15th August 2023
Chris Bowden, MD, Squeaky
5 minute read
13 Power Purchase Agreement (PPA) terms explained
In common with most technical fields, the world of power purchase agreements (PPAs) is shrouded in a thick cloak of jargon. To make matters worse, the same concepts often have different terminology attached, particularly across different jurisdictions. This short guide explains some of the key PPA terms we use at Squeaky, alongside some of the other names by which they are referred to by others in the industry.
Route-to-market or market-access PPA
In a route-to-market PPA, a generator agrees to sell the output of a facility referenced to the prevailing market price (as quoted on an exchange such as N2EX or EPEX). These are also known as market-access PPAs and are predominantly offered by utilities or aggregators. They typically include a discount to the market price, in exchange for services including registration of the meter within the system (which requires a supply license), forecasting, balancing and physical trading.
Pay-as-produced or as-generated PPA
In a pay-as-produced (PaP) PPA, the offtaker buys all power produced by the facility, by each half hour in the UK, typically for a fixed price. These are also called as-generated PPAs.
In a baseload PPA, the offtaker buys a constant volume of power for a specified period (annual, seasonal or monthly) over the term of the agreement, typically for a fixed price. These are also known as firm PPAs, although firm PPAs can be firmed to peakload or other shapes, to match the demand profile of the buyer.
Shape or profile risk
This risk, which is sometimes referred to as profile risk, is where the profile of a facility’s power production does not align with the demand profile of the end user. This might be due to the nature of the technology (solar generators produce most power in the middle of the day) or due to the inherent variability of renewable energy generation. While it's possible to predict the overall output of intermittent technologies over a longer timeframe, short-term generation can significantly fluctuate due to weather conditions.
Sometimes conflated with shape risk, which is an inter-temporal mismatch of generation and demand, volume risk relates to greater or lesser generation than expected over a period of time (typically annually). In a pay-as-produced PPA, generation greater than expected can result in an excess quantity of power for the offtaker, whilst lower-than-expected generation would result in the offtaker receiving less power than anticipated.
This risk, which is driven by shape and volume risk, pertains to the variability and unpredictability of generation by intermittent energy facilities and the price that is ‘captured’ by the facility compared with the average firm market price over the same period. Capture risk is a key consideration that affects both generators and pay-as-produced PPA offtakers. For generators, capture risk influences the revenues they earn. Offtakers, meanwhile, may end up paying for power at a predetermined fixed rate which is delivered at times in which the market price is lower.
Dividing the capture price for a facility by the firm (baseload) market price gives the capture rate. This is also sometimes known as an asset’s quality factor. The capture rate for a particular renewable generation facility will vary over time and depends on the measurement period. It is primarily driven by the type of renewable technology. Influencing factors include:
- Daily variation in generation. Solar facilities only operate during the day, when prices are typically higher than at night, increasing the capture rate of a solar facility.
- Inter-seasonal variation in generation. Roughly 75% of annual generation of a UK solar facility occurs during the summer, when power prices are generally lower than the winter, therefore reducing solar facilities’ capture rate over a year. By contrast, wind generation is typically winter-weighted.
- Cannibalisation risk (see below).
An increasing proportion of wind and solar generation on the grid will reduce the capture prices for those technologies. Within any grid that covers a limited geographical area, such as the UK, generation of one wind facility is likely to be correlated with other wind facilities. Similarly, solar facilities all generate power in the same pattern when the sun is shining. Therefore, during periods of high generation for one facility, the grid will tend to have an excess of supply, driving down prices. By contrast, market prices would likely be higher at times the facility, and facilities using the same technology, are not generating. As a growing volume of similar renewable energy technologies are added to a grid, the net impact of these effects can be to significantly reduce the value they can capture from the power they sell – hence the term cannibalisation.
Balancing risk represents the risk that a facility’s actual output will be different to its next-day forecast generation. This can lead to the system operator charging its operator penalty fees. For a wind or solar generator, managing the balancing risk can either be done by setting up trading arrangements to manage it in house or, more typically, is outsourced to an intermediary via a route-to-market PPA, in exchange for a balancing discount from the contract reference price. Route-to-market PPAs contracts typically deliver around 95% of the reference price, while a system price contract that does not include any balancing discount would typically deliver 98-99% of the reference price.
This term is often used to describe mismatches in energy supply and demand. However, within the PPA market, it describes the mismatch between the reference price within a PPA and the actual prices to which contract participants are exposed. Mismatches could, for example, be found in a power market with zonal pricing, such as the US, where a virtual PPA is struck against an index (like Ercot) but the consumer buys physical power priced against a different index. In the UK, a contract for difference (CfD), which is settled against the Intermittent Market Reference Price (calculated using day-ahead data from EPEX Spot and NordPool), combined with a route-to-market PPA settled against N2EX, is exposed to basis risk.
Firming, shaping or shaping and balancing
Firming, often referred to as shaping, or shaping and balancing, is the conversion of as-produced power generation (as per a PaP PPA) into firm power (typically baseload), thereby eliminating shape, volume, capture, and balancing risks for the offtaker.
Availability is a key metric measuring a facility’s operational performance . It is typically calculated as a percentage, representing the total volume of electricity a facility is able to produce at a point in time, divided by its contracted capacity. This is a mechanical availability and doesn’t take into account weather conditions or other factors such as grid constraints, etc. It is usually covered by a manufacturer’s warranty and is also impacted by regular maintenance of the facility. Mechanical availability typically falls over time, due to the degradation of physical assets.
Contracts for difference
A CfD is a financial mechanism to stabilise the revenues a facility generates. In the UK, generators are invited to bid a strike price which they are prepared to receive to sell power. If the market price for that power is below that strike, they receive payments from the Low Carbon Contracts Company (LCCC), a government-owned entity. If it is above the strike, they agree to pay the difference to the LCCC. This is referred to as a two-way CFD, as opposed to the one-way CFDs common in Germany, where a generator is guaranteed a minimum level of revenue, but retains additional revenue if wholesale market prices exceed the CFD strike price. CfDs are settled against a market index (in the UK a combination of indices) meaning a generator either needs a route-to-market PPA, or needs to manage forecasting, balancing and trading the power themselves.