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This article has been written by  Geetanjali Shastri pursuing the Diploma in Advanced Contract Drafting, Negotiation and Dispute Resolution from LawSikho. This article has been edited by Ruchika Mohapatra (Associate, Lawsikho). 

Introduction

The demand for clean energy continues to increase as companies around the world want to implement strong renewable energy strategies and focus on sustainable business practices that reduce their carbon footprint. Clean energy also gives organizations a reputation as stakeholders among consumers who recognize that they are a business that also contributes to the well-being of society. Goals are usually achieved by more traditional means of gaining power (Power Purchase Agreement, hereinafter PPA). The developer owns, operates and maintains the renewable energy; in a third party PPA and purchases renewable energy for a predetermined period of time.

What’s a virtual power purchase agreement?

A virtual power purchase agreement is a long-term agreement between a company and a developer. As the name suggests, there is no physical energy exchange in the virtual energy purchase contract.

 When a company signs a VPPA( Virtual Power Purchase Agreement), it promises to pay a fixed price for each unit of power produced by a wind or solar power plant for a fixed time. It is then sold on the wholesale market by the developer. Preferred places where residents can access electricity generated through renewable energy resources are the usual and preferred selling points.

A virtual PPA is simply a monetary agreement, unlike a physical energy purchase agreement. That is why it is also called a purchase agreement for financial strength. It is essentially a “financial exchange” contract that is not related to physical electricity delivery. Typically, the contract conditions will be drawn up as a contract for difference.

The corporation will agree on a fixed price to pay for the generated power and then take a risk on the wholesale market outturn price. If the market price for electricity is greater than their fixed price, they will benefit from the contract. If it is lower, they will lose since they are tied into a higher fixed power price.‍

How does a virtual power purchase agreement work?

Step 1: A developer makes the decision to construct a renewable energy project. He starts the green fielding phase by researching permissions, ideal locations, and grid links.

Step 2: The new buyer and developer sign the VPPA at this point. For a period of 10 to 12 years, you agree to all terms and conditions. The VPPA assists the developer in obtaining the necessary project funds.

Step 3: Once built, the developer begins selling the energy generated on the power market. Remember, the corporate buyer has committed to pay a fixed price for renewable energy; the developer, too, is exposed to price fluctuations.

Step 4: At the end of the settlement period, the developer computes the difference between the market price and the contract price. Now, if the renewable energy initiatives earn more money on the open market than the fixed contract price, the developer pays the buyer an excess. Otherwise, the buyer will be obligated to pay the difference to the developer.

‍Comparing physical PPA with virtual PPA‍

When we compare the differences between a Physical and Virtual PPA, we can observe that they are comparable. Both types will have similar cost savings, additionality, and market image. The distinctions between the two are disguised in the finer points.

  • SAME POWER GRID

When signing a Physical PPA, the offtaker must be connected to the same electricity grid as the renewable energy plant. Otherwise, physical delivery of electricity would be impossible.

This restriction does not apply to virtual PPAs, and the renewable energy generator can be put anywhere. This opens the door to cross-border PPAs and allows a corporation to acquire multiple forms of renewable energy or even larger volumes.

However, the corporation may still desire to have good energy cost alignment with its local energy market. In this situation, the renewable generator under a Virtual PPA would need to be on the same grid as the off-taker or in a power market that is highly connected with the off-home taker’s market. This ensures that the PPA provides an effective price hedging.

  • FINANCIAL DERIVATIVE ACCOUNTING

The other major distinction between a Physical and Virtual PPA is how they are accounted for. Companies situated in the United States will utilise US GAAP accounting standards under present rules, while those based in Europe will use IFRS. Global corporations may be required to report financials in accordance with both standards.

The two accounting standards have differing regulations when it comes to PPAs. One important distinction is that Virtual PPAs may be classified as a financial derivative under IFRS guidelines but not under US GAAP. This is a major issue since financial derivative accounting can have an impact on a company’s ongoing financial reporting.

How can virtual power purchase agreements assist corporations?

This is where the concept of “coverage” comes into play. No matter what the price is in the open market, buyers always benefit from a fixed level of strength and therefore, stand protected from price volatility. Also, like traditional PPAs, virtual power purchase agreements create renewable energy credits for businesses. They receive a renewable energy certificate (REC) from the developer for every megawatt hour of energy produced. Another aspect that benefits buyers and the wider market is addition. It is about adding new sustainable energy sources to the existing grid network.

What type of corporations can purchase VPPAs?  

Currently, almost any entity classified as a company can purchase a VPPA. However, this is not always the case. Previously, developers preferred to sell these contracts to one giant company or service company. Once the primary buyer is secured, the remaining watts are sold to a secondary (and usually smaller) player. Of course, this approach limits the use of PPA to only the highest level. Over the years, this condition has subsided. Developers are now separating projects to attract more corporate purchasers in order to increase investment in renewable energy. These buyers have the option of deciding how much energy they want to invest. The foundation of such an idea is aggregation. This enables small purchasers to form alliances with large corporations, create purchasing power agreements, and, as a result, bring renewable energy projects to fruition. Is aggregation, however, a logistical challenge? Yes, although this can be offset by a significant emphasis on digitalization. Managing many purchasers, their contracts, donations, and payments can be made easier with the use of a robust cloud-based platform.

