The role of bilateral long term power purchase agreements

The last years brought into the energy sector a debate around the reconfiguration of the energy mix, in the context of the decarbonization target at EU level and then undertaken as the target at country level, corroborated with the end of the support scheme for renewable sources in the form of green certificates in 2016, followed by the European legislation regarding the functioning of the common electricity market.

WE NEED NEW GENERATION UNITS

More specifically, in the context where the direction of travel is towards replacing old generation capacities, based on fossil fuels, with those on natural gas, as a transition fuel, and especially with new capacities based on low carbon technologies, in the long run, Romania has once again become an interesting pole on the investment map, especially for international independent producers. According to the National Integrated Energy and Climate Change Plan, Romania has undertaken a target of 30.7% total share of energy from renewable sources in the gross final energy consumption and to reach this target, it has estimated a need of approximately 7 GW of new wind and solar energy capacity, in addition to repowering the existing capacities. In parallel, the existing coal-fired capacities will be shut down in few years and some of the nuclear power facilities will be temporarily closed for refurbishment. This entails a significant minus in the generation part of the equation, which is likely to reshape the energy mix in the coming years, if these capacities that disappear will not be replaced by others. This becomes even more stringent in the context where Romania has become a net importer of energy, and the withdrawal of these capacities will mean an increased import, however limited as supported by the import capacity of the transmission system.

BOOST FOR PPAS

Therefore, attracting investment to accelerate the development of new capacities requires a stable, predictable legal framework aligned with the common EU market. Romania has not benefited from new investments in recent years, especially after the closure of the support scheme based on green certificates. In the international market, however, several factors concurred towards the re-establishment of the conditions that underpinned investors’ appetite, so that countries such as Poland, Hungary and Bulgaria continued to attract investors. In other developed power markets (USA, UK, Germany, Nordic countries, Spain, etc.) the disappearance of support schemes, the lower price of technology that has made the selling price of electricity from renewable sources at parity with grid prices offered by other producers, the producer’s need to ensure long-term cash flows and the assurance of the purchase of electricity at a predictable price for the consumer from the utility companies generated an increase in transactions with electricity in the form of long-term bilateral contracts, freely negotiated (PPAs).

What are these? PPAs are electricity sale contracts, usually concluded between a producer and a purchaser – named “offtaker”, typically for a long term, between 10-15 years. Besides the traditional buyers, such as utility companies and traders, a new category of offtakers, electricity-consuming companies, has emerged. Why? Because, increasingly in the last decade, large corporations, especially those in the field of technology (as Google, Amazon, Microsoft and others), have adopted development strategies based on social responsibility and environmental sustainability targets, including by actively seeking to reduce their carbon footprint.

Therefore, this social awareness trend of corporate social responsibility in terms of sustainable environmental policy has generated a demand for turnkey projects, located at the place of consumption of the operational point of the corporation, for own consumption (where electricity exceeding internal consumption of the corporation is sold to the grid). In addition to meeting the carbon footprint reduction target and adopting a long-term sustainable strategy, for a corporation, this type of green field, “behind the meter” capacity is usually contracted for long term through a PPA structure, which can also be a tool for hedging against the volatility of market energy price risks.

Therefore, the market for long-term bilateral contracts and especially the market for bilateral contracts concluded between a producer and a corporation (corporate PPAs) has grown significantly in recent years in Europe, especially in the Nordic countries.

Corporate PPAs are however not new – they have developed gradually in different markets. As we slightly start to see a standardization (EFET has developed framework contracts) there is no “market PPA” at European or global level. Compared to construction contracts (FIDIC), which are generally difficult to standardize – PPAs tend to be extremely individualized, with terms and conditions negotiated in extenso depending on technology, production profile, type of financing, etc.

However, the variation of PPA forms has not stopped the various projects which made use of this instrument from being bankable. It is required to clarify and harmonize the key catalysts of the process together with all the contracts that make up the full suite of project documentation.

As mentioned, many corporations have set ambitious targets for renewable energy sourcing or for emissions reduction – whether via leading organizations such as RE100 or independently. Meeting these commitments can be done relatively easy through the purchase of green power products from their utility supplier or by procuring renewable energy certificates matching their needs. Often the existence of the Corporate PPA can be the mere reason for the project to come to life – hence corporations can demonstrate that they generate a solid demand on the market for long term.

