Is now the right time for PPAs?
by Stuart Kirk
A growing number of large UK Commercial & Industrial users of power have signed long term (15-20yrs) Power Purchase Agreements (PPAs) with renewable generation.
These companies include McDonalds, HM Government, BT, HSBC, Lloyds, M&S, Sainsbury and Vodafone. Large companies, like Unilever, are publicly stating their intention to move entirely to clean power. Following the 2015 Paris Climate Change Conference (COP21), a growing number of companies, large and small, are signing up to RE100 and committing to 100% renewable power. However, very few of these companies will be able to fulfil this with onsite generation and therefore through Grid renewable solutions will certainly play a part in their energy strategy.
This highlights that a transition from fossil fuel based generation to an increasing mix of clean or renewable generation is underway. This isn’t simply about “going green” anymore, it makes business sense, is brand enhancing and results in a premium stock market valuation.
So why are companies acting now on PPAs?
- Energy Prices are at, or approaching, a cyclical low point. It is a good time to consider putting in place long term supply arrangements. No doubt geopolitics and the politics of OPEC will continue to ensure that energy prices remain volatile but a lot of observers are thinking that the risk is to the upside from here.
- Putting in place a long term hedge via a PPA on a proportion of your power supplies makes sense. Whilst we can all Draw graphs from varying data sources on the long term forecast for power prices and get wildly varying results, the profile of a PPA deal is more aligned to the hedging strategy of companies, it is a trajectory that compliments corporate governance rather than seeking to risk the markets.
- The increase of renewable generation capacity in the UK over the last three years, particularly the growth in Solar PV, means that a long term PPA can be put in place to source power from UK renewable generation, securely and competitively.
- However, there is only a finite pool of renewable generation assets that have Renewable Obligation (RO) subsidy. RO will disappear at the end of March 2017. In the meantime, both before 31st March 2016, and before 31st March 2017, a significant amount of additional Solar PV capacity is expected to be built. The opportunity is to put in place a long term PPA on these assets before they are refinanced.
- The key determinant of the price of power achieved under the PPA is the cost of capital. In a negative real interest rate environment, very large pools of long term capital (life insurance and pension funds) are looking to achieve positive real returns and surety of long term cash flow. The more credit-worthy your company is as an offtaker, and the longer the period of the PPA, the greater the surety of cash flow and the lower the cost of capital that can be achieved.
- A premium to wholesale power prices is required to put a PPA in place. Recent market knowledge and experience suggest that long term PPAs, with credit-worthy counterparties, can be put in place at circa £47-49/MWhr. This is index-linked. It is important to stress that each PPA will be specific to the counter-parties concerned and that a negotiated process is required to achieve this.
- Why is it worth paying more for a PPA when the wholesale power price is well below this? The simple answer is because energy prices are forecast to rise over the longer term. And there is a cost to having a long term hedge in place. Lastly, under most current hedging arrangements it is usually not possible to achieve more than a rolling 2-3 year hedge. All of the DECC electricity price forecasts are for prices to rise between now and 2030. Only in the low-case forecast do they dip until 2020.
- It is important to note that the wholesale price of electricity is not the complete story in determining your unit price. There is far more impact on the other associated costs such as transmission charges, distribution charges and carbon taxes that make up the price on the bill and these will not be protected by a PPA. Furthermore, your supplier may well insist on a balancing charge as part of a “sleeving agreement” to manage the actual power supply from this PPA. This should not put you off seeking such arrangement, but they are factors that need considering when agreeing a price structure.
Decision making levers:
- PPAs will not beat wholesale price today, but may very well be favourable in the future.
- PPAs are often measured against wholesale price, but should be measured against a hedged position.
- On site generation is more favourable to offset the “other costs” on the energy bill, but it requires space, capital and long term planning.
- PPAs are available now and are currently under pressure from a low market, benefitting the off taker.
- PPAs are a quick route to green energy.
- Many Blue Chip companies are adopting this approach, what are they seeing?
- PPAs through Solar PV generation assets match peak load demand which may well be considerably higher than wholesale price for some companies.
- The reduction/removal of Government incentive funding for renewable investment is creating a limited stock of green energy generation assets at present.
- The PPA solution does require a long term business view.
Going green makes business sense and results in a premium stock market valuation. A long term PPA on renewable assets for a proportion of your supply allows you to achieve this. However, there is a finite pool of RO assets to which long term PPAs can be applied, and a negotiated competitive process is required to achieve the lowest cost of capital and the best power price. So, the message is, if your Board of Directors is intending to go green, don’t delay with starting the negotiation for a long term PPA.
If you wish to learn more about power purchase agreements, please contact Stuart Kirk at firstname.lastname@example.org or on 0800 0016596.
Stuart Kirk is an experienced energy manager, owner of Enerlyse Ltd and a board member of Energy Managers Association. He is a qualified ESOS Lead Assessor and RICS chartered surveyor. Stuart also undertakes training for the Energy Managers Association and RICS.