To be eligible for a PPA, a project must be located in a state or jurisdiction where third-party ownership of energy generation equipment is allowed. Some state regulations limit or restrict non-utility providers in regulated markets from selling electric power. For more information on where PPAs are available, see this map from Database of State Incentives for Renewable Energy (DSIRE).
Under a PPA, the customer signs a contract with a third-party developer to purchase power generated by solar panels, wind turbines, combined heat and power (CHP) equipment, or other forms of energy generation on a facility's roof or nearby location. The customer is therefore also known as the offtaker, or the purchaser of power. While the customer/offtaker often provides the physical space to host the system, this is not a requirement and the host and customer/offtaker may be separate entities in leased spaces. The developer and its investors own the equipment for the duration of the PPA. The developer typically provides initial project coordination services such as bridge financing, design, and permitting with little-to-no cost to the customer. Equipment installation may be completed in-house by the developer or by a contracted installer.
The electric output generated by the energy system is then purchased by the customer at a rate that is generally lower than the utility's retail rate, generating immediate cost savings. The PPA rate usually increases by 1-5% each year for the contract term (i.e. a price escalator) to account for gradual decreases in system operational efficiency, operating and maintenance costs, and increases in the retail rate of electricity. PPAs are generally long-term agreements of 10-25 years. At the end of the contract term, the customer may be able to extend the term, purchase the system from the developer, or have the equipment removed from the property.
The utility serving the customer provides an interconnection from the energy system to the power grid and will continue service if the system does not produce enough power to meet the customer's electrical needs. When the system produces excess power, it can be sold to the utility, typically at the retail electricity rate. This process is called net metering, and most states have adopted net metering policies. For more information on net metering, visit NCSL's State Net-Metering Policy Overview.
The developer will typically create a special purpose entity (SPE) for each project that serves as the legal owner of the energy system. The SPE exists to raise debt and equity investment in the project, resulting in mutual ownership of the SPE (and therefore the project) by the developer and investor(s). The SPE allows for investment at the project level without subjecting investors to risks associated with the developer's other projects, while also minimizing risk for the developer should the project default or experience other issues.
There are tax credits and rebates available at both the federal and state levels for renewable energy projects. Examples include the Solar Investment Tax Credit and the Production Tax Credit for wind energy. These incentives can be used by the developer and investors to reduce costs and make projects more attractive for potential investment. Visit DSIRE for more information on available incentives for renewable energy by location.
The system owner will generally retain all environmental benefits of putting clean energy onto the grid, such as Renewable Energy Certificates (RECs). RECs are tradable, non-tangible energy commodities that are issued when one megawatt-hour (MWh) of electricity is generated from a renewable energy source and delivered to the grid. These certificates are a way for businesses to verify carbon reductions from specific projects and count towards organizational targets for renewable energy use. Mandatory REC markets exist in states with renewable energy portfolio standards (RPS), but there are also voluntary REC markets available for those who want to purchase them. REC arbitrage, which is the near-instantaneous buying and selling of RECs in different markets, may be an option to decrease overall costs if the customer is located in a market with high REC prices. For more information on REC arbitrage, visit EPA's REC Guide.
AN ALTERNATIVE APPROACH: THE OFFSITE PPA
An alternative to a direct PPA with onsite power generation is an offsite PPA, also referred to as a virtual or synthetic PPA. Under an offsite PPA, the customer and the renewable energy project do not need to be located in the same region. This gives customers more options when choosing projects and allows customers to take advantage of PPAs even in states where onsite PPAs are not available, or if there are physical space constraints that would prevent the installation of generation equipment.
In an offsite PPA, the customer enters into a long-term PPA with the owner of a renewable energy project but does not take physical delivery of the power generated, which is instead sold to the local grid at market price. The customer and project owner agree on a fixed rate for the cost of the generated power, which is also referred to as a strike price. The project owner then sends the customer funds in a settlement transfer for the difference between the revenue from energy sold at the market price minus the customer's fixed rate amount. The amount of this settlement transfer depends on the market price for energy, and in cases where the PPA strike price exceeds the market price for electricity, the customer is required to pay the difference to the project owner. The customer continues to make normal payments to its utility, but some of these costs will be offset by the funds received in the PPA settlement transfers. This payment arrangement between the customer and the project owner is referred to as a fixed-for-floating swap or contract for differences.
Offsite PPAs are often used as an energy price hedge. In addition to the financial benefits of offsite PPAs, the customer will generally retain the rights to any RECs associated with the PPA.
POSITIVE CASH FLOWS-PPAs can cover 100% of project cost, and the price of power purchased through the provider is typically less than the retail rate for electricity. This often makes the PPA cash flow positive for the customer from day one.
THIRD-PARTY OWNERSHIP AND OPERATION-Under a PPA, a third party installs, owns, and maintains the energy system, allowing the customer to avoid the risks and complexity of equipment ownership.
OFF BALANCE SHEET-The PPA is designed to be an off-balance sheet financing solution, with regular payments that are treated as an operating expense like a standard utility bill.
PREDICTABLE ENERGY PRICES-PPAs lock-in energy prices at an agreed-upon rate and protect the customer from utility rate fluctuations over time.
RISK OF OVERPAYMENT-The annual price escalator under a PPA (usually 1-5%) may result in the customer paying a rate higher than the market rate, if retail electricity prices decline or increase more slowly than the escalator.
LIMITED AVAILABILITY-Laws surrounding PPAs vary by state. Some states have laws that create barriers for PPAs or outlaw them entirely.
CONTRACT COMPLEXITY-PPAs can have complex contracts and higher transaction costs than buying a system outright.