A Power Purchase Agreement: No Longer the Only Option for Independent Generators

As the end of any contract draws near, a counterparty must consider alternatives, and a power purchase agreement (PPA) is no different. With deregulation progressing in the United States and elsewhere, the options available to independent generators are expanding, and now often include access to wholesale power markets, hedging, and aggregators, while the associated opportunities to make money from price moves to those markets.

Recent Declines

The long-term power purchase agreement has been deteriorating in some regions. This has been driven by uncertainty over the impact on wholesale prices of a greater penetration of intermittent renewable generation, as well as local and national energy policy changes and changes to supply and demand fundamentals.

Wholesale physical power trade still typically occurs through bilateral transactions, including PPAs. But with some utilities moving to cut risk exposure, and competition in the retail markets providing merchant generators with a wider choice of whom to sell to and when, simple power purchase agreements are on the decline in most developed markets.

One option is to sell power to aggregators, who often get better prices from utilities or the market. This can be done by offering an enhanced service able to respond to price changes by incorporating flexibility, as well as advantages of scale. In competitive markets, generators can also sell to aggregators who may be supplying a specialist retailer, for example, one selling green power, or even directly to the retailer, perhaps with an element of variable price.

Taking Risks

A power purchase agreement allows a facility owner to secure a revenue stream from a project, which can be necessary to finance new facilities. As assets mature and credit is repaid, the need for this security recedes and the plant can operate on a more merchant basis. If a plant wants a power purchase agreement, it's best to offer flexibility, particularly guaranteeing supply at peak times. It's this flexible supply that's becoming more important as renewable penetration grows. If you cannot secure a PPA, however, plants must manage the risk associated with a less certain revenue stream.

The level of power purchase agreement coverage partly reflects how much risk traditional buyers want to take on—the less PPA coverage a buyer has, the more downside market price risk is passed to the generator. But a cleverly run plant should also be able to capture more of the high-priced periods on wholesale markets, which a PPA does not permit. In addition, the price may include all the project's renewable energy credits, including carbon credits.

Adjusting for new market conditions, some big buyers offer innovative power purchase agreements, making them more flexible for suppliers. For example, an expert PPA may be able to help an aging generator pursue its own trading strategy. Alternatively, traditional fixed price PPAs are still available for up to 3 years for those with a fixed output, and, if electricity production is variable, it provides deals that can track the market price and fix when you wish.

Changing the Rules

In the United States, recent legislation has promoted independent system operators (ISOs), moving away from bilateral transactions and power pool agreements. Along with facilitating open access to transmission, ISOs operate the transmission system independently and foster competition for electricity generation among wholesale market participants, decreasing reliance on PPAs.

Utilities have also joined regional transmission organizations (RTOs), which, like an ISO, manage the transmission systems equitably. Each of the ISOs and RTOs has energy and ancillary services markets in which buyers and sellers can bid for or offer generation. While major sections of the country operate under more traditional market structures, RTO regions serve two-thirds of the US electricity load.

Power purchase agreements are becoming difficult to secure in some areas, such as in California, where only 30 percent of power producers are expected to use them in the next 5 years. As noted by the Federal Energy Regulatory Commission, three major integrated utilities serve Californian residents. These utilities either buy on the wholesale power market or directly from IPPS, reselling to consumers in monopoly service areas through owned and maintained grids.

Partly driven by California's climate change law and net zero energy goals, the state is cutting back on utility-scale, fossil-fired power plants and promoting a new system driven by renewable and distributed power of all sizes and technologies, owned by customers, utilities, and third parties. It's clear new information technology and demand-side response are helping create opportunities beyond the simple PPA.