A power purchase agreement is an arrangment between usually two parties – the host and a services provider – whereby the host allows the provider to install a renewable energy system on its property and agrees to purchase the power generated by the system for a specific time frame, usually around 20 years. The host does not own the system. PPAs are used for solar and wind installations, with solar being the most prevalant by far. I have heard that geothermal transaction of this type was is in the works, if not done already. The power created by the system is used by the host, who has the right to sell any excess power created above and beyond the host’s needs to the local utility.
The price paid for the power is generally lower than what the host would pay to the utility, and there is always a price escalation clause – which can be pegged to a formula using GDP, inflation or some other factor. This is important to the services provider so that they can roughly estimate their revenue stream. There are important provisions relating to the cost of the power which will be discussed in later posts.
There are other parties to the transaction – which sometimes are needed and sometimes not. As stated before, the utility plays an important role by purchasing the excess power generated. The utility can provide for the interconnection to the grid as well as net metering in areas where available. Alternatively, if the utility does not perform these services, the services provider can enter into an Interconnection and/or Net Metering Agreement with the utility.
The solar services provider usually purchases the equipment from a third party manufacturer (there are a lot of Chinese manufacturers, but there is tension brewing on this topic), and will either install the equipment itself, or engage a third party installer. If a third party installer is used, then there is usually an agreement as to which party will maintain the equipment.
Now the most important issue – who pays for everything up front? Except for service providers that can fund transactions on their own, there is an investor involved that will provide the services provider with the funds to get the deal together and the initial installation in place. They are a few ways to structure it, but the investor, like all investors is attempting to get a nice return over his investment horizon while minimizing risks.
Sometimes the host will, instead of contracting with the services provider directly, form a subsidiary special purpose entity (usually an LLC) to handle the obligations and distributions of credits/funds over the life of the agreement.
Where and with Who?
The services provider is only going to consider an installation that is large enough to allow it to recoup its costs. This generally is a commercial installation over 40kW. There are transactional costs that accompany getting a PPA in place, as well as myriad other up front costs. Most of these are inelastic, in that they don’t change from installation to installation (except for the scale of each installation).
PPAs are only really available in states that have authorized such transactions, or also in states that have not dissallowed them. Some states have passed authorizations for PPA’s to be used in any industry, some states have explicity stated that they can only be used in certain industries, some states have laws which seem to or do prohibit them, and some states have taken no official position – see the DSIRE site for a map showing this. New York has officially approved the PPA structure, see NY Public Service Law section 2.13.
Why do it?
There are a number of benefits to such a transaction for all parties involved. The host benefits from minimal up-front cost, lower energy costs on day one, no maintenance responsibilities, an increase in property value, and it can benefit if it is seeking green building certification. Service providers benefit by obtaining a revenue stream over a longer period of time. Also, depending on what state you are located in, there is the potential to cash in on RECs, SRECs, or Green Tags and other federal and state incentives/credits which can be a huge benefit for the services provider – or whoever else receives the benefit of these Credits/Certificates under your agreement. Investors benefit by recouping their investment. Overall, the benefits include lowering dependency on traditional energy sources, and of course, job creation.
While the benefits generally outweigh the negatives, there are things to consider. For the host, there is the possibility the installation does not create enough power to supply its needs – then it would have to purchase power from the utility. Also for the host, there are some costs to be weary of, mainly related to negotiating the PPA and any increases in property taxes due to the system. The service provider and investor are essentially betting that the host will remain in business over the life of the PPA, which in the current economic times are difficult to judge.
Something always negotiated in the PPA are the allocation of the downside risks. Neither the host nor services provider (usually pushed by the investor) want to indemnify the other side for any damages. Also there is the risk of force majeure and liability for system dowtime. These are hot button issues which must be addressed.
All in all, the PPA structure has a lot to offer and should be looked into by any large commercial or industrial operator with room to spare at its facility or on its roof. Those that use a large amount of electricity stand to benefit the most. The PPA structure is also a great driver of sustainable energy practices and renewable energy sources, as multiple parties stand to benefit.