Markets change fast, it takes agility to take full advantage of opportunities.

13 min read
Markets change fast, it takes agility to take full advantage of opportunities.
The following interview was first published in the Italian energy magazine Nuova Energia. This is our own English translation. If you prefer you can download the orginal article in italian.

The combination of ambitious renewables targets set at a European level and an economic environment with an excess of liquidity, made in the last years market parity renewables investments particularly attractive for market participants from all over the world; a trend that now spreads more and more both geographically and technologically.

The sector is in full swing today, but only a few years ago the potential of long-term contracts was not yet realized, in a forward market that - especially following the 2008 crisis - was only used to buy and sell energy with a time horizon of two-three years in the future.

To better understand this trend and its dynamics, Nuova Energia met Dario Gallanti, Partner at ONE, responsible for Southern Europe.

Power Purchase Agreement (PPA) is basically an energy purchase contract. What is the real novelty when compared to other types of agreements?

PPA is indeed a concept that can be defined in several ways and the term itself is certainly not a recent invention. More specifically, in the post subsidy era this type of contract regulates the purchase of a certain amount of energy between a seller (in this case the renewable asset) and a buyer (also called off taker) for a pre-defined period of time, to cover the revenue from the energy selling and therefore to help guarantee the investment return. Over time, in the market parity space we have witnessed a significant change in the types of PPA; apart from the PPAs changing, the parties involved have also changed.

For instance in Iberia, which is currently the most advanced and liquid market for unsubsidized investments in Southern Europe, in addition to independent producers and private equity funds, we find a growing number of long-term investors (such as sovereign wealth funds or pension funds) which, contrarily to the past, are now interested in taking also some of the risks involved in the development of the project.

The Iberian Peninsula and Italy represent two hot markets for market parity. What are the differences between the two countries?

From the point of view of the different market stakeholders there are considerable differences, many of which are just a matter of timing and track record.

In many ways Italy now seems to be in the same position as Spain was two years ago but, thanks to the Iberian experience, I doubt that Italy will take the same time to bridge this gap.

In the solar sector, in Spain the development trajectory of the sector from the subsidy era to the market parity one has seen fewer interruptions than the Italian one. Many Spanish developers, once the subsidized market boom had receded in Southern Europe, have taken part in foreign initiatives, especially in South America, which have ensured business continuity and a prompt development of market parity opportunities as soon as the first interested investors re-entered the Iberian market.

Speaking of bureaucracy in the development activities, what are the difficulties to overcome?

In the case of Spain, the biggest bottlenecks are in terms of grid connection. According to the latest data released to the public, there are connection requests for over 100 GW from all over the country.

As for Italy, it seems to suffer from a misalignment in the authorization process which includes all the activities that follow the connection request. From this point of view, our country urgently needs greater harmonization between the present and future objectives agreed at national level and the procedures for issuing permits that are carried out at regional level.

Once the permit is received, what differences do you perceive in the role of the banks?

In both countries banks are certainly attracted by market parity initiatives: especially for solar, these investments show a relatively low operational and technological risk profile especially when considered in the light of transaction margins, which in the case of market parity initiatives - typically of medium size - require higher credit volumes to keep the cost of a single transaction low.

In Spain, debt financing for market parity projects has developed very quickly over the last 18 months, thanks to the fact that with the right duration, structure and off takers, PPAs allow for debt ratios comparable to those seen with fully incentivized assets.

Italy additionally suffers from authorization limits. The majority of the (few) fully authorized projects carried out with market parity transactions financed to date are part of broader portfolios of subsidized initiatives. An acceleration in the granting of permits would allow Italy to fill the gaps quickly, also considering that a number of Spanish banks seem more than keen to replicate the successes achieved at home with projects located in Italy.

And here we find once again the same old national Achilles’ heel…

It is also interesting to compare the two countries in terms of liquidity on the forward energy markets, which for many off takers is the starting point for pricing in long-term PPA. The increased liquidity on longer tenor products we see on the Spanish market platforms, is directly connected to more and more PPAs getting signed, thus creating a self re-enforcing cycle of long term transparency.

Again, we expect that as the number of permits granted in Italy increases, so will the number of successful closed PPAs, resulting in the same positive mechanism.

What impact has increased market liquidity had on the duration of the PPA?

On the one hand, it allows off takers to make the best use of the energy markets to cover part of the risks associated with PPAs, insofar as it allows final consumers to create long-term energy price expectations.

On the other hand, however, the greater the liquidity on the energy market, the lower the value of the risk premium that the buyer will be able to earn from the seller, this representing for some off takers an incentive to further extend the duration of the contract to ensure that such product remains in the same risk/return category.

Talking of PPA tenors, what time frame are we talking about?

To date, we can say that the largest number of PPAs in market parity currently signed in Europe are clustering around a duration of 10 years, as this often brings an optimum in the business plan when matched with the size and duration of debt.

However, some of the largest transactions in which we have participated - e. E.g. the current largest private PPA in the world, which we collaborated on last year - involve up to 20-years agreements.

Does such a thing as a standard PPA exist?

From our privileged point of view, we have realized that each PPA is different from the other, and we do not think there is much room for standardization in the medium term. The reason is that so is the interest of every investor approaching this market, as under such configuration developers and investors are allowed to make a tailor-made risk selection based on their unique utility function.

To be put in other words, in market parity space, investors can only mildly compete on CAPEX and OPEX. The different investment strategies are mostly reflected on the revenue part of the business plan, hence the outmost importance of the PPA and of its “customization”.

