As corporate renewable buying surges, innovative PPAs pressure utilities to improve green tariffs
Financial intermediaries are de-risking all-time low-cost renewables purchases, driving record private sector buying and pressuring utilities to match the offerings.
The use of corporate renewables contracts and utility green tariffs in the U.S. to acquire renewables generation doubled in 2018.
Green tariff structures that allow utilities to serve corporate demand for renewables within regulatory rules continue to evolve slowly. But power purchase agreements (PPAs) between renewables developers and big energy users are adding innovative, risk-limiting financial strategies that make them more appealing and challenge utilities to match the offers.
PPAs are used by corporations like Amazon, Apple and Facebook to secure fixed price renewables that match their total energy consumption and meet basic principles guaranteeing fair access and competitive prices. But renewables' output varies, and PPA holders must, at times, buy renewable MWhs in power markets at higher than contract prices. This creates the risks of price and energy supply uncertainty.
"Renewables PPAs have been used by a small number of large and focused companies," risk consultant RESurety CEO Lee Taylor, who co-designed a breakthrough risk solution with Microsoft, told Utility Dive. "To expand renewables growth, new buyers are needed, and products for them are being simplified and de-risked."
Five tools to address risks in renewables PPAs are detailed in A Corporate Purchaser's Guide to Risk Mitigation from the Rocky Mountain Institute (RMI). If used by large energy users, renewables developers and their financial partners, the mitigations could turn the 2018 corporate procurement spike into long-term expansion, according to RMI.
But utilities have long managed price and supply risk for customers, and many companies would welcome being relieved of the complexities of managing the uncertainties that come with PPAs, according to buyers and analysts. Utilities and regulators who rise to this new challenge by providing new opportunities may retain corporate buyers and attract new load. Those who do not may face the exit of key customers.
Recent customer surveys show broad demand for renewables. Through November 2018, 99 cities had 100% renewables commitments. And the number of Fortune 500 companies with 100% renewables goals grew from 23 in 2017 to 53 in 2018.
Between 2014 and 2017, large energy users closed 90 renewables contracts representing 8.93 GW, but in 2018 alone 42 companies closed 75 deals representing 6.53 GW, according to the Business Renewables Center.
It is striking that over half of 2018's growth in corporate renewable deals was from new buyers and new types of buyers, World Resources Institute (WRI) Senior Manager for Utility Innovation and Global Energy Priya Barua told Utility Dive. This acceleration of PPA-based deals "is putting pressure on utilities."
"Some corporate customers tell us they are not in the utility business and don't want to get into the utility business."
Manager of Customer Renewable Energy Programs, Puget Sound Energy
Through 2017, green tariffs accounted for approximately 1.1 GW of deals, according to Barua. But 2018's 1.13 GW of utility green tariff deals, though still a small part of the 6.53 GW purchased by corporate buyers last year, doubled the total of deals made through green tariffs.
"Corporates moved to PPAs to take advantage of low-cost renewables," and green tariffs trailed because "there is not quite as much upside," WRI U.S. Director for Energy Lori Bird told Utility Dive. Nevertheless, green tariff deals continue to grow because buyers see reduced risk in using them "to limit exposure to market price volatility," while PPAs require them "to either take on the risk or push it to developers and financial intermediaries."
The green tariff and the PPA "are very different and not every company wants to have the level of expertise required to negotiate a PPA," Puget Sound Energy (PSE) Manager of Customer Renewable Energy Programs Heather Mulligan told Utility Dive. "Some corporate customers tell us they are not in the utility business and don't want to get into the utility business."
"There is no one answer," Bird said. "Customers just need to understand the risks."
Risks and mitigations
The bulk of corporate renewables contracts are through the "virtual" PPA (VPPA) which, from a financial risk perspective, is no different than the traditional PPA for delivery of electrons from a developer to an off-taker, RESurety's Taylor said.
The terms are used interchangeably, but the VPPA is a "virtual" transfer of electrons because the corporate buyer continues to receive standard electricity from its local utility. The VPPA guarantees delivery of an equal amount of renewables generation to another market that offsets its consumption.
Concern with risk is increasing because buyers now see PPAs as "imperfect tools" that do not adequately address price and supply uncertainties, and "risk-sensitive corporate buyers are looking for tools to manage it," Taylor said.
In addition, climate change-driven weather extremes are increasing project output variability that, with rising system renewables penetrations, means more system variability and more price and supply uncertainty, he said.
There are five key risks associated with a fixed price VPPA, according to RMI: Price risk is the difference between the VPPA price and the market price; basis risk is the difference between the market price and the buyer's retail electricity price; shape risk is the risk that project output is not simultaneous with the buyer's consumption; volume risk is from projects not producing the total MWhs contracted for; and operational risk comes from under-performance of a project's equipment.
Each VPPA risk is addressed by one or more mitigation strategies, some now commonly used and some just emerging. They address uncertainties typically taken on by utilities in green tariffs. "These strategies shift risk between the buyer and the developer or to an intermediary," RMI Associate and paper co-author Rachit Kansal told Utility Dive.
RMI identified the following strategies in its report:
- A hub settled VPPA addresses basis risk by specifying contractually that the generation be sold into the hub market, where it is likely to be higher-priced than in the node market. It is the only mitigation strategy RMI found to now be commonplace.
- A floor sets a minimum price, and a collar adds a maximum price in the VPPA. Floors and collars address basis and shape risk by protecting the parties from extreme market price volatility.
- Proxy generation addresses operational risk by requiring the developer to supply the amount of generation required by the VPPA even if the project's equipment fails. Microsoft used this strategy in its VPPA with wind developer Capital Power, RMI reported.
