Power Purchasing Agreements
Cheap but Risky Long Term
Energy Supplies

Strategic Insight Report 29/8/2013

An interesting opportunity exists to purchase long-term electricity for about 5p/kWh over 10 – 20 year time horizon using Power Purchase Agreements (PPAs). These are available from new independent renewable electricity generators needing to lock away contracts to underpin their funding arrangements. Many of these new generators are fuelled by anaerobic digestion converting waste in gas which is then used to fire the turbines.

Energy buyers using PPAs typically buy no more than 10-20% of their future electricity requirements in this way in order to spread their risks against the power price dropping. This is done by setting up a flexible purchase contract to sleeve the PPA through an energy supplier. The remaining electricity requirement is then purchased on the forward or spot market, depending on the risk management strategy.

Benefits of Power Purchase Agreements

The long-term 5p/kWh price compares quite well to current forward electricity prices 4.5p to 5.8p/kWh prices available in the market shown below:

 

Strategic Insight Report 29/8/2013
Source: Spectometer 22 Aug 13

The 5p/kWh long-term power prices are also attractive compared to typical long-term renewables business cases which currently assume power prices increasing 6%/year for the next 10-20 years. These assumptions are simply based on power prices having increased 8.5%/year over the last 10 years.

A further benefit of PPAs are the prospects of avoiding some of the environmental charges, although this would require on-site generation or taking the power direct from the generator to avoid it being supplied through the transmission and distribution network.

These benefits need to be weighed against substantial risks. The main risk is being locked into high 5p/kWh power prices prior to market prices falling to lower levels. A long-term downside risk driver is a system supplied by more subsidised renewable and nuclear electricity, especially with UK targeting 15% of electricity demand to be supplied by non-fossil fuels by 2020 up from 3% today. The problem with subsidies is they distort the economics of price setting. Rather than the cheapest most efficient generators bidding most competitively to secure dispatch, subsidised generators will have incentive to bid aggressively for dispatch in order to secure their subsidy. In fact we have run analysis which demonstrates that during the night renewables and nuclear could compete for dispatched at negative prices, so effectively paying energy users to consume electricity so they receive their subsidy.

Germany is a perfect example of this market dynamic with forward prices currently trading as low as €3.5c/kWh and negative prices during the night. These prices have been driven by solar and renewables with up to 30% of market share during daylight hours. Despite low commodity prices, end user prices have still gone up to about 12.5p/kWh due to 5p/kWh subsidy to fund the renewable generators.

There are other risks involved with long-term commercial arrangements which are inherently risky and should be treated with care and consideration. Risks include

  • Credit risk that Independent generator could go into administration. The energy buyer would then have to replace the long-term supply with potentially much higher forward/spot prices. The independent generator will face regulatory risks in addition to its own customer credit risks.
  • Energy buyer business could change or energy requirements could change. This could result in high take-or-pay/compensate costs being incurred.
  • Difficulties of managing a long-term commercial relationship with a monopoly supplier resulting from having locked into a 10-20 year supply contract with a single energy supplier and broker,
  • Technological development. Power prices could fall rather than rise. By its nature, technological progress can’t be forecasted. However, the historical cost reduction and new opportunities presented from new technologies can be projected forward.

Beond can assist customers who are looking to combine Power Purchase Agreements (PPAs) with their long term risk management strategy.

We provide risk services workshops to explore your risk appetite for flexible purchasing contracts with PPA’s .

We offer transparent tenders that compare all energy supplier offers on a like-for-like basis and advise on how to incorporate 5-10% of your energy requirements into a long term hedge.

Our risk management services provide a broader range of hedges to manage the commodity price volatility whilst our technology services provides advice on how to avoid increases in the environmental charges by reducing energy usage.

We also retain expertise to assess energy efficiency tenders, on-site renewables projects, assesses financial model assumptions and project manages the installation via our network of consultants, that focus on innovative thinking.