A conversation on the history and development of PPAs

This interview begins a mini-series that touches on the history of Power Purchase Agreements (PPAs), the critical approach to their associated risks, and advanced procurement strategies. Firstly, let´s take a moment to consider how it all started. I asked our experts here at E&C to give us a brief introduction to PPAs and their place within the energy transition.

If you're interested in going into further depth on PPAs, specifically the coming age of the corporate PPA market, you can access the full content, including a glimpse into the future of 24/7 renewable energy, via the complete White Paper here.

Benedict De Meulemeester CEO

Dina Karamarko Lead Partner

OK, so Benedict, let's start with the basics. What are PPAs and when did they start playing a role in the corporate energy transition?

‘PPA’ stands for Power Purchase Agreement. There are many ways that you can use that definition. In a very broad sense, any energy contract, any electricity contract could be considered a Power Purchase Agreement. There can also be PPAs on gas-fired power stations, coal-fired power stations or nuclear power stations. But very specifically for decades the term has been used to designate an electricity contract where the electricity is bought directly by a consumer from a producer, so bypassing the traditional role of the supplier, the retailer, of the electricity. We saw it starting with tech companies around 2010. They were the first ones that started to sign such contracts.

PPAs have become very popular in recent years specifically for the direct procurement of electricity by an end consumer from a renewable asset; from solar parks, from wind power... In that sense, they've come to play a very important role in the energy transition because lots of these PPAs have fixed price agreements or fixed price agreements long-term, meaning that they secure the revenue stream for the investor that wants to build the renewable asset, which means that it's a key element for that investor to get the financing arranged for building that asset.

You mentioned that it started with tech companies, why did these companies choose to green with PPAs rather than certificates?

Tech companies saw PPAs as a superior alternative to buying with certificates. Ever since certificates, proving the green character of the electricity you're buying, have been in the market, there have been accusations of greenwashing around the corner, saying the electricity would have been produced anyway. And, of course, to protect themselves against that, the tech companies thought, ´But OK, if we sign these agreements directly with the assets with these PPAs, then we can really prove that we have helped this renewable asset to be built. We've secured the financing with it´. So PPAs have better green credentials than the traditional certificates in themselves have due to which it is being seen as a higher quality participation in the energy transition by corporates than just buying certificates.

I want to make an important remark here: in every PPA, certificates are included and should be included because it's the way that you prove that the electricity actually came from the renewable asset. A PPA is more like an add-on to certificates than something that really replaces them. But in terms of strategy on how you green, there are clearly two choices you can make: either you stick with buying certificates or you take the next step, and you are engaging in PPAs.

OK, Dina, let's get your opinion on this. You've been working on sustainability topics for a very long time. Do you see PPAs as a higher-quality approach to decarbonization?

Definitely. I do believe that PPAs are a better corporate investment in the energy transition compared to just buying EACs [Energy Attribute Certificates]. But there are several attributes of PPAs that result in a stronger decarbonization impact. Just to name a few; it is really thanks to corporates that are taking the market price risk of the renewable assets that create stable revenue for developers and thus also result in greening of the grid. Then secondly, if done in the right way, where an industrial client maximizes the volume produced and consumed, PPAs can also enable long-term energy price stability, which is not what you have with EAC buying. Then thirdly, when signed at the right time, PPAs can also lock in competitive energy prices and reduce exposure to electricity price volatility. That is, if the PPA is based on the fixed price. And then finally, well, instead of relying on already existing assets that EACs are linked to, corporates often ensure that renewable projects come online by putting additionality high on their list of priorities.

Benedict, in the past years we've seen - not just big tech companies - but also companies from many other sectors starting to sign PPAs to green their energy supply. How did that happen?

The first reason I would say is the ESG [Environmental, Social and Governance]; the necessity for companies to report on their participation in the energy transition and in decarbonization. What we saw then is the automotive sector, the car manufacturers, picked up seriously on this topic for a myriad of reasons.

One of those is Dieselgate, where car manufacturers were depicted negatively in the news on their environmental credentials. We then saw car manufacturers setting up very ambitious decarbonization plans, including Scope 3, meaning that they put pressure on their suppliers and sent out RFPs to say, ´If you do not buy green electricity through PPAs, we will not buy car parts from you´. That has been like a ripple effect that really went into the market where all those suppliers also had to buy those PPAs.

Of course, we can also not neglect the fact that there's a lot of money made with PPAs. For example, by brokers, so that's been heavily promoted by people with a commercial interest in those PPAs.

And lastly, we also saw a bit of an uptick in the 2021–2022 price crisis where PPAs in some cases were considered to be a way of reducing cost. That was quite dangerous, because then when the wholesale market came down to more normal levels again, they dropped below those PPA price levels. And we see some clients now stuck with an expensive PPA that they signed at that moment. The right focus that the price crisis put on PPAs is, like Dina said, the potential of PPA to stabilize your energy costs. So those clients that look more at it from a risk management point of view, for them, PPAs can be a valuable addition to their supply mix.

Dina, what about your experience? What reasons do you see PPAs becoming such a cherished corporate greening instrument?

Well, this differs from company to company. There can also be some market maturity or volume-related limitations. But in general, we often see a combination of different elements. One of them can be the ability to hedge against price volatility, which is, like Benedict mentioned, a crucial lesson from the recent energy crisis that further strengthens the case for PPAs. We do see that tech companies are setting the industry standard for green energy procurement. But it is really due to the corporate reputation and competitive advantage that PPAs are being adopted by other sectors. Then what you have is PPAs that provide a high-impact, credible and measurable solution for achieving sustainability targets, especially when combined with additionality. And then finally, if we take a look at talks we have with our clients, they are really making the energy transition an integral part of their procurement strategies. That is also the reason why PPAs are rapidly gaining traction: because they are combined with risk and diversification.

