In recent years, there has been a significant increase in large organizations looking to reduce their carbon footprint. This has led several industrial and multinational organizations to negotiate Power Purchase Agreements (PPAs) directly with renewable energy project producers. PPAs offer organizations significant benefits, but they also come with some disadvantages. Is a PPA the right choice to fuel your corporate sustainability strategy? To help answer that question, we’ve compiled some important information for you to consider.
What is a Power Purchase Agreement and How Does it Work?
A Power Purchase Agreement (PPA) is a contractual agreement between two parties for the purchase of power generated by a renewable energy system, such as solar, hydro or wind power. The third-party generator owns and operates the renewable energy system and sells the system’s electric output to the customer, generally at a fixed rate for a specified duration of time. PPAs are most often a long-term period between 10 and 25 years, but shorter-term PPAs have been gaining traction.
There are different types of PPAs that vary based on the type and location of the renewable energy project and the amount of electricity delivered to the customer. The two basic types of PPAs are physical and virtual (also known as a financial or synthetic PPA).
- Physical PPAs allow a third-party power generator to build, maintain and operate a renewable energy system on behalf of an organization. Physical PPAs can be on-site or off-site. An on-site PPA generates electricity at or close to the place of consumption via a private-use cable. Off-site PPAs generate electricity at a different location, then transmit electricity via the public grid.
- Virtual PPAs allow a purchaser to acquire the renewable energy attributes of a project, rather than the electricity itself. The purchaser continues to receive electricity through the local utility provider but generally agrees to a fixed price with a renewable energy generator.
In both cases, a PPA allows organizations to enjoy the advantages of renewable energy without owning and operating a renewable energy system. In this blog, we focus on physical PPAs and what they entail for businesses exploring this option.
Physical PPA Eligibility
Some state regulations limit or restrict non-utility providers from selling electric power. To be eligible for a physical PPA, a renewable energy project must be located in a state or jurisdiction where third-party ownership of energy generation equipment is permitted. To find out if PPAs are available in your area, click here.
Considerations of a Physical PPA
Before entering into a physical PPA, it’s important that both parties evaluate all aspects of the terms of the contract, including any potential technical and financial risks, as each project and transaction will be unique. Some important considerations for a purchaser to keep in mind before entering into a physical PPA include, but are not limited to, the following:
• Upfront costs: Most PPAs require minimal to no money down and no payments until the renewable energy system begins to generate electricity.
• Stable and reduced energy bill: The electricity generated by the renewable energy system is typically sold to the purchaser at a fixed rate that is generally lower than rates offered by a utility company. The purchaser benefits from receiving stable energy at a low, predictable price for the duration of time specified in the PPA.
• Risk exposure: Fully evaluate the terms of the PPA and any associated risk exposure. Risks associated with PPAs often fall within the following categories: development, performance, pricing, length of contract, and legal and regulatory concerns.
• Government incentives: Federal, state and local governments encourage organizations to invest in renewable energy and may offer incentives for doing so. Incentives enabled through the Inflation Reduction Act, for instance, offer eligible organizations an Investment Tax Credit or Production Tax Credit to help offset the tax liability of investing in renewable energy. Grant and loan programs from federal government agencies such as the U.S. Department of Energy are also available, along with a host of state and local financial incentives. You can visit the Database of State Incentives for Renewable & Efficiency® (DSIRE) to identify any incentives in your area.
• Location: PPAs are largely restricted to organizations located in competitive electricity markets. In some instances, the organization must be located in the same power grid region where the electricity will be consumed. There are also state regulations that limit or restrict non-utility providers from selling electric power.
• Duration of time: The average duration of a physical PPA is 10 years or more, so if the organization needs to relocate to another property, or any other unforeseen issue occurs, it could pose some challenges.
• Contract complexity: PPAs are complex financing tools that include multiple facets of terms and conditions, including, but not limited to: pricing, third-party sales, underperformance or delays of generated power, breach of contract and termination.
• Making claims about renewable energy use: Renewable Energy Certificates (RECs) are used to account, track and assign ownership to renewable energy projects. Generally, for physical PPAs, RECs are conveyed to the power generator and not the purchaser. Accordingly, the purchaser may not be able to make renewable energy claims without obtaining exclusive rights to the associated RECs.
PPAs can offer organizations a credible way to meet their sustainability goals while also reducing their utility costs. Organizations considering a PPA may benefit from conducting a close analysis of the resources available to them and consulting with qualified legal counsel and a tax professional to evaluate the financial benefits and implications of these renewable energy financing tools.
Old Republic Title’s National Energy Title Division is a significant industry player when it comes to insuring title for renewable energy projects. Our dedicated team of professionals understands the unique risks and requirements of large energy projects, and has the knowledge, experience and expertise to successfully underwrite and close complex, high-liability transactions. For more information, visit oldrepublictitle.com/commercial/ncs/#energy.
The information addressed herein is current as of August 2, 2023. Old Republic Title, its officers and employees do not provide, and this communication is not intended to be, investment, tax or legal advice. Old Republic Title makes no representations or warranties regarding the accuracy of the information or tax consequences addressed herein. You should consult an investment, tax or legal professional of your choosing to advise you of the benefits and risks of your specific transaction.