Power Purchase Agreements: Catalysts for change in complex markets

Howard Walper –  Hi, everybody, I'm Howard Walper, CEO Americas for Commodities People, as you may know we're just a few days away from Energy Trading Week Americas, and I'm lucky to be here with a couple of industry experts from Baringa who'll be participating in the conference. So please let me introduce Lisa Flowers and Ben Heininger, who are part of Baringa's North American leading energy and resource practice. How are you guys doing?

Lisa Flowers – Good, glad to be here. Howard.

Howard Walper – We're glad to have you. How are you doing, Ben?

Ben Heininger – I'm very well, thank you.

Howard Walper – Great. We're going to be discussing the role of Power Purchase Agreements and the implications for both buyers and sellers.

Power Purchase Agreements colloquially referred to as PPAs have started to become headline news depending on what you read. As demonstrated by Microsoft's deal to buy power from constellations, Mothball, 3 Mile Island plan, for 20 years. Baringa’s expertise is focused at both ends of an assets development lifecycle and much of it's underpinned by their power and gas price projections which span the entire US, and which are used by decision makers to inform both risk management and strategy. So some great information here coming from you folks. Again, thanks for joining me. I imagine some people out there aren't too familiar with Power Purchase Agreements or PPAs. It would be great to understand exactly what they are?

Ben Heininger –  Thanks Howard. Yeah, I'll take that one. So simply put a Power Purchase Agreement is the an agreement between two parties to buy or sell power in the case of physical PPA, which we'll touch on briefly later or more simply, execute what's effectively a fix for floating swap that's tied to the price of power, so that's referred to as natural PPA. Physical PPAs are common in many jurisdictions. And US, it's typically associated with the sale of power by developer to a utility, so it's physical electrons to the extent that those are a thing. And you know those are bought by utilities to meet the needs of their consumers – so people like you and me. In Europe a larger share of what are called Corporate Power Purchase Agreements which we'll touch on too. And then, as I mentioned briefly, we have financial PPAs, so that swap that fixed and those are entered into by a wide range of counterparties, as they don't necessarily need any attachment to the underlying commodity.

Howard Walper – Yeah, that makes a lot of sense. I mean, what role do these play in the market? 

Ben Heininger – They're super important is the bottom line, and they're absolutely critical in getting assets built. Whether that's thermal assets, gas plants or renewable plants. The reason for that is that the loss of assets are project financed. So developers are going to banks to ask for some money. They're going to borrow that money to build the asset, and to secure that money they need to demonstrate that they've got a long term agreement to make money. Basically, they can sell power for a price. That's often where we're engaged, or my colleagues are engaged providing these projections that are used by banks to underwrite their lending. 

But increasingly, they're being used by parties like corporates, so Amazon, for example. to reduce their emissions. So if you're buying a purchase agreement from a renewable asset, you can often get the renewable energy certificates as they're known in the US energy attributes, and those are used to reduce your Scope 2, so they have that benefit as well. And the final one really is something I know Lisa is going to touch on briefly – is there a hedge? They provide security and risk management to both buyers and sellers of power.

Howard Walper – It's all very interesting stuff. You have mentioned corporates here. How well placed are they to manage the exposure that these contracts create.

Ben Heininger – Good question. I think there's a growing awareness of the risk that they create as well as the benefits. And it's certainly something that's becoming a greater area of focus. When you think about a Corporate Power Purchase Agreement, you've moved from a world in which you're buying from your utility through a sort of typical energy supply agreement, to this long term hedge effectively. And that creates sort of new and unfamiliar risks, obviously, price risk. And what you'll see is that simply, or you know, maybe 5 years ago. and to some extent a lot of people still today are evaluating the value of this PPA, or how in or out of the money it is by just looking at a view of price. So they go – what's the price in the market at the moment, or what's the near term view of price? If you're approaching it in that way you see a lot of variability and fluctuation in the value of that position, which is challenging to communicate internally and also to shareholders. What other people are starting to do as a result of that is using longer term projections like the ones that we have that are a bit more stable. So provide sort of greater clarity over that position on an ongoing basis. 

But that misses a lot of the sort of, I wouldn’t say, hidden risks. but some of the within your risk that you can get, so commodity price shocks, and that. So if you think in Europe, after the invasion of Ukraine gas prices spiked, and that led to a lot of challenges for our clients in Europe and equally in the US, a lot of people became familiar with the storm Uri, and the impact of that had. And that creates a lot of that sort of unpredictable over a long term horizon. But being able to look at that shorter frame of reference is very important, and that's something that we're really starting to do for our clients, as well.

Howard Walper – It's really fascinating. I mean, it sounds like there's quite a lot of risk embedded in these agreements for corporates. Lisa, this one is this one's for you and Lisa it's great to see you just discussing how many years we go back together. We've done a few things together in the past. This feels like one for you. I'd imagine that asset owners, generators, are better at managing the associated risks with PPAs.

Lisa Flowers – Yeah, I think that that's pretty much the perception we kind of take in house, as you know, when Ben's doing his look at the number of future prices and things like that. But it depends on the operating model really, of that asset owner. Are they truly just a developer, is that what they would start out to be? Are they an equity house? You know Ben was alerting to. People are getting the equity to build them. Is it a corporate spin off from a deregular utility possibly, they went to the now wholesale shop. So it really depends on the operating model. We're seeing more companies that started in that true development side of the business. You know that they wanted their model to be build and sell. So now we're seeing more of those going – wait a minute, maybe there is a reason I want to keep this right. So we're looking to keep it on the balance sheet. but with that they need to stand up the right commercial operations. Once they sign that PPA, as Ben mentioned the different off takers that are out there. So they manage that with an Amazon, or people like that. But there's a big shift in their operating model, there needs to take place across the people, the process and the technology to now manage it because they're used to just being on more the engineering construction side to be able to really optimize these assets. So it is a definite, different lift for them, but they can do it.

Howard Walper – I mean, it turns out that not everything is, I guess, quite what it seems then. What are the different ways that you see parties managing their various exposures?

Lisa Flowers – Yeah. So again, Ben, kind of touched on it. Their physical PPA – Power Purchase Agreement physical – they sell off the asset. Also the financial market term is more the VPPA, so it's virtual in nature. A key component of that makes that really go to a brighter, broader, I'll call it audience, but the market can take it, they're not obligated, as you said, to take the physical. But then usually there is that renewable energy credit component part of that that they get, so that does offset. So that's a key way that they can hedge that. Asset traders, they're also able to manage their exposure more in addition to PTAs, but different types of trades, being out in the market. There's physical trades, there's financial futures. And definitely now, depending on markets and types, there's all the different congestion products. And a lot of them will go out also and do options, and they can be futures of options as the energy. There'll also be weather options to hedge the risk like a winter storm Uri and other things. So they have a lot of options out in the market to do it.

Howard Walper – Great! Well, thank you for all this information, it's been really interesting. Again, if you want to find out more about this, come to Energy Trading Week Americas here in Houston. Our friends from Baringa will be there. So, Lisa Ben, thank you very much for being with us, and thank you for watching today have a great day.