What are Power Purchase Agreements (PPA)?

Power Purchase Agreement literally means ‘electricity purchase agreement’. The abbreviation PPA is usually used.

A PPA is a long-term contract between an electricity producer and an electricity consumer. The contract regulates the supply of a quantity of electricity at a fixed price and over a fixed period of time. In principle, PPAs are technology-neutral, but this type of contract is usually used for the sale or purchase of electricity from renewable energy sources. PPAs are therefore often also referred to as green PPAs.

For producers, a PPA is a way of agreeing the purchase of their electricity from renewable energy plants and thus securing the investment. PPAs are used for follow-up financing for plants that are no longer subsidised under the EEG. In contrast to subsidy mechanisms such as the Renewable Energy Sources Act (EEG), a PPA is therefore a market-based, flexible and customised financing instrument.
For customers, a PPA is an opportunity to secure PPA electricity from renewable energies at a fixed price. This enables companies to achieve two things: firstly, it reduces their risk of having to pay fluctuating wholesale electricity prices, and secondly, a wind PPA or solar PPA improves the company's carbon footprint.

As a PPA is an individual contract between the producer and the buyer, they have to negotiate many individual contract components. These include

• Term: With a PPA, a buyer purchases electricity at a fixed price over a specified period of time, often 5-20 years.
• Price: The price can be fixed for the term and is calculated from the market value and expectations regarding price developments on the futures markets. The PPA is then called a fixed PPA. If a PPA is linked to the exchange price, it is called a variable PPA or floating PPA. Post-EEG plants in particular are often remunerated flexibly on the basis of spot prices or monthly market values, as this approach reduces the risks and obligations of the contracting parties.
• Origin of the electricity: In the case of actual physical delivery, the PPA is concluded for specific plants, such as a wind farm or solar park. In this case, it is referred to as a physical PPA.
• Delivery: If it is a financing instrument without a direct flow of electricity, the contract is referred to as a synthetic PPA or virtual PPA.
• Further details: In addition to the term and pricing, a PPA regulates details such as the distribution of risk and the characteristics of the electricity. It is usually a wind PPA or a photovoltaic PPA.
   

As with many things, the biggest advantage of PPAs is also their biggest disadvantage: due to their individuality and flexibility, they offer an extreme range in contract design. The partners must take into account general energy law, the EEG and civil law, as well as the development of state regulation.
It is also difficult to predict market developments, estimate fluctuating generation and calculate prices accordingly. It is therefore advisable to hedge the PPA with electricity forwards and other hedging strategies.
The European Federation of Energy Traders (EFET) has developed a PPA model contract that contains common clauses and formulations. This framework helps to define the classic factors such as purchase quantities, delivery times and prices, as well as regulating things like behavioural rules, maintenance obligations and termination clauses.

There are different ways to designate PPAs. The flow of electricity, the location of the plants and the customer-supplier relationship all play a role.

Greenfield PPAs and green corporate PPAs

Greenfield PPAs are usually referred to as wind PPAs or photovoltaic PPAs where the contractual partner is an electricity producer.

Green corporate PPAs are usually referred to when a wind PPA or photovoltaic PPA is involved in which the contractual partner is an electricity consumer - such as an industrial company or an energy supplier or reseller.

On-Site PPA and Off-Site-PPA

Another distinguishing feature is the location of generation and offtake. In the case of an on-site PPA, the generation plant and electricity consumer are located close to each other. In this case, electricity is supplied directly; the public electricity grid is not used. This is the case, for example, when a solar plant is located directly on the premises of an industrial company.

In the case of an off-site PPA, the public grid is used to supply electricity. Balancing group management is therefore necessary here. If an energy service provider handles the PPA and takes on various services such as forecasting, balancing group management, marketing of guarantees of origin or risks, the PPA is also referred to as a sleeved PPA.

Physical PPAs, direct PPAs and virtual PPAs

Physical PPAs and direct PPAs are bilateral contracts between the producer and the buyer in which the producer supplies the electricity directly to the buyer. No electricity is fed into the public grid. This is usually the case when the generation plant and the point of consumption are in close proximity to each other. The term is also used synonymously with on-site PPA.

Virtual PPAs, synthetic PPAs or financial PPAs are contracts in which the electricity is not physically supplied. The electricity producer and consumer are in different price zones or balancing groups and the physical flow of electricity is decoupled from the financial cash flow. PPA electricity is traded in the traditional way, for example on the electricity exchange: a PPA provider is usually involved who sells the electricity produced. The same amount of electricity is purchased for delivery. The quality of the electricity supply - for example green electricity - is characterised by guarantees of origin.
 

An operator of a renewable energy plant should prepare well for the conclusion of a power purchase agreement. Firstly, they must compile the facts about the plant, such as the output in MWp, the coordinates of the site, the planned commissioning and the desired contract term. In addition, a decision on the articles of association and a building permit should be available.
 

With this data, he can first clarify the financing of the project: Banks can assess the profitability of the project and make financing offers. As a service provider, a PPA company can provide an initial price indication for the remuneration.
 

As the project progresses, the operator must ensure that the systems can be controlled remotely. He must also set up an account for the guarantees of origin with the register of guarantees of origin at the Federal Environment Agency.

PPAs vs. other financing models

In addition to PPAs, there are other financing models for renewable energies. These include

• Feed-in tariff: In Germany, the Renewable Energy Sources Act (EEG) was introduced for this purpose. This is based on a feed-in tariff, under which operators of renewable energy plants receive a guaranteed payment for the electricity they feed into the grid.
• Tax incentives and loans: Governments can make the expansion of renewable energy systems attractive through tax incentives such as depreciation or investment allowances. Favourable loans from state or state-subsidised banks (e.g. KfW in Germany) are also among the funding instruments.
• Venture capital and private equity: Venture capital is also an important source of financing for start-ups and innovative technologies in the field of renewable energies.
• Crowdfunding and citizen energy cooperatives: These models enable private individuals to invest in renewable energies, even with small amounts. Citizens' energy cooperatives allow members to participate in the financing of plants.
• Support programmes and subsidies: In addition to the models mentioned above, there are various funding programmes and subsidies offered by the EU, the federal government, the federal states or local authorities. These can include grants, low-interest loans or other financial support.

What is the difference to EEG remuneration?

There are many differences between Power Purchase Agreements and the EEG tariff. The most important points include

• Regulation vs. market: the EEG tariff is a state-regulated subsidy that is defined by laws and state requirements. PPAs, on the other hand, are private-sector contracts that are negotiated between two parties.
• Pricing: In the case of EEG remuneration, the price is set by the state, whereas with PPAs it is determined by negotiations between the parties.
• Flexibility: PPAs offer more flexibility in terms of contract conditions. EEG tariffs have fixed framework conditions that are the same for all participants.
• Access: The EEG tariff is open to all qualified renewable energy producers. PPAs, on the other hand, require the ability to find a suitable contractual partner and reach an agreement.
• Risk: With PPAs, the risk lies with the contracting parties, for example if electricity prices develop differently than expected.
   

Overall, both mechanisms complement each other. They offer different incentives and financing options for the generation of electricity from renewable energies and thus contribute - each in its own way - to the success of the energy transition in Germany.

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