Power Purchase Agreements (PPA) – what are they?

The VT Gravis Clean Energy Income Fund invests in companies listed on stock exchanges in OECD countries which own operational renewable energy assets, with long-term visibility over cash flows, e.g. companies at the heart of the transition to a low carbon economy. Whilst the business model for the generation of electricity from renewable energy sources is relatively simple, there are many aspects of the sector which are worth exploring and understanding. In the coming weeks Will Argent, Fund Adviser to the VT Gravis Clean Energy Income Fund, will explore five aspects underpinning the renewable energy sector and broader decarbonisation theme, beginning with Power Purchase Agreements (PPA) which underpin the income arising from many of these assets world-wide - adding significantly to the dependability of the dividends paid by the Fund.

A PPA represents an agreement between a power generator and their customer (an off-taker) – typically a utility company or other large corporate entity - for the sale or purchase of electricity outside wholesale markets. The PPA will define the commercial terms between the generator and the off-taker, including the schedule for delivery of power, pricing, and ultimate termination of the agreement – the term of which could be as long as 20 years or more. 

Although PPAs are not a new concept, their use has grown rapidly in recent years owing to increased adoption of renewable energy. Firstly, as the economics of renewable energy generation have become competitive with conventional forms of power generation, governments have phased out many of the subsidy schemes (Feed in Tariffs, Renewable Obligation Certificates etc.) that initially primed the renewables industry. To underpin the investment required to develop a new renewable energy asset without any form of subsidy and to shore up the financial validity of the project, a power generator will seek to structure a PPA around the asset in order to secure a long-term and stable revenue stream, and to reduce sensitivity to spot power prices. Spot power prices can be volatile, so the PPA reduces an element of uncertainty for both the generator and purchaser, over the long term. Secondly, a growing cohort of corporate entities (and utilities) is seeking to purchase more power from renewable sources as part of their commitment to reduce emissions and build more sustainable enterprises. Multinational tech giants including Amazon and Google have joined large industrial and high-intensity users of electricity such as Siemens, Rio Tinto and Akzo Nobel (historically the main corporate users of PPAs) in building portfolios of renewable energy assets and entering into agreements to buy power directly and indirectly from independent renewable energy generators. 

PPAs may be structured in different ways, with flexibility in length of contract, the delivery profile, or the volume to be delivered, for example. 

The usage, sophistication and maturity of the PPA market differs between regions and it is clear that areas with lower prevalence of subsidy support, for example, will tend to have a larger, more active PPA market since price sensitivity is greater and developers will seek to de-risk their assets from a financial perspective. With a history of sizeable subsidy support for renewable energy generators (alongside other factors), the UK PPA market remains less mature compared with that of the Nordic countries or North America, for example, and where PPAs have been utilised they have typically been for relatively short contract periods. However, as subsidy support mechanisms have been withdrawn, the UK corporate PPA market and many others across Europe in particular, are beginning to transform and grow. 

The demand for renewable energy from corporations has been spurred by sustainability objectives but also by the much-improved economics of renewable energy technologies and more flexible regulation. This has driven a surge in the quantum of corporate PPAs being signed and in 2019 a record 19.7GW worth of contracts were agreed according to Bloomberg New Energy Finance, representing year-on-year growth of c.45%. In 2020, to the end of July, almost 9GW of PPAs have been signed with approximately 60% of that coming from U.S. corporates. 

Efforts to decarbonise the global economy will require continued growth in installations of renewable energy capacity and the intermittent nature of wind, hydroelectric and solar power generation, for instance, will result in greater volatility in spot electricity prices. PPAs provide a way to mitigate this price risk for both generators and off-takers and facilitate the development of new renewable projects by improving cash flow certainty.

The VT Gravis Clean Energy Income Fund invests in companies that own renewable power generation assets and these companies are highly active in PPA markets. Such contracts have underpinned the income-producing credentials of these portfolio companies and have meant that dividend distributions have been maintained, and in many instances increased, despite the economic contraction induced by the COVID-19 pandemic. 

For more information on the VT Gravis Clean Energy Income Fund please visit our website.

William Argent 

Fund Adviser, Director 

^{Past performance is not necessarily a guide to future performance. The value of your investment may go down as well as up.}