Does this mean that by signing PPAs you're out of the woods, safe from greenwashing accusations?

What do you think, Dina?

I would say, not necessarily because signing a PPA; yes, it is a strong step towards decarbonization, but the credibility of a PPA depends on several factors. We've already mentioned additionality: are you signing a PPA with the new or existing asset? Also, is your PPA actually reducing emissions in a sense that operations from the renewable assets are aligned with your energy consumption patterns, or are you just signing a PPA for the sake of EACs, which sometimes happens with cross-border PPAs (really limiting the PPA to a financial transaction or the cost of greening)? And then, finally, I think companies need to be very careful with sustainability claims that they are making, not only in their sustainability reports but also in their overall communication. Sometimes we see claims like, ´We have 100% of our electricity covered in a single PPA pay-as-produced´. That's nonsense. It cannot exist in the market. It counts only when you can prove that you're green on an hourly level. For EACs, this is not the case yet, but it is inevitable. In my point of view, heading towards 24/7 renewables, and their PPAs, can definitely be quite a good asset in the whole story.

What I can add to that, with my experience in being in the energy market now for 25 years, most companies I've met with do actually have very genuine intentions when they launch their decarbonization programmes. But the risk of being accused of greenwashing is always around the corner. That is just because there's a whole bunch of people out there that, whatever corporates do, they will always distrust it. So that's something to always be reckoned with.

What makes it sometimes difficult for PPAs? I see two main things. One thing that Dina mentioned indeed, and that's really coming up, is the fact that all accounting of how much green electricity you have today works on an annual basis. You simply have your certificates be through a PPA or bought directly from the market separate from the renewable energy production, and you buy your certificates. Then, at the end of the year, if you could say, ‘I consumed 100 GW hours and I have 100 GW hours’ worth of certificates’, you're supposed to be 100% green. But this doesn't mean that every time you were consuming electricity, those renewable assets were producing.

We can now see that there's a focus on 24/7 renewables. That could be the next thing, although there are some companies like Amazon that are proposing another view, which is more like sourcing electricity, sourcing certificates from those countries where it has the highest carbon reduction impact. These are two schools of thought at this moment. But you can see that there's going to be a next thing, and there's going to be a next level, and the pressure that is being put on companies to be serious about how green they are. Knowing all of that, I think it's very important to be careful not to put all your eggs in one basket: spread your risk over different PPAs, for example.

What I've also seen with some customers is they start with really good intentions in the negotiation of a PPA. They define what PPA they want to sign, with, for example, very high additionality requirements. But that comes at a price stack. They get discouraged by that and, in the process of negotiating that contract, you see the standards they put for themselves go down and down. I've seen some clients signing a PPA agreement in which the additionality had just been thrown overboard. That's something to be very, very careful with.

In itself; the additionality criterium is highly problematic. It is broadly defined as a ´newly built´ or ´recently built´ asset, but how do you define that? Where do you put the line? Do you sign the contract before the asset gets built? But then somebody can say, ´Yeah, but it was planned anyway. They already had a permit to build it´. In some cases, if it's less than one year old, then it's considered to be recently built, and that is additional. But there will always be people that put that into question.

Considering the challenges and the advantages of PPAs, does this mean that they're still the best choice for E&C clients?

I would say it depends on how you define the choice. Signing PPA is not a standalone strategy but should rather be considered as part of a broader approach. Our clients have to align their energy procurement strategy with, first of all, robust risk management instead of simply following market trends. Decisions regarding the energy transition should definitely be weighted carefully; both benefits and associated risks.

For me, it's not a question of whether you sign a PPA, but rather how to structure it. That includes, first of all, the selection of the right type of PPA: pay-as-produced, based load, pay-as-nominated, or something else. Identifying the right technologies based on the profile of the client and their future needs but also determining the appropriate commitment level. We´ve seen that most mistakes have been made in the past where the volume commitment is simply too much based on the needs. And then balancing the risk between the developer and the buyer and ultimately, what the energy crisis showed us, choosing the optimal timing for signing a PPA. All these elements are more relevant when it comes to making the right choice, rather than just rushing into it and signing it for the sake of ticking the box or showing your stakeholders what you've done.

Yeah, I think PPAs are here to stay. But they're not the miracle solution that some thought they would be five years ago. You need to be very prudent when you sign a PPA and to have a very good analysis of what the impact is on your total portfolio situation of every PPA that you've signed. I'm happy to see that the PPA market is becoming more mature, both on the supplier side, with more creativity in the kind of products that are being offered, but also on the client side where we see a lot of companies adopting a much more critical look at those PPAs than they did five years ago when they thought it was just this easy fix. So that's good. It's a good evolution and they are probably here to stay.

As you can see, there´s a lot to say about the risks and opportunities of PPAs. Stay tuned for the next interview, where we will explore the complexities of PPAs, the risks associated with wholesale price volatility, and the necessity for companies to navigate these challenges strategically to ensure stable energy costs and contribute meaningfully to renewable energy initiatives.

If you´d like to skip ahead and access the full content, you can download the White Paper that goes into the full detail on PPAs and their place in the Corporate energy market.

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