Let’s dig deeper into each of these ‘risk buckets’.
There are three primary market risks of intermittent energy generation like wind and solar.
Wholesale Price Risk is the underlying wholesale price risk typically referenced against the traded baseload prices, which are visible to both buyer and seller up to three years ahead.
And, are also open to negotiation beyond this period.
In fact, short-dated wholesale prices can, and have, moved by over 100% in the last year.
The second market risk of a CPPA is
Let’s start with a quick explanation.
The term ‘capture price’ is related to the actual electricity price achieved by a generator in the market, and it is compared against the wholesale price measured as a baseload.
Here’s the challenge, the inherent intermittency of power generated from renewables can create pressures on revenue as periods of highest output don’t necessarily correspond to periods of highest demand.
It’s worth noting that this may be even more problematic if wind and solar conditions are favourable because this depresses prices.
This is also referred to as ‘price cannibalisation’.
Unfortunately, the depressive effect of ‘price cannibalisation’ is expected to grow over the coming years and this has a direct impact on the cost of a CPPA.
Finally, when considering a CPPA, you must consider the
The imbalance price is the price of electricity that generators or supplier pay of an imbalance in the UK electricity grid.
When an asset’s imbalance correlates to the power system imbalance (as intermittent generation does) the cost will be higher.
Whilst it is not as significant a risk as Capture Risk, Imbalance Risk can add a few more per cent to the cost of a PPA over its life.
Key takeaway: Whilst the wholesale price risk is typically fixed for the term of the CPPA, the price capture and imbalance risks are typically fixed for a shorter term via a utility and are typically taken by the buyer. As more buyers enter the market this cost is likely to go up.
That said, these risks can be allocated differently and to different parties within each deal.
This is why it is important to have a clear definition and understanding of the market risks emerging from a CPPA.
Educating yourself is the first step towards a good mitigation strategy.
#2. Credit and contractual risks of a CPPA.
Now let’s take a closer look at the credit risks of a CPPA.
This may not come as a surprise, but credit constantly comes up as one of the key risks of a CPPA.
Poor credit can sink a deal, so it’s important to consider this risk upfront.
The first thing to be aware of is that both parties have very different exposures.
For example, if the corporate defaults it could wipe out the entire equity of the generator and some of the project debt if it is financed this way.
On the other hand, if the generator defaults, the corporate is only exposed to the replacement cost of the CPPA. This could actually be a profit if the CPPA is priced higher than the market when the energy generator goes bust.
In addition, under a CPPA, power is delivered as it is generated througout the day. But payments for that power are typically monthly and in arrears.
In a nutshell, this means that the generator is effectively lending power to the corporate.
On top of this, once a wind farm or solar park is built, its feedstock costs - wind and sun - are all free. And its fixed opex is typically very low in comparision to its revenues.
As a result, solar parks and wind farms generate huge amounts of cash.
Combine this with the minimal mechanical risks and it is clear to see that renewable generation projects are very low risk (hence why pension companies like to own them). As such generators will typically be more concerned about the buyers credit risk than the buyer should be about the generator.
On the flip side, there are ways you can address some of the payment risks, such as: advance payments, material adverse clauses (MACs), increased payment frequency, and ensuring you are covered by payment insurance.
It is worth noting that generators may also seek parent company guarantees (PCGs) if the buyer is part of a larger group or they may look for a Letter of Credit or another form of collateral (cash, or liquid securities for example) on an escrow account.
Generators will also typically ask for increased credit support if the buyer’s credit or tangible net worth falls below a certain rating or value.
Key takeaway: It is important for a buyer to be flexible and not think they are entering a typical bilateral arrangement where both parties have similar exposures.
A final note on the risks of CPPAs.
If you are a buyer, you should also consider force majeure risk, which allows parties to cease meeting contractual obligations during unforeseen events outside of reasonable control.
And operation risk which includes the performance of the project, including curtailment, equipment malfunctions, and unplanned system outage.
What Is the Future for CPPAs?
In the future I think we will see more innovation in aggregation.
Corporate or public sector buyers with low energy demands, little experience, or poor credit profiles, will club together to procure a CPPA.
Here’s an example. In 2019, twenty of the country’s leading universities joined forces to strike a renewable energy deal to reduce both their bills and carbon footprints.
The universities bought £50 million of clean energy from a portfolio of wind farms. The deal fixed power prices at a competitive rate for the next ten years, and in turn, minimised their exposure to market volatility.
the first CPPA of its kind in the UK.
Elsewhere, I predict there will be an expansion of CPPAs to mid-sized corporates as contracting frameworks become more standardised.
Plus, we may also see more third-party traders and insurers coming into the market to provide services.
But what I know for sure is that the demand for CPPAs has never been bigger.
Renewable energy is finally shifting to a sellers’ market.
So much so that if the RE100 companies in the UK decided to procure all their energy from CPPAs, there wouldn’t be enough available supply.
And that’s before mid-market corporates and public sector bodies enter the market in a meaningful way.
The future looks bright for generators and the transition to green energy.
DOWNLOAD CPPA GUIDE MORE BLOGS