As Aotearoa New Zealand tackles its transition to cleaner energy, interest in power purchase agreements (PPAs) is increasing, particularly from businesses. Generators and retailers have been using PPAs since the advent of electricity markets, but over the last decade or so, businesses globally have been entering into PPAs in large volumes (~150 GW from 2008 to 2022) in an effort to control energy costs and decarbonise.
PPAs can be confusing for businesses (and energy experts too) because they come in many different shapes and forms, there’s lots of PPA terminology, and also duplication of terms. For example, an ‘on-site PPA’ can also be called a ‘private wire PPA’.
In this post, we discuss how a PPA is different from typical electricity supply agreements, and explain the various PPA structures and terms in the market. Hopefully, by the end of this post, you’ll know what a PPA is and have a better grasp of PPA terminology.
Electricity supply agreements and PPAs are both agreements that set out the terms and conditions for the sale and purchase of electricity. However, there are some important differences.
Supply agreements and PPAs can be combined, for example using a mechanism called ‘PPA sleeving’. Sleeving is where a PPA is bundled into a supply agreement so the buyer can benefit from the PPA while retaining the convenience of a retailer. Earlier in 2023, EVA arranged New Zealand’s first ever trial of corporate PPA sleeving.
Until recently, PPAs in New Zealand were only entered into by more sophisticated electricity buyers. They’re now becoming more widely accepted and used, assisted by PPA sleeving, rising electricity prices and fast-approaching sustainability targets (often set for 2025 or 2030).
It’s important to know that PPAs come in three main contract structures:
In each of these structures, the seller typically owns all or part of the generation project, and the buyer agrees to physically or notionally purchase electricity, and often green products, from the project.
In a physical PPA, the project’s electricity is physically traded between the seller and the buyer. The electricity is purchased at an agreed delivery point and, in most cases, notionally passes through the national and/or local electricity network. In New Zealand, our rules require all electricity to be physically delivered to a market participant, such as a retailer. Physical PPAs therefore aren’t suitable for the vast majority of businesses.
A classic use case for a physical PPA structure is a retailer purchasing electricity from an independent generator that’s connected to the national or local network.
In a virtual PPA, no electricity is physically traded between the seller and the buyer, meaning the transaction is purely financial. The project’s electricity is purchased at an agreed delivery point, and delivery of the electricity is said to be ‘virtual’ or ‘financial’ in nature. As there is no physical delivery the buyer doesn’t need to be a market participant. Virtual PPAs can therefore be entered into by any buyer, including businesses, and use a Contract for Differences (CfD) pricing structure (explained below).
A classic use case for a virtual PPA structure is a business purchasing electricity from a generator under a CfD pricing structure.
As the name suggests, an on-site PPA is for a situation where the generation project is on the same site as, or very close to, the buyer. Electricity is delivered directly from the generation facility to the buyer’s assets rather than being notionally passed through the national and/or local electricity network. On-site PPAs usually include provisions for developers to lease the space (land, rooftop) where the generation assets are installed. The PPA is therefore more complex if this space is owned by a landlord, or the buyer wants the flexibility to move sites.
A classic use case for an on-site PPA structure is a business purchasing electricity from a rooftop solar system installed and financed by a developer.
Like supply agreements, PPAs must define the volume and price of the delivered electricity. The structure chosen will depend on the generation type and the risk appetite of the seller and buyer.
Sellers of baseload generation, such as a geothermal, typically agree to providing a fixed volume of electricity. Sellers of intermittent generation, such as solar or wind, are more likely to offer a variable volume of electricity that follows the facility’s production.
Most PPAs set a fixed price(s), or a floor price(s), to provide sellers and buyers with more revenue and payment certainty respectively. Less often, the price(s) is variable, set at a market price (e.g. spot prices), or linked to a market price or index.
PPAs are labelled with various terms to help describe the energy source, counterparty or structure (contract, volume, pricing). A list of the most common terms is below. These terms can be combined to describe a PPA in detail, for example, a business may enter into a ‘Renewable pay-as-consumed corporate virtual PPA’. That’s a mouthful.
CfDs aren’t unique to the electricity market. They’re a financial instrument, first developed in commodity trading where, as described above, the buyer and seller are required to make difference payments. In electricity, if a seller or buyer is exposed to spot prices, a CfD is typically used to convert that spot price into a fixed price.
The term CfD is a source of confusion within the New Zealand electricity market as can be used to describe two different electricity products, either a:
Risk management CfDs tend to be shorter (1-3 month), smaller volume contracts, whereas PPA CfDs tend to be longer (5-15 year), higher volume contracts. Both products can be used as a risk management (hedging) tool, but only the PPA is linked to a specific generation project(s).
Due to mandatory market-making rules, risk management CfDs are the most commonly traded electricity contract in New Zealand, with ~180,000 transacted in 2022. Currently there are no market disclosure requirements for PPAs, but the total number of PPAs transacted each year is likely to be well under 100.
Finally, now that we’re familiar with PPA terminology, below is a list of the most common PPAs in New Zealand’s electricity market at this time. The majority of PPAs in NZ are renewable. In all cases, the PPA seller is a developer or generator.
In 2023 to date, there have been around five publicly disclosed utility and corporate PPAs. According to Transpower, this figure must increase to accelerate the development of renewable generation and support Aotearoa’s clean energy transition.