The evolving landscape of power purchase agreements (PPAs)

Introduction

Power Purchase Agreements (PPAs) are increasingly essential for companies committed to sustainability and navigating the energy transition. Once the domain of large industrial players, PPAs are now critical tools for businesses of all sizes seeking to secure renewable energy and meet ambitious decarbonization goals.

In the context of growing corporate responsibility and volatile energy markets, PPAs offer a strategic pathway to not only stabilise energy costs but also drive innovation and resilience.  This article delves into the evolving role of PPAs in supporting these  goals, offering practical guidance alongside strategic insights.  It takes the different perspectives of the authors from covering Sustainability Consultancy, Impact Startups, Multinational Corporations and the Global Energy Sector Forums. Through real-world examples and forward-looking analysis, it highlights how businesses can effectively leverage PPAs to lead in the energy transition, creating value while contributing to a sustainable future.

What are PPAs and how are they sold?

Power Purchase Agreements (PPAs) are not off-the-shelf solutions; they are transformative projects that need to be customised to local regulations, market dynamics, and strategic objectives.

With a PPA, the buyer receives green energy from a renewable energy installation and certificates that verify the origin of this energy. For every megawatt-hour (MWh) produced, the buyer is issued certificates that confirm the electricity was generated from a specific renewable energy source. These certificates are crucial for Scope 2 greenhouse gas emissions reporting.

Types of PPAs:

1. Physical PPAs: In a physical PPA, both the energy producer and the buyer must be within the same electricity market or in interconnected markets to allow for the physical delivery of electricity. For every purchased MWh, the buyer also receives a certificate, which can be used for Scope 2 reporting under the GHG Protocol.

2. Virtual PPAs: Unlike physical PPAs, virtual PPAs do not involve the physical delivery of electricity; the buyer does not take ownership of the electricity. Instead, it is a financial contract that locks in a fixed price. Despite this, the buyer still receives certificates for each MWh, verifying that the energy originated from a specific renewable source, which can also be used for Scope 2 reporting.

Additionality in PPAs: Organisations that opt for a PPA with additionality commit to purchasing energy from a new renewable energy project at a fixed price. This commitment positively influences investment decisions, facilitating the construction of new renewable energy projects and increasing the supply of green energy to the grid.

contract structures:

1. Fixed-Volume PPAs: In this type of contract, the energy producer agrees to deliver a predetermined amount of electricity over the contract period at a fixed price per MWh. If actual production falls short of the agreed volume, the shortfall is settled at the market price. Fixed-volume PPAs generally have higher prices due to the producer bearing the risk of underproduction. The most common delivery interval is hourly ("Baseload"), where producers can achieve higher prices because of the strict hourly delivery commitment. Flexible delivery profiles, such as quarterly or annual intervals, can also be arranged, though they are less common and typically come with lower prices than Baseload contracts.

2. Pay-as-Produced PPAs: In a pay-as-produced contract, the buyer agrees to purchase the energy produced, either in whole or in part, at a fixed price. The producer, therefore, does not bear any risk related to the production volume or profile. These contracts are less common than fixed-volume agreements, as the buyer assumes the risk of underproduction. Pay-as-produced contracts are suitable for nearly the entire P50 production but generally have lower prices compared to fixed-volume contracts. This is why most companies chose PaP-contracts.

(P50 and P90 are probability metrics used in energy generation forecasting. The P50 figure represents the average expected generation, indicating that the project's output is forecasted to exceed this level 50% of the time throughout its lifespan. In contrast, the P90 figure reflects a more conservative estimate, showing the level of generation expected to be exceeded 90% of the time over the project's life.)

Pricing Considerations: The expected price in these contracts depends on the risks assumed by the buyer. While Baseload contracts typically offer a discount ranging from 11% to 17%, pay-as-produced contracts can see discounts between 16% and 26% (Source: Aquila Capital).

An innovative model that enables smaller companies to enter into a PPA is a multi-buyer PPA. Multi-buyer Power Purchase Agreements (PPAs) are an innovative solution that allows multiple companies to combine their energy demands and collectively purchase renewable energy through a shared contract. This approach is particularly advantageous for smaller companies that may lack the financial resources or expertise to enter into a PPA independently. By aggregating their needs, these companies can benefit from economies of scale, which significantly lowers procurement and financing costs. 

