE of France is another major participant along with Iberdrola and Fisterra Energy from Spain. Finally, Mexico’s CFE Calificados also plays a part.

What is CFE Calificados?

CFE Calificados is the private arm of the Mexican state-owned electricity company, CFE. CFE Calificados provides power and Clean Energy Certificates (CEL). Large multinational firms, such as Toyota, have made power purchase agreements with CFE Calificados.

How will political changes in Mexico impact PPAs?

There are some changes in policies, but the Mexican government has honored previous agreements. While there were delays in renewable energy auctions, private power purchase agreements have continued to operate. We do not expect significant changes in power purchase agreements.

How long does it take to switch energy suppliers?

It typically takes between six and nine months to change to a new energy supplier using a PPA. The first stage is selecting a supplier through a strict RFP process and negotiating an agreement. This typically requires 30 to 60 days to complete. The next step includes obtaining quotes for pricing meters, which vary considerably based on the requirements of the project. Finally, it takes two to four weeks to install the equipment in most cases.

Are there any other risks or costs associated with PPAs?

Yes, there are several issues to watch for when negotiating PPAs. Pricing meters generally cost at least $8,000 or more, and new transformers will typically be needed for the new supplier. A full installation of meters and transformers, across several plants, can be more than one million dollars of investment. The transformers are also highly customized, so purchase orders can take six months to complete.

Another issue to be aware of is that all legally binding agreements are in Spanish. While English translations are available, it is the Spanish language version that will be legally binding. We believe firms should use local attorneys and consultants as part of the negotiation process.






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