TYPES OF PPAS

There are several types of PPAs: physical and virtual / synthetic PPAs, and among those with physical delivery, standard contracts or “sleeved” PPAs.

Compared to a standard contract between a producer and a corporation-type consumer, in case of “sleeved” ones there are complex contracting arrangements between the producer and the corporate off-taker. The corporate off-taker is reliant, in this case, on a supplier from the market, which increases the complexity and the risk of reliance on a single energy supplier. In this instance, the producer agrees to the corporate terms, while the supplier provides energy to the corporate consumer. In this case, the supplier also takes over the obligations to balance the consumption of the corporation and is responsible to fulfil the additional needs of the corporation by providing the electricity which the generator cannot produce. This structure exempts the corporate offtaker from any regulatory considerations and additional contractual efforts, as the supplier takes care of all such obligations under the contract, at an additional cost. In fact, the energy is still going to the wholesale market, but the corporation benefits from the credit for energy consumption from renewable sources. The contract may be tripartite or two separate contracts may be concluded.

Synthetic PPA-type contracts are those in which a producer sells energy on the wholesale market at competitive prices, and also concludes a contract with a corporate off-taker for a fixed price for the renewable electricity. These structures constitute a hedging instrument whereby the electricity is purchased and sold on the wholesale market. The agreement between the producer and the corporate off-taker aims to reduce the risk against the volatility of market prices at a given time, for a long term (usually linked to the finance condition terms).

Such a possible structure could be a contract for e difference with an option with a price collar (which protects against large losses but also limits gains). This type of contracts also allows for a wider structure that can accommodate more buyers. Such contracts are considered financial instruments and are subject to financial regulations which must be accounted for when designing such legal and financial understandings.

CONTRACTUAL FREEDOM FOR A FUNCTIONAL MARKET

As mentioned above, the current architecture of the Romanian market tends towards accelerated need for investments in new projects, by virtue of new policies in the field, increased demand from corporations and changes in the composition of the energy mix. Until now, long-term contracts have been expressly prohibited by the Energy and Natural Gas Law no. 123/2012, but recently, through the Government Emergency Ordinance no. 74/2020, these contracts are expressly permitted for capacities commissioned starting June 2020. In the last eight years, the only way for the producers to sell the electricity was through OPCOM, on a centralized market, based on standard trading products offered on this platform. This limitation significantly constrained the option of financing and developing new projects, in the absence of other support schemes. Due to the lack of such support, which is no longer a necessary condition for developers, given the decrease in the cost of technology that allows renewable power prices to be at par with the grid prices, the relevance of this legal and commercial instrument – respectively free, bilateral, long term contract for selling the production – becomes a key element in the decision of investors, especially for the independent power producers. OPCOM has announced its intention to offer the market a new trading instrument dedicated to the long-term sale of electricity, which is welcomed and offers a valid solution to existing and future producers. However, it remains undisputed, given the international practice and the recent market of PPAs, that these are essentially individualized contracts, customized to meet all the technical, commercial and legal conditions necessary for the development and financing of new capacities. European Regulation 943/2019 on the internal electricity market functioning, directly applicable from 2020, expressly provides for the market participants to conclude directly negotiated contracts “over the counter”, outside the centralized markets, recognizing the role of these contracts for financing new projects.

In conclusion, the contractual freedom in the field of selling and purchasing electricity (in compliance with the framework of primary and secondary legislation, acknowledging aspects related to the reporting obligations and respectively, the monitoring by the energy and financial market regulators) becomes in the current context a particularly important aspect in the local landscape, with the potential to significantly influence the appetite and profile of investors and traders, as well as the provision of levers for a functional competitive market.

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This article firstly appeared in the printed edition of Energynomics Magazine, issued in July 2020.

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About Author

Gabriel Avăcăriței

Journalist experienced with both old and new media, Gabriel has been the editor in chief of energynomics.ro since 2013. His great command in communication, organizing information and publishing are put to work every working day in order to develop all the projects of the energynomics.ro B2B communication platform: website, magazine, and own-events.

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