Navigating the ups and downs of the Power Purchase Agreement (PPA) market: how to set your company up for success

The trend for global corporate PPAs transactions has been positive for over a decade. Growing awareness of the tremendous benefits of PPAs – from achieving corporate reduction targets to hedging against price volatility – has attracted more corporate buyers, resulting in consistent year-on-year growth of transactions.

Businesses have been able to use PPAs as the centrepiece of their scope 2 reduction strategy, whilst also benefiting from the long-term electricity price certainty they provide.

During the past two to three years, however, energy markets have experienced unprecedented volatility. The disruptive effects of the global COVID pandemic at the start of 2020, which led to significant demand destruction and historic low energy prices, was followed in 2022 by historic high energy prices as a result of Russia's invasion of the Ukraine and the resultant loss of Russian gas to Western Europe. Never before in Europe have energy buyers been exposed to such significant price swings in such a short period of time.

A rise across commodity markets has meant rising costs for renewable energy project developers, who have been forced to pass on these cost increases to buyers, causing considerable disruption to PPA markets. Consequently, PPA prices have increased significantly across all regions in the past 12 months. According to LevelTen's price index of average PPA prices, prices increased by 23% for wind and 37% for solar in Europe in the period from Q1 to Q3 2022. In North America across the same period, prices increased by 14% for wind and 16% for solar.

What are the main factors influencing the changing PPA landscape?

• The increasing challenge and cost of sourcing raw materials – and freighting them. Between Q1 2021 and Q1 2022, the cost of the commodities required to manufacture key components across wind and solar projects increased dramatically. Aluminium doubled in price, PV grade polysilicon quadrupled in price, steel rose by more than 50%, copper by more than 70%, and the cost of transporting anything from China increased five-fold.
• The ongoing volatility of the commodity market. The cost of constructing new-build projects has been heavily influenced by the ongoing volatility of the commodity market. As developers typically only procure key components once the corporate PPA is agreed and the financing is in place, it has been extremely challenging to source fully fixed PPA price offers.
• The rising cost of debt. New-build projects have also been exposed to the rising cost of finance, which is tightly linked to the price at which the project is able to sell energy. A rise in borrowing costs from banks has pushed PPA prices higher because project finance is typically required.
• The PPA permission and connection procedure is taking longer and longer. The protraction of this process is a problem even in liquid PPA markets, as a result of COVID backlogs and increasing project applications.
• Changes to the supply and demand profile. More and more buyers are interested in PPAs as a way to manage their long-term energy costs and hedge against uptrending energy prices.

Growing corporate interest in PPAs, coupled with the recent energy price shocks, have pushed the market to flip from a buyers market to a sellers market. PPA buyers are being forced to re-evaluate their sourcing approach to make sure that the time and effort they invest has the best chance of success. In today's PPA markets, more than ever before, full preparation prior to formal market engagement is critical – this is the key to making the process as expedient and efficient as possible.

Although PPAs still offer the potential to beat the market, based on comparisons with long-term energy price forecasts, buyers should bear in mind the following challenges and imperatives:

• The price validity of PPAs is considerably shorter. Developers are currently exposed to changing market conditions, meaning the price at which they are able to offer PPAs is changing much more often. Buyers have to be more agile and make decisions more quickly in order to secure project exclusivity, else they risk losing the project to another corporate buyer – of which there are many.
• Buyers have to be better prepared. Critical 'go or no go' topics, such as accounting implications and credit requirements, need to be squared prior to releasing a tender, to ensure that the tendering process is not held up.
• Stakeholders need to be educated. They also need to be included in the earliest stages of the discussion. Stakeholders should have an understanding of the risks and benefits of a PPA and be in a position to contribute to the decision-making process that will inform the strategy. This should all happen prior to the tender, not during, as developers become less patient and are liable to engage with other buyers and/or retract their price offers if the process loses momentum.
• Buyers have to be decisive. Buyers need to agree on the commercial strategy with senior stakeholders before they release the tender. Getting clarity on any financial 'red flags' (e.g. credit provisions) and acceptable business case thresholds will allow buyers to better evaluate which projects meet their internal price expectations and will streamline the tendering process for both the buyer and the seller.

How can PPA buyers best address these challenges?

Getting everything ready before you release a formal tender is key. First, ensure your internal stakeholders are educated about the various PPA types and pricing structures available, as well as the risks and opportunities associated with them. Any potential hurdles presented by credit provisions and accounting should be weighed up beforehand, and ways to mitigate and manage these challenges should be explored and agreed upon. Furthermore, gathering initial data around project availability, market pricing and the associated business cases across all relevant geographies will help set realistic expectations about what can be achieved during a sourcing process.

Good PPA strategies are led by data: gathering this and completing the commercial analysis before you put out a formal tender is crucial; this enables you, the buyer, to present real business cases and secure provisional approval based on known commercial thresholds or ranges.

Ultimately, being quicker and being able to act more decisively will greatly increase the probability of securing a corporate PPA in these challenging times.