Power Purchase Agreements – where we are, how we got here and where do we go next?

Historically renewable build up has followed national subsidy scheme availability. The industry gearing up was practically closed over night as subsidy schemes were changed e.g. on shore wind in Denmark in the early 2000’s and PV in the Czech republic in 2009 and 2010. Due to the highly lucrative nature of the subsidies provided, this stop and go effect has allowed development to continue despite political interference. Nevertheless, this state of affairs does not favour anyone least of all consumers/tax payers who end up footing the bill.

Fortunately, with falling production costs and innovative mechanisms such as Power Purchase Agreements (PPAs) 1 for handling the challenges faced by unsubsidised assets, we are now experiencing a rapid change in the renewable sector which potentially allows for an unsubsidised green transition.

Where we are now and how we got here

As subsidies are being phased out and market products are taking their place, we are seeing a momentous shift in projects being constructed. In Germany, for example, there has been a rapid reduction in on shore wind in 2018 whilst Spain has seen PPAs far in excess of 1 GW of new capacity signed 2.

The global aspect of the PPA market is another element that attracts and entices investment funds as the skills acquired from a European transaction can be transposed into the global market.

In the case of Spain, the market has long been shunned by renewables investors after the retroactive cut to subsidies destroyed investor confidence and shut down development of new projects. While a state backed system may not have reinvigorated the market due to doubts about the Spanish state, the new purely market-based offering has drawn in many foreign investment funds as it offers competitive returns without the project size restrictions as are commonly seen in subsidised projects. The previous concerns of political risk have been exchanged with a classic counter-party risk assessment. Such an assessment is by no means an easy undertaking as the investor needs to be certain that his off-taker can still purchase the electricity at the given price up to 20 years later. At the same time counter-party risk assessment is a classic risk management discipline that many investors feel more equipped to quantify than e.g. political risk.

The attractiveness of market parity assets have convinced investors, led by investment funds and institutional investors, of the benefits of moving away from subsidised projects and from the pressure on all other segments of the renewable value chain to deliver projects. This has led to not only a boom in PV development all over Spain and Portugal but a boom which is spilling over into other markets as investors are seeking to close large portfolios.

For the authors of this article it has meant an increased focus on markets globally instead of the classic European PPA markets of Iberia and the Nordics. The clients whom we have successfully advised are taking us further and further afield starting this year with markets as diverse as Serbia, Panama and Australia in addition to several other EU countries. The global aspect of the PPA market is another element that attracts and entices investment funds as the skills acquired from a European transaction can be transposed into the global market. Not only the investors are global in their outlook, the most bankable and attractive off-takers tend to have a global presence which leads to the possibility of global framework agreements allowing investors to close unprecedented deals in size and scope.

What will happen next?

As this trend spreads to more markets, politicians in markets maintaining subsidies will be forced to ask themselves if the renewable industry has not outlived the need for subsidies and if it is time to allow the market to decide which energy generation plants should be constructed and where. This will naturally lead to consolidation of developers as all levels in the renewable value chain will be forced to reduce costs in order to remain profitable since the end of subsidies will undoubtedly reduce the margins. At the same time this cost-cutting mechanism will be supported by larger project sizes in areas with higher renewable resource availability which in the end should prove to be sufficient to drive on development as we have seen in Spain and Portugal already.

1 A power purchase agreement in the context of this article should be understood as a long term (10+ years) obligation to buy a set production from a renewable energy asset replacing the previous subsidy regime as the basis of financing.

2 The total number is not verifiable but the authors of this article closed more than 1 GW, which although is a large percentage of the total, certainly does not make up all the volume in the market.

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