What effect can a contract with such an extreme level of customization have on transactions?

Coming to transaction, in the market parity era, we can say that PPAs are the real cornerstone of transactions. On the basis of our experience, we have created a graphical model that can provide the various stakeholders with a sort of quick guide, orienting them in the complex world of this type of transactions.

The scheme, known as “ONE star” as it graphically composes a star, represents the close links between the various parties and elements involved in the transaction, and clearly shows how these do not remain static, but are constantly evolving throughout the transaction itself.

The ONE star

Tell us more in detail.

For example, considering a certain development pipeline, this will only fit a limited number of investors, which will be interested to secure a certain PPA structure with a limited number of off taker. Not every off taker will have appetite to offer the same PPA structure and the financing bank will structure the debt both on the basis of the credit worthiness of such off takers and even more depending on the content of the PPA structure. Without going through all the branches of the star, it is clear how the transacted PPA represents the fine balance among the utility functions of all the actors involved. For this very reason, the negotiation process often jams at one of the many intersection points where participants come into contact with each other; our task at ONE is to provide tools and solutions to ensure that the various requirements are reflected in the PPA and that the transaction is successful.

What is the added value you offer the customer?

The rapid market development leaves a knowledge gap in most organizations as transaction innovation is rarely made public. With the strongest track record of transactions and the ability to “read” the market, as ONE we create the competitive advantage that allows our customers to move with the speed and agility necessary to take full advantage of the opportunities available. As a first step, we assist investors in structuring the market product that best meets their needs in terms of risk profile and financing solution. These financial requirements are translated into specific PPA requirements. In a second step, we identify the possible PPA counterparties among those that best suit the characteristics of the product of scope. Finally, we assist the client during the negotiation phase, accompanying them in negotiations with the banks until the agreement is closed.

What are the challenges for corporate buyers?

Let’s start by saying that corporate customers are certainly showing a growing interest throughout entire Europe, directly proportional to their need to put “truly” green energy supply on the agenda. For some large consumers, the purchase of Certificates of Guarantee of Origin from incentivized plants is often no longer perceived as a sufficient commitment; moreover, the idea of additionality is beginning to appear increasingly high on the list of priorities of the sustainability departments of many companies.

Solar Park

This additionality aspect is something that certainly has wider repercussions.

That’s right. The idea is that it is indeed the direct commitment of the final energy consumer through the signing of a PPA that allows the construction of new renewables capacity. This becoming direct contribution to energy transition, to reducing emissions and to creating new jobs. However, the reason why only a handful of “Direct corporate PPAs” have been closed in Southern Europe (and none in Italy at the time of writing) is the limited experience of corporate groups in establishing direct relationships with renewables, which derives mainly from the midstream role historically played by utilities.

As happened in the Iberian Peninsula exactly a year ago with the signing of the first direct type corporate PPA by Arcelor Mittal, which we assisted on, it is no coincidence that also in Italy the first commitments of the groups regarding medium-term green supplies were made by the steel industry companies, traditionally among the most sensitive to the aspects of competitiveness and risk management related to energy supply.

Rather interestingly, the strategy of the first-mover has strong spin-offs in terms of externalities, since once the first player in a specific energy-intensive sector makes a commitment of that kind for part of its energy, competitors are forced to follow in its footsteps so as not to lose competitiveness. Also, this phenomenon is therefore capable of triggering a self-re-enforcing circle in investments in new renewable capacity.

What can we expect in Europe and in Italy?

From a pan-European perspective, we can expect more and more private-wire agreements as the concept of additionality makes its way into large companies.

In our country the permitting procedure is of paramount importance and how quickly authorities will be able to adapt to this renewable’s renaissance, as permits will be the driving force for the rest of the value chain. On the off takers side, as much as on financial institutions, we see a fiercer competition with more international players actively looking at Italy.

ONE and a history of primacy

Our New Energy, now better known by the acronym ONE, was founded in 2016 based on the intuition of a group of like-minded energy trading professionals bringing their experiences from the off taker side to revolutionize the status quo of investments in renewable energy based on incentives. Honoring its own name, the company took part in several market parity transactions at their "first time": the first market parity transaction in the history of Spain, the first PPA in market parity in Portugal, the first 10 year fixed price PPA in Italy, the first direct corporate PPA in Southern Europe and even the first secondary PPA based on a renewables PPA signed between utilities in Southern Europe. Only three years after its creation, ONE is the European leader in PPA transaction advisory and celebrates in these days the goal of the first 2.5 GW of market parity assisted transactions, a figure that corresponds to 30% of all PPAs without incentives concluded in Southern Europe.

What effect does the extra-ordinary CoVid 19 situation have on the blossoming PPA market?

In terms of volumes, so far, the demand from off takers for PPAs in Southern Europe has not changed drastically. Everyone who was looking into buying power long term will still be looking at buying long term as the underlying business model remains the same, even more as the current low-price scenario is bringing people to buy more energy for a speculative position.

Where we do see the effect is on the future power prices which have come down significantly and these are reflected in the PPA pricing from every off taker (more so for those hedging in the market), even though off takers have currently absorbed a good part of the drop, implying that the PPA pricing has experienced a much lower drop than the underlying market power prices (e.g. Cal 2021, Cal 2022). Certainly, alternative and more complex PPA structures will be increasingly important and on the agenda in this volatile and uncertain environment… at least until the next market rebound!

Dario Gallanti
Dario Gallanti

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