Power Purchase Agreements: What You Should Know

What is a Power Purchase Agreement (PPA)?

Power Purchase Agreement (PPA) financing of solar projects was created in the late 1990’s, and has become increasingly popular with commercial utility customers as an affordable way to reduce electrical energy costs and carbon footprint.

In a PPA, a customer enters into a 20 to 25-year agreement with a solar developer, typically an EPC (Engineering, Procurement & Construction company) to finance and build a solar project on their property. The developer then sells the electricity generated by the solar facility back to the customer. This arrangement saves a customer money if they are buying energy from the solar project at a lower rate than they would have paid the utility for that energy.

Customers typically are not going “off the grid” with this arrangement—they’ll still need power from the utility when the sun isn’t shining, or if the PPA system isn’t producing enough for your needs. These projects also commonly export energy to the grid during peak sun periods, banking credit with the utility to further offset energy costs. The customer also won’t realize the tax credits and incentives for installing solar—these are claimed by the developer, who owns the system.

PPAs are popular for several reasons: there’s little to no upfront cost, and you typically realize immediate first year savings. Perhaps just as important, the owner of the system has an ongoing incentive to ensure the system is maintained and performs well, because they earn revenue from the power produced by the system.

PPAs create value for the customer by saving money, not by generating revenue. These potential savings are based on assumptions about the cost of electricity from the local electrical utility and the value of energy that is generated by the solar facility, which is established by the electrical utility’s rate tariffs. Thus, the savings from a PPA depend on the cost of energy from the PPA, the cost of utility energy, and how the utility charges for that energy.

Understanding the Risks of a PPA, and How to Manage Them

As with any type of long-term investment, PPAs do come with risk. Changes in utility energy cost escalation and rate tariffs dramatically impact projected savings. Customers must ensure that PPA energy pricing and buyout terms will result in project savings using conservative assumptions, that system sizing and design are correct and that contract provisions are equitable.

Moreover, the solar industry is dynamic and subject to intense and often unpredictable market and policy pressures. Your PPA provider may merge with another company, sell your system off, or disappear altogether. If your contract isn’t written to protect you in such a scenario, you may find yourself in limbo with a system that isn’t performing the way it should.

These risks can be mitigated with diligence and oversight. When assisting its commercial clients with PPA agreements, Sage recommends the following to manage PPA risks:

• A PPA rate that saves money in the first year of operation

•   No annual escalation of the PPA rate

•   Careful financial and performance modeling that accounts for potential utility tariff restructuring, long-term energy market trends and system performance degradation

•   Understand and establish current and future electrical energy usage at the site

•   Size systems carefully to avoid overproduction and loss of value

•   Know the developer: their experience, financial stability, financing sources

•   Include a performance guarantee to safeguard projected savings

•   Ensure that buyout provisions are reasonable and add potential value

•   Include contract provisions to protect the host customer for changes in PV system ownership

•   Ensure the contract requires removal of systems at the cost of the system owner at the end of the term or if the system owner fails to meet their obligations

Want to learn more about how to finance your next solar energy project? Read more from our CEO, Arno Aghamalian, in the Washington Post.

If you’re a commercial customer considering a solar PV PPA, Sage can provide independent oversight and expertise to help manage risk and maximize the lifetime savings of your project.