PPA Contracts: Effective Protection for Companies Against Energy Shocks

Compared to the pre-crisis year of 2019, the number of such contracts has increased by almost three hundred percent, and the volume of energy purchased in this way has doubled. Given that significant price volatility is expected in the upcoming period, many analysts believe that the trend of increasing the number of PPAs, especially corporate ones, will continue.

– The signing of corporate PPAs intensified after the energy crisis. Companies seek to protect themselves from future energy shocks in this way. This is precisely the main benefit for the buyer: a stable price of electricity, which allows for good cost planning in the future. Additionally, since these are contracts for the purchase of electricity from renewable sources, companies thus receive a guarantee of the origin of the electricity, which is important for meeting ESG goals, especially for large companies, with the understanding that in the future, smaller companies will also have to meet these goals – explained Mario Klarić, director of Professio Energije, a company that signed a ten-year corporate virtual PPA with HT in 2023 for the delivery of 50 GWh of electricity per year.

Companies most often do not cover their entire electricity needs with such contracts, but hedge a significant portion and thus reduce the risk of volatile electricity prices in the future.

On the other hand, the electricity producer, in this specific case VE Mazin, thus ensures the profitability of the project. Along with companies with very ambitious green goals that are exposed to customers, the largest corporate buyers of renewable energy in Europe are from the industry, ICT, retail, telecommunications, engineering, and technology sectors, i.e., companies for which energy plays a key role in the costs of the goods they produce, and therefore they want to secure at least a certain percentage of their energy needs through PPAs on a permanent basis. For example, last year, Amazon signed the most PPAs, as many as seven, with a total capacity of 1.87 GW (more than the installed capacity of all Croatian wind farms). According to the number of signed PPAs, another IT conglomerate, Google, was second last year, while the ‘silver’ in terms of capacity went to the oil giant Shell.

Sectors with lower margins and strong competition are more hesitant to opt for long-term PPAs that exceed the usual business cycle.

– Contracts are most often signed for five to twenty years. If they enable the construction of a new renewable energy source, then they are long-term, for ten years or more. On the other hand, companies have become accustomed to procuring electricity for shorter periods, up to three years, which is why short-term PPAs, those up to five years, are more acceptable to them. Regarding the correlation with market price, the basis is always the expected market prices, so the first step for both contracting parties in defining the price of the PPA is to predict the price that electricity produced from a specific production facility can achieve on the wholesale energy market during the contractual period. Additionally, the seller wants to maximize the returns from the project and achieve the highest possible price, but certainly not lower than the leveled cost of electricity production, as in that case, the project would be unprofitable. The buyer, on the other hand, aims to stabilize electricity supply costs through the contract, or to reduce them as much as possible to remain competitive – explained Minea Skok, chief researcher in the Transmission and Distribution Department of the Energy Institute Hrvoje Požar.

There are several models of PPAs, but the most common is to contract a fixed price (with or without inflation indexing) or one that is capped on the upper side or both upper and lower sides. If the price is capped on both sides, it means that the buyer will not pay more than the upper limit, or that the producer will not earn less than the lower price. Its amount is influenced by a number of factors, such as the duration of the contract, the profile (volume) of electricity that is the subject of the contract (in a pay-as-produced contract, where payment is based on production, lower prices are characteristic than in a monthly/annual baseload contract), the way risk is distributed between the contracting parties (volume, profile…), and the type of renewable energy sources (solar power plant, wind farm, hybrid facility). For example, in the third quarter of last year, prices in solar PPAs in Europe were 74 euros per megawatt-hour, while those for electricity production from wind approached 100 euros per megawatt-hour.

– Each model has its advantages and disadvantages; the decision is up to the producer who will choose. Contracts with indexed prices allow producers access to the market but also expose them to it. Those with fixed prices transfer the market price risk to the buyer, so the producer receives the same price regardless of the current market price. From the perspective of electricity producers, the decision is most often based on the method of financing projects. Those financed by loans will prefer contracts with fixed prices as they ensure a high possibility of profit, but this limits their potential for a large return in the event of a market price spike. The terms of the contracts vary from one to ten years, with most being short-term, from one to three years – explained Branimir Beljan, regional manager from Danske Commodities, a company that has the largest balance sheet group in Croatia and has signed various types of contracts: with indexed prices day-ahead, baseload, fixed long-term, but also various combinations of these models.

Danske Commodities has signed contracts with WPD’s wind farm Orlice and the wind farms of Professio Energije in the vicinity of Zadar after they exited the subsidized state feed-in tariff.

– vPPA contracts are signed for one year for existing and built renewable energy sources up to seven years, depending on client preferences. Regarding the quantity of energy, renewable energy producers typically contract 70 to 80 percent of the produced energy, while consumers prefer to hedge 40 to 70 percent of their consumption. Prices are most often indexed (price increase for the inflation growth factor) and linked to CROPEX. In principle, consumers also purchase all guarantees of origin for that energy – noted Mladen Šicel, head of the Contracting Department at KOER.

A fixed price of electricity from the perspective of the buyer/consumer sounds appealing, especially in light of the high price volatility we witnessed in 2022. However, Skok warns that signing a corporate PPA, especially for more than three years, carries risks.

– It is possible to notice that due to high and volatile prices in the wholesale electricity market in 2022, some PPAs were signed at high prices (‘panic buying’), and such companies may end up paying prices higher than market prices. Delays in the development of renewable energy sources, e.g., due to reduced availability of supply, and high market prices (increased demand from customers due to high supplier prices) raise PPA prices. High variability, i.e., price instability is not an ideal environment for decision-making and signing long-term contracts. From the perspective of a ten-year horizon, it is complex to forecast prices in the electricity market, so I certainly recommend education and assistance from technical, economic, and legal consultants to prepare for electricity procurement based on PPAs. We are entering a period of prolonged price volatility in the market, which complicates contract signing, but it certainly provides additional motivation to enter into them – concluded Skok.

By all accounts, PPAs are here to stay. There is ample room for their growth as it is estimated that those signed in the last ten years have covered only about three percent of the consumption of the industry and service sectors. Companies’ interest is growing, and the reform of the wholesale electricity market model, which is expected to come into force soon in the EU, should facilitate their signing even for smaller companies, which until now have had limited opportunities to sign them for various reasons (credit rating, complex contracting process, fewer renewable energy offers that would match their consumption). One of the prerequisites for stronger development of PPAs is a greater supply of ready-to-build renewable energy projects in Croatia, which is not yet the case as many have been caught in the jaws of administration.