What is Power Purchase Agreement? 

Power Purchase agreement (PPA) is a contractual agreement between an electricity generator (provider) and the party who is purchasing the power/energy (off taker). The off taker could be an electric utility, a power supplier, a load aggregator, or an end user. In a market term, the provider is a seller and the off taker is a buyer. This arrangement is common in both gas and electricity markets.  While renewable energy is a primary focus, a PPA is a long-term contract between a renewable energy (RE) developer and an end user for the purchase of green or clean electricity at pre-specified prices. However, conventional generation is also eligible for PPA. 

Types of PPA 

There are three common types of PPA: 

1) direct or on-site PPA, 2) indirect or sleeved PPA, and 3) synthetic or virtual PPA. Direct and indirect PPA are considered as physical models, while synthetic PPA is considered as financial model.

1) Direct Wire or On-Site PPA means a direct physical connection between the provider and the off taker. The generation asset may be built (by the developer or provider) on and next to the location of the off taker. The electricity grid is not involved in delivery. However, the off taker may still connect to and buy from the grid. The electricity rates of direct PPA are usually more competitive than those of electric utility; given that it is behind-the-meter and on-site generation can offset network costs significantly. Nevertheless, this model is less flexible because the generation asset is attached to the off taker and limited by the available space.   

2) Indirect or Sleeved PPA involves sourcing electricity from a specified source (usually RE provider) without physical connection. The electricity is then delivered through the electricity grid so that the grid acts as a sleeve. Without physical connection, it could not be guaranteed that the green electricity from the provider is actually delivered to the off taker. At best, the off taker may be able to verify that the electricity from the provider is delivered to the grid, known as Guarantee of Origin (GO) or Renewable Energy Certificate (REC) process (traceability). This model allows the off taker to access green electricity although RE sources are far away. However, complications can arise when a) there is a barrier to entry (grid access) or b) the access charge (sleeving fee), which is determined by the electric utility, is high. This model might be considered less green than Direct Wire PPA if no new renewable energy capacity is added to the grid or if it relies on outdated resources (non-additionality). 

3) Synthetic or Virtual PPA is an option to access green electricity without physical connection to RE sources. It is a financial instrument widely used in the United States, while also gaining traction in Europe. The off taker simply pays for green electricity, without physical delivery. The provider sells the electricity to the market and delivers it to the grid, so the source of electricity reaching the off-taker is not specifically identified—it could be either green or not. The selling price seen by the provider is definitely market price which is varying from time to time. The buying price paid by the off taker is a fixed, agreed price over a certain period of time. When the market price drops below the agreed price, the off taker pays the price difference to the provider. In economic sense, it is a direct price subsidy to the provider. On the contrary, when the market price rises above the agreed price, the off taker receives the price difference from the provider. Financial derivatives such as swap and option are commonly used in synthetic PPA to manage these price variations. The main objective of synthetic PPA is to provide a supporting mechanism for RE regardless of the actual power flow over the grid. The provider benefits from a subsidized price over a certain period, while the off taker stabilizes energy costs and benefits from RE without the need for physical energy delivery. Like Indirect PPAs, traceability mechanisms allow the off-taker to verify the origin of the electricity through certifications such as Guarantees of Origin (GO) or Renewable Energy Certificates (REC). 

Benefits of PPAs 

PPAs are becoming increasingly popular in the push towards carbon neutrality as they offer a way to increase RE capacity without taking a risk on capital investment and avoiding O&M burden. Business matching is flexible and more available when the provider and off taker are geographically separated, even on different grids. Physical constraints on the electricity grid are less binding. PPA also provides a link for other carbon mitigation strategies, such as offset programs and green energy credits.  

Summary

• Power Purchase Agreements (PPAs) are contractual agreements for purchasing electricity between a generator and a buyer.

• There are three types of PPAs: Direct Wire, Indirect, and Synthetic, each with varying features like term length, price, complexity, and traceability.

• PPAs offer benefits like increased renewable energy capacity, flexibility, and a link to carbon mitigation strategies.