Are virtual power purchase agreements transformational?

Undoubtedly, VPPAs are transformational. The clean energy industry has been changed through virtual power purchase agreements.  They have opened doors for smaller businesses who previously believed that only the Google, Amazon, and Microsoft of or alike could take on the carbon offset challenge. The impact of VPPAs can be divided into two categories: sustainability and borderless management. The adoption of virtual power purchase agreements has sped the process of making our world and our energy sources more sustainable. In the United States, 2018 was a record year for renewable energy contracts. Within the first ten months, 4.81 GW of virtual agreements were executed.

Demand for virtual PPAs 

Corporate purchasers account for more than half of all renewable energy asset contracts. They are critical actors in making renewable energy a commodity in some of the world’s most powerful economies.

As a result, the demand for virtual power purchase agreements has primarily come from firms with less expertise in selling renewable energy.

As a result, VPPAs encourage them to contribute to the development of a new wind or solar project while also meeting their own sustainability goals.

There are multiple compelling reasons as to why businesses are flocking to offsite power purchase agreements (PPAs) to satisfy their sustainability goals, contribute to the development of more renewable energy projects, and manage variable energy budgets. In contrast to distributed/on-site power generation, offsite power purchase agreements (PPAs) are not bound by the availability of enough rooftop space, grid connection options, or other constraints at a corporation’s location (e.g., rooftop solar panels). When a business decides to pursue an offsite power purchase agreement, it has two options: a physical PPA or a virtual PPA (VPPA). Although a physical PPA and VPPA may sound similar, in practice they are different. With a physical PPA, – as the name implies – the corporation, or a designated third party, takes title to the physical energy at a specified delivery point on the electric grid. The physical energy can then be transmitted from that specified delivery point to the corporation’s energy account or meter.

Are we prepared to handle regulatory and accounting issues?

Physical PPAs and VPPAs have various regulatory duties that must be met by the buyer. As previously stated, physical PPAs necessitate the use of a licensed power marketer to allow the supply of physical energy from the plant to the buyer’s account. There are important qualifications required if the buyer chooses to undertake this service without the assistance of a third-party professional (e.g. FERC licensing). Due to these complications, very few non-utility corporate buyers have pursued a physical PPA without the assistance of a third party.

Different accounting treatments and derivative reporting requirements may apply to VPPAs and physical PPAs. Buyers should be aware of these obligations in order to prevent unwelcome regulatory complications. As a swap’ (fixed-for-floating swap) arrangement, VPPAs trigger Dodd-Frank Wall Street Reform and Consumer Protection Act reporting, record-keeping, and registration requirements for the buyer and seller. While these standards are simple to meet, buyers should obtain business and legal advice on how to fully grasp them before signing a VPPA contract.

Do we want to sign a PPA with more than one project?

Signing a PPA (physical or virtual) with more than one project can help to reduce risks. Because of location constraints and the high cost of energy management services, participation in physical PPAs is limited to projects located near the corporation’s facilities. It is easier for a firm to purchase energy from a varied range of projects in different states and/or wholesale markets using VPPAs. A corporation, for example, may purchase electricity from an ERCOT wind farm, a PJM solar farm, and a CAISO geothermal plant.

What is a physical (or sleeved) PPA?

A physical or sleeved PPA is a contract between a renewable energy generator and a site for the delivery of electricity through the power system. The renewable energy developer and off-taker will agree on a price for the duration of the PPA, which is typically set €/MWh with annual indexation.

A physical PPA allows a third-party power supplier or marketer to wrap the power volumes into a current energy contract for a corporation. Contracting with this strategy requires a corporation to cope with the variability of renewable plant power production and how this relates to their power usage.‍

Examples of PPA’s in Europe

A recent deal between Iberdrola and Danone is set to serve as a model for Physical PPAs. As an example, the arrangement has not been mentioned whether it is physical or virtual, but Iberdrola is more likely to be the project developer as well as the supplier for Danone’s facilities in Spain and to “power nap” for them. Danone will obtain some of its energy from Europe’s largest photovoltaic solar facility as a result of the contract. Novartis has completed a huge Virtual PPA arrangement to take power from Spain’s new solar power facilities. Overall, more than 275 MW of clean power is expected to be added to the system under the contract. This is a good example because Novartis follows IFRS accounting standards and PPA is likely to follow derivative accounting. This indicates that businesses are willing to take a certain level of financial reporting risk from Virtual PPA.

Conclusion

Power purchase agreements are contracts between energy consumers and developers. With newer norms and a strong shift toward borderless management, virtual power purchase agreements (VPPAs) have now become a popular option. VPPAs are easily scalable and enable buyers to satisfy a large portion of sustainability goals with a relatively small number of deals.

References


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