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Risk mitigation & management in Power Purchase Agreements

June 8th, 2024
Wind farm on a farm

PPAs are a legal contract between a renewable energy project owner and an energy buyer - they are beneficial to both, as the renewable energy producer receives fixed financing for the lifetime of their project, while an energy buyer can contribute to projects that reduce carbon emissions. They can take many forms, including more rigid, fixed PPAs or more flexible hybrid or floating, but all come with their own risks. Here we explore the risks associated with PPAs and the best way to address them.

Balancing Risks and Benefits in PPA Negotiation

What is risk when it comes to PPA contracts, and how can you negotiate your contract to balance the risks and benefits? When we talk about risk in relation to PPA, one of the most prominent risks is forecasted generation vs. actual generation. Below we explore the types of variables that can be present in this element of a PPA.

Volume risk

Renewable energy can fall prey to a number of variables because of the nature of how the energy is generated. Solar, for example, relies on direct sunlight, whereas as wind relies on certain meteorological conditions to generate energy. These periods of generation can vary over time, for example, wind generation might be higher one year from the next dependant on weather conditions. Pay-as-produced PPAs land this risk on the buyer.

Profile or shape risk

A third party can be chosen to fill in the gaps in energy outage during hour-to-hour generation, which can change depending on things like daylight hours or wind speed during a particular period. Factors like operational or non-operational days can also have an impact on this risk element. 

Identifying Risks & Strategies for Risk Mitigation and Assessment

When entering a PPA, it’s vital you identify and assess potential risks associated with the contract. Renewable energy PPAs can potentially carry more risk than traditional energy sources, which could be beneficial, or not, so appointing further specialist advice around the following risks is advisable:

Increased energy prices

The energy market had seen spikes in the cost of energy over the previous years, making fixing with a longer-term PPA a more sensible option. Floating PPAs, which can rise and fall with energy prices may be riskier option, however. 

Volatility with pricing

As the market changes and volatility is present in the pricing structures, other market conditions can cause original PPA pricing to fall short of pre-agreed prices. 

Insecure energy supply

The nature of renewable energy that supply PPAs is that the energy supply is not as secure as traditional energy sources. This may create some insecurity with potential supply. 

Impending net zero targets and time restrictions to meet them 

Many businesses are entering PPAs because of approaching carbon emission reduction targets, a PPA may help them to achieve these goals. As these targets approach, longer-term PPAs may miss these deadlines, so it’s important to factor this in when negotiating the length of PPA.

Policy and Regulatory Risks

With such a changing market, policy and regulatory guidelines are regularly changing. Make sure you keep abreast of future changes to policies and regulations to try and mitigate risk before your PPA is finalised. 

Tools for Risk Mitigation in PPA Contracts

Entering a PPA comes with risk, so it’s always vital you seek expert advice before entering one. There are many options you can explore when it comes to potentially mitigating the risk of your PPA, so make sure you discuss the following options with your adviser: 

Hedging contracts

Hedging contracts are a financial tool that can help to off-set a PPA buyer’s risk to market volatility or price fluctuation, mitigating risks to market volatility.

Diversify your energy portfolio 

Investing in one type of energy for your portfolio could put all of your risk in one place. Rather than putting all of your eggs in one basket, a PPA that includes a combination of energy types, such as a bundled PPA, can allow you to spread the risk over several different types of energy sources, including traditional types of energy such as coal. 

Prior research

Doing prior research to any PPA contract is vital, and this includes researching your potential renewable energy provider’s credentials. The factors you choose to look at may include the long-term viability of the project, financial health and any previous past performance.

Flexible contracts

Negotiating a PPA that is flexible in its terms in relation to market environment and changing policies may help to tackle market volatility and the associated risk. This could include amendments to the contract throughout its lifespan.

Case Study in Effective PPA Risk Management: LevelTen

One of the key issues with taking out a PPA is the complex nature of PPA contracts. There are several different types of PPA structures your potential PPA could follow, and each has its own sets of nuances depending on the type of contract chosen. The key different types of PPAs you might opt for include: 

  • Fixed 

  • Hybrid 

  • Floating

  • Market following 

  • Bundled 

The risk associated with complexity of contract can relate to a number of factors but could result in large financial losses if not approached correctly. Certain software providers have purpose-built systems to deal with PPAs to aim to mitigate these risks, including LevelTen. LevelTen software avoided their client a costly $70,000 loss that would have occurred due to an accounting system, by providing an overview of their PPA in an easy-to-view dashboard. This type of tool can help PPA clients in the following areas:

  • Identified a human accounting error in the PPA system that could have cost their client $70,000

  • Software helps to reflect historical and future PPA performance 

  • All project data feeds into one dashboard for easy overview tailored to the terms of your PPA

Talk to an expert about managing PPA risk