Power purchase agreements provide renewable energy generators with a steady source of income in highly volatile power markets. For buyers, they offer not only a credible way to green their own operations, but also more certainty in their business planning. While many actors have almost forgotten the latter in recent years, the current turmoil on energy and power markets is a stark reminder of the importance of being able to cover energy needs at a reliable cost. PPAs are often central to investment decisions, since they mitigate market risks, mainly related to fluctuations of energy prices. They are especially important for renewable energy projects that do not rely on public support.
The EIB has supported a significant number of renewable energy projects backed by power purchase agreements in recent years. Prominent examples include the financing of the Markbygden ETT windfarm in northern Sweden, which sells its power output to a subsidiary of Norwegian aluminium company Norsk Hydro under a 19-year PPA, and the Cabrera Solar PV project in southern Spain, that has a 10-year power agreement with internet giant Amazon for a significant share of its electricity production.
Generally, PPAs are more common in the United States. However, this form of financing has gained traction in the European Union over the last few years, where it has been used to finance almost 9 GW of production, led by large contracts in Spain and Scandinavia. Despite this recent growth, a number of challenges remain, though most regulatory barriers to such agreements are addressed by the European Union’s Clean energy for all Europeans package, which was adopted in 2019. Some EU Member States, however, have yet to transpose the European legislative framework into their national laws.
Price risk and credit worthiness are major barriers
One factor limiting the popularity of PPAs in Europe is the limited ability of corporates to expose themselves to electricity market risks. Large power buyers with a limited risk appetite who face stiff competition in their own sectors are reluctant to sign long-term fixed price contracts. They fear that their competitiveness could suffer if the market price for power declines and their competitors enjoy lower energy costs. This discourages sectors with tight margins and fierce competition, including many industrial sectors, from filling a significant part of their demand through long-term power purchase agreements, which might exceed their natural business cycles.
Credit worthiness is also a major barrier for most sectors, particularly in heavy industry and manufacturing, and in European economies with less developed long-term financial markets. For example, an organisation might have an appropriate consumption pattern for long-term power agreements but lack a rating from any major credit rating agency. Lenders to renewable projects typically require offtakers to have a strong investment grade credit ratings to consider a PPA-based project bankable.
Much of the renewable electricity needed to reach European and national renewable energy and climate targets will need to come from offshore wind assets. The offshore wind sector, however, is characterised by long construction times and the large scale of many projects. This creates an additional barrier to the use of PPAs by offshore wind projects as companies may be reluctant to commit to a fixed price years in advance and because most projects are too large for a single offtaker. While renewable projects can, in principle, sign multiple PPAs with different offtakers, this comes with significant transaction costs and increases project complexity.