- A volume firming agreement (VFA) transfers risk to an intermediary with detailed understanding of energy markets and weather variations. The intermediary, often an insurer, addresses shape and volume risk by guaranteeing 24/7 delivery of renewables-generated electricity. For this, it charges a premium over the VPPA price. Microsoft and RESurety co-designed VFAs for wind project VPPAs.
- A fixed volume swap would require a financial intermediary to take on the buyer's price risk and basis risks by paying the fixed VPPA price for the generation. But it would require the buyer to take on the volume risk by guaranteeing delivery of the generation. This has not been used for VPPAs.
"In the last few years, new corporate buyers with small- and medium-sized loads and different risk tolerances are getting involved," RMI's Kansal said. "This line of risk management products allows moving from a one-size-fits-all approach to a many-sizes-for-all approach that allows buyers to choose the best fit option."
But, as the RMI paper acknowledged, most mitigations have not been widely used. Do they work?
But do they work?
There is little public data on the mitigation strategies' effectiveness, but "RESurety customers have over 5 GW of renewables capacity actively settling, and many want their new contracts to have risk mitigations because they are working," Taylor said.
At the project level, risk "can only be shifted between the developer, the buyer and the insurer," he said. "But if an insurer's portfolio perfectly offsets risk between two projects, it is destroyed."
Profits and losses for corporate buyers holding VPPAs from over- and under-production and market price volatility can be balanced by an insurer with a diversified global portfolio of renewables projects, Taylor said. "The total amount of risk in a portfolio is less than the sum of the risk of each individual project."
There are "workable solutions" for all five of the RMI risks, Max Scher, sustainability manager for software provider SalesForce, emailed Utility Dive. After closing a wind project VPPA in 2018, "price risk still stands out" for the company because it typically "falls on the buyer," Scher added.
Reinsurers "are basically insuring the sun and the wind, and they are extremely sophisticated at weather risk. If they had gone too far wrong, they would be bankrupt."
VP of Strategic Renewables, Schneider Electric
Schneider Electric's Renewable Energy and Cleantech Services has consulted on "over half the corporate PPAs that had outside consultants," its VP of Strategic Renewables John Powers told Utility Dive. Contracting for fixed-price renewable generation "is a good strategy for any large energy user because it is a hedge against electricity price volatility."
RMI's mitigation strategies, which Schneider has negotiated and continues to negotiate into contracts, "can insulate clients from downside risks," Powers added.
Recent market prices for renewables are higher than the contract prices for projects now generating, "so most of those clients are in the money," he said. "Buyers who have collars may have sacrificed some upside, but it is a volatile world, and in the next cyclical downturn, those clients will be happy they are protected from bigger losses."
Reinsurers like Allianz, Swiss RE and Munich RE have successfully used portfolios to manage risk for project developers and their banks for years, he said. "They are basically insuring the sun and the wind, and they are extremely sophisticated at weather risk. If they had gone too far wrong, they would be bankrupt."
Enel Green Power North America has worked with RESurety for risk mitigation, its Commercial Office Senior Director Brenda LeMay told Utility Dive. "What is emerging is a mass customization approach to deal-making. Each off-taker wants something different, so we are always adapting. We have done at least nine corporate transactions, and each is different."
The VPPA is an effective mechanism for procuring renewables, but Salesforce prefers working with its local utility, Scher said. Other buyers agreed. But utilities need to make renewables procurement work for buyers.
Can utilities keep up?
A VPPA is a good option, but even when de-risked is riskier and more complicated than a retail electricity purchase in which the utility manages all the uncertainty and provides a predictable rate, Scher said.
Salesforce prefers green tariffs and other solutions from utilities and electricity providers, "and whenever possible, we work with them" because they are "critical to scaling the number of renewable energy buyers," he said.
Most buyers would like to work through their utility's green tariff to achieve their goals, but a VPPA, even with the added cost of risk mitigation strategies, is likely to be more cost-effective, RESurety's Taylor responded. "Green tariffs were supposed to be a simpler way to procure low-cost renewables, but they are often too complicated and costly."
Schneider Electric advises clients on utility green tariffs, "but in 99% of cases, it is not as good a deal," Powers agreed. "In a regulated market, it might be the only option, but in a deregulated market, we always recommend clients consider the utility and direct contracts with developers."
There are only a few top tier corporate buyers who have been able to address VPPA risk, but emerging risk mitigation strategies will expand that number, Energy Innovations Senior Fellow Eric Gimon told Utility Dive. They are likely to lead to simpler, standardized deal offerings from intermediaries.
As VPPA deals accelerate, "utilities could face an existential threat and pressure will increase on them to provide the same green power and risk management in a cheaper, easier package," Gimon said. "Forward-thinking utilities may follow Xcel Energy's example and offer 100% clean power to all customers, including corporate buyers, and bring all the complications of financial risk back to the utility."
Regulators could slow this transition if they fail to see that the cost of renewables is low enough to allow the strategy to work, he said. "But utilities can argue there is a public interest in getting ahead of the problem with structures that allow large energy users to get what they want from their utilities."
Utilities using this strategy are likely to attract new load from existing customers and new customers, while recalcitrant utilities lose load and opportunities for growth, he added.
At today's low prices, PSE and other regulated utilities will continue adding more renewables as fast as it is financially possible, "but we cannot do it as fast as some customers want us to," PSE's Mulligan said. "Green tariffs are an excellent solution for buyers that do not want to take on the uncertainties of VPPAs, but want more renewables and emissions reductions faster than regulated utilities can provide them."
Early corporate procurements allowed buyers to use VPPAs to lead by example, but at that time, the cost of renewables made premium-priced green tariffs necessary, Gimon said. "Now the price of renewables is so low that utilities can do what corporate buyers and their financial partners are doing."