Moreover, multi-buyer PPAs provide easier access to renewable energy by sharing the complexities and due diligence processes among participants. This collaborative model also offers the advantage of diversification, allowing companies to spread their energy procurement across multiple projects, geographic locations, and renewable technologies, thereby reducing risks associated with relying on a single energy source.

Beyond the financial and operational benefits, multi-buyer PPAs enable companies to make significant strides in their sustainability goals. By working together, they can tackle Scope 3 emissions and extend their decarbonization efforts across their entire supply chain. This collective approach not only amplifies their environmental impact but also aligns with broader sustainability objectives, making renewable energy more accessible and impactful for businesses of all sizes.

The role of PPAs in advancing the energy transition

Power Purchase Agreements (PPAs) have become essential tools for companies seeking to drive the energy transition and embed sustainability into their operations. These agreements not only provide a stable source of renewable energy but also align financial performance with environmental goals, particularly as regulatory pressures, like the Corporate Sustainability Reporting Directive (CSRD), intensify. By locking in long-term renewable energy contracts, companies can mitigate energy price volatility while enhancing their sustainability credentials, thus meeting both investor and consumer expectations.

PPAs are catalysts for innovation, pushing companies to explore new technologies and operational models. For example, Philips’ partnership with Cero Generation on an agrovoltaic project in Italy exemplifies how PPAs can serve dual purposes—generating renewable energy while supporting local agriculture. Similarly, the PPA between Statkraft and H2 Green Steel showcases how such agreements can drive decarbonization in traditionally carbon-intensive industries, paving the way for a low-carbon future.

However, the increasing demand for PPAs presents challenges, including higher costs and competition for renewable resources, particularly affecting small and medium-sized enterprises (SMEs). To navigate these challenges, businesses must view PPAs not just as procurement tools, but as strategic investments in sustainability and resilience. Engaging with startups and innovative technologies, like Microsoft’s PPA with Helion Energy for nuclear fusion, highlights the need for foresight in securing future energy needs.

PPAs are crucial for companies committed to leading the energy transition. By strategically leveraging PPAs, businesses can enhance their sustainability performance, drive innovation, reduce risk and increase competitiveness as they position themselves as leaders in the race to decarbonize.

Case studies and real-world examples: Combined effort

Real-world examples of Power Purchase Agreements (PPAs) reveal the diverse approaches and outcomes achieved by companies across various industries. Philips, for instance, has been proactive in using PPAs to secure renewable energy while supporting innovative projects. The company’s vPPA with Neoen, which involves a 126 MW wind farm in Finland, not only powers its operations but also exemplifies strategic industry collaboration, with partners like Heineken and Signify. Additionally, Philips’ agrovoltaic project with Cero Generation in Italy demonstrates how PPAs can combine solar power with agriculture, benefiting both sustainability efforts and local communities.

PPA’s play are not only a driving force for expansion of existing technologies but also for creating and accelerating innovation. They are likely to become critical for potential game-changers such as Hydrogen, Floating Wind, Solar Fuels, Tidal Power, Nuclear Fusion, Enhanced Geothermal Systems and Wave Power.  This is demonstrated by Startups making significant strides in the PPA space. Eco Wave Power, for example, has signed a PPA with Israel’s National Electric Company to provide wave-generated electricity, highlighting the potential for new renewable sources to diversify energy portfolios. Similarly, Statkraft’s PPA with the  startup H2 Green Steel showcases how tailored agreements can drive significant decarbonization in heavy industries, with H2 Green Steel’s 800MW electrolyser creating green hydrogen making its steel production reduce emissions by 95% compared to traditional methods.

These case studies illustrate key lessons: the importance of strategic collaboration, the value of investing in emerging technologies, and the need to diversify energy sources to enhance sustainability and resilience. By learning from these examples, companies can better navigate the complexities of the PPA market and achieve their sustainability goals.

Why now is the time for PPAs: Key factors driving the urgency

Rising demand for clean energy

The demand for clean energy is on an upward trajectory, with significant drivers across various sectors. The rapidly increasing needs of data centers, fueled by the explosion of AI applications and cryptocurrency mining, are set to push energy consumption to new heights. 

