Negotiating a PPA for renewable energy? Pay careful attention to negative price risks. :: Negotiating a PPA for renewable energy? Pay careful attention to negative price risks. :: Daymark Energy Advisors

Power Purchase Agreements (PPAs) are a popular and practical way to buy renewable energy. In a typical renewable PPA, the buyer agrees to buy all the energy produced by a wind or solar resource at a predictable (fixed or indexed) price for a defined length of time (up to 25 years).  This kind of agreement gives the developer the revenue assurance it needs to finance construction of the project, and it gives the buyer access to renewable energy at a predictable price without having to take on the burdens of developing or managing the project directly.

In addition to building a portfolio of green energy resources to serve their customers or power their business, a PPA can be an excellent hedge for buyers against fluctuating energy market prices. When natural gas prices spike (as they did in 2022), so do prices for all kinds of electricity. In choosing a PPA, buyers assess the possible benefits of the price certainty offered by a PPA, keeping in mind that they could be locking in a price that ends up above the market.  It is a trade-off of unpredictability for certainty that can benefit all parties to the agreement.

Negotiating a good PPA contract has its challenges, however. There are other risks besides energy price that have to be assigned to one or both parties—for example, the potential for changes in the cost of project insurance, or new regulations that impose costs, or increasing costs of equipment, if the PPA is for a system that has not yet been built.   The most carefully-designed PPAs balance such risks between the parties, by assigning them to the party most able to control them, or otherwise ensuring that the principle of reciprocity is embedded for risks and benefits that could swing to either the buyer or seller.

One risk that buyers should pay close attention to in negotiating a PPA in the context of a wholesale electricity market is negative price risk. This is an important risk to understand, since it can mean that the predictable price buyers think they are getting is not as predictable as it seems.

In a wholesale market, if too much power is competing to flow along constrained transmission lines, or if the power supply is not flexible enough to respond to changing demand throughout the day, spot market prices can go negative. The most recent available data (from 2023) from Berkeley Lab show negative pricing as occurring in all RTOs and more than 20% of the time in parts of SPP.  When prices are negative, rather than getting paid for every MWh of energy provided to the grid, generators must pay the RTO for every MWh they supply to the grid—reflecting the additional costs they impose on the system overall by contributing to grid congestion.

Why would generators pay to produce electricity?  For resources like wind and solar, the “fuel” is free—their marginal cost of operation is zero--so it is generally understood that they will choose to produce even when the price is zero. Even when the price goes below zero, they may pay the RTO to produce in order to qualify for other incentives or revenues, including Production Tax Credits (PTCs) or Renewable Energy Credits (RECs).

Depending on how it treats the risk of negative prices, a PPA can compound incentives, creating a signal to continue generating despite negative market pricing. If buyers take on unlimited negative pricing risk, then the generator has an incentive to offer power into the market at any level of negative pricing—and the buyer’s price suddenly becomes unpredictable, since the buyer is liable to pay negative RTO prices on top of the contracted PPA energy price.

Given that the typical length of a PPA is 25 years, the possibility of increasing frequency of negative prices during the PPA term as renewable penetration increases throughout the country means that exposure to negative pricing can be a serious risk for renewable PPA buyers. 

For this reason, PPA buyers need to review PPA agreements carefully to be sure they understand the negative price risk they are taking on. Limited negative price risk can be acceptable, if it allows buyers and sellers to take full advantage of subsidies offered through PTCs or RECs, and if buyers fully understand their exposure and are convinced that the price offered justifies price risk limited by the potential upside. However, buyers should never take on unlimited negative price risk—it is not good for either buyers or the overall efficiency of the market when generators have no incentive to respond to the signals being sent by negative prices.

PPAs remain a valuable tool for buyers--careful review of negative pricing provisions in PPAs can help to ensure that these agreements deliver on the promise of predictable pricing for energy consumers. To continue this conversation, please reach out to Louisa or Stan on our procurements team using the buttons below.

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