In Europe, despite a slow recovery in electricity demand following the energy crisis, the war in Ukraine, and sluggish industrial growth, the International Energy Agency (IEA) projects an average annual growth in electricity demand of 2.3% from 2024 to 2026. This anticipated increase is paralleled by growing corporate interest in Power Purchase Agreements (PPAs), with 2024 expected to see a significant rise in procurement activities, also due to CSRD pushing companies to decarbonise. As competition for renewable energy capacity intensifies, we can expect this to drive up prices, making it crucial for corporate buyers to act quickly to secure favourable terms.

In the United States, the Federal Energy Regulatory Commission (FERC) forecasts that national electricity demand will grow by 2.6% to 4.7% over the next five years. Grid Strategies suggests that these figures may even be conservative, with additional capacity likely to be added in upcoming forecasts. With the 2030 sustainability goals on the horizon, more corporate buyers will enter the PPA market to meet their commitments, further increasing demand and, consequently, the cost of securing renewable energy through PPAs. Early movers stand to benefit by locking in better prices before the rush intensifies.

High cost of capital for project developers

Despite anticipated reductions in the cost of capital due to lower interest rates and government subsidies—such as those provided by the Inflation Reduction Act in the U.S. and the EU’s Energy Market Reforms—the gap between available capital and the investment needed to meet decarbonization targets remains vast. The Boston Consulting Group’s Center for Energy Impact estimates an $18 trillion capital shortfall between current commitments and the investments necessary to achieve net-zero goals by 2030, with the electricity and end-use sectors accounting for 90% of this deficit.

This capital scarcity means financial institutions can afford to be highly selective, favouring projects with low-risk profiles and strong financials. While gradually declining interest rates and subsidies will provide some relief, capital costs in the renewable sector are expected to remain elevated. Given the capital-intensive nature of wind and solar projects, these factors will continue to exert upward pressure on project development costs, making it unlikely that PPA prices will decrease significantly in the near future.

Interconnection bottlenecks limiting new project development

Interconnection delays are a significant barrier to bringing new renewable energy projects online. In Europe, countries like Spain and Italy face interconnection queues exceeding 150 GW of planned renewable capacity, while in the UK, some projects face decade-long waits for grid connection. These bureaucratic hurdles and administrative inefficiencies present a significant challenge to developers and PPA buyers alike, with policy reforms still years away from making a meaningful impact.

Given these constraints, buyers must adopt a realistic outlook on future market supply and prioritise sourcing from mature projects that have already cleared major development hurdles, such as securing interconnection agreements. While average market prices for PPAs may see slight declines in the near term, prices for advanced-stage projects with a high likelihood of delivering on time will likely remain at a premium. Therefore, securing PPAs from such projects now could be critical for organisations aiming to meet their sustainability targets without delay.

Future outlook: Critical opinion and future trends

The future of Power Purchase Agreements (PPAs) is set to be shaped by regulatory changes, market dynamics, and technological advancements. As frameworks like the Corporate Sustainability Reporting Directive (CSRD) and the Inflation Reduction Act drive higher standards for corporate environmental responsibility, the demand for PPAs will likely increase, leading to more competition and potentially higher costs for renewable energy. This trend could challenge small and medium-sized enterprises (SMEs), which may need to collaborate with others to access PPAs.

Technological innovation will be crucial in addressing these challenges. Advances in renewable energy sources, such as solar, wind, and battery storage systems, will expand the possibilities for PPAs. Emerging technologies like hydrogen, carbon capture, and e-fuels will further diversify the energy landscape, offering companies new avenues to meet their sustainability goals. 

However, the increasing integration of renewable energy poses challenges for existing grid infrastructures. As more PPAs are signed and more renewable projects come online, the strain on grids could lead to inefficiencies and delays. Investments in grid modernization and expansion will be essential to ensure that the energy generated under PPAs is effectively utilised.  The growing integration of renewables is also transforming Power Purchase Agreements (PPAs) into key financial instruments for energy traders. As renewable energy introduces variability and risk, traders increasingly may use PPAs to hedge against price fluctuations, stabilise cash flows, and capitalise on green energy premiums in volatile markets, enhancing financial strategies.

To stay ahead in the evolving PPA market, companies should invest in innovation, diversify their energy sources, and collaborate with others to enhance their buying power and access to PPAs. They should also advocate for grid improvements and stay informed about regulatory changes to adapt their strategies accordingly. The PPA market offers significant opportunities for companies to lead in sustainability and resilience, but it requires proactive, strategic engagement with the complexities and innovations of the energy transition.