Introduction

A ‘Power Purchase Agreement’ (PPA) is a contractual agreement usually entered between private sector companies and public sector companies for purchase of power. PPA is the initial agreement that enables ‘Public-Private Partnership’ (PPP) within power sector. Most often, it is a state-owned purchaser (also referred as ‘off-taker’) contracting with private generating company for supply of electricity, to further transmit and supply electricity to its destined location.

PPA outlines all terms of sale between contracting parties, which can include the commercial operation date (COD), supply schedule, penalties for late deliveries, fee structures, termination of contract etc. PPA acts as major source of funding for generators. Private generator’s capacity to secure funding for project, recoup capital expenses, and generate return on equity depends heavily on the structure and risk allocation mechanism under PPA.

While some components may be same for all PPAs, certain mid-range power plants or plants operating with enhanced technologies etc., would require distinct considerations in the agreement and they are free to make deviations.[1]

Q) What is the life term of a PPA?

A PPA’s contractual terms can range from two to twenty years (even longer), during which time the off-taker purchases electricity from the generator. During the agreement, off-taker can avail other ancillary services from the generator too. Funding of independently owned power generating assets is significantly influenced by these agreements. ‘Independent Power Producers’ (IPPs) are usually sellers under PPA.

A PPA can be executed for varied durations:

• Short term/Temporary or Emergency PPA: Usually executed for small and rural projects on short-term basis from mobile power plants. (2 to 5 years)

• Medium and Long term PPAs: Usually executed for commercial and industrial projects on medium or long-term basis from permanent power plants. (5 to 20 years)

Q) What are the different types/forms of PPAs?

There can be multiple forms of PPAs. However, the pertinent forms for our consideration which are in practice are ‘Physical PPAs’ and ‘Virtual PPAs.’

Physical PPAs

There can essentially be two different types of Physical PPAs used to purchase fixed quantity of electricity at fixed rate. However, only difference between them is the manner in which electricity is supplied to buyer.

I. On Site PPA

A direct line of physical supply of electricity is required for an on-site PPA, which calls for the production facility and end consumer to be close to one another. With an on-site PPA, production plant is situated next to consumer’s metering point. Installation specifications are determined by consumer’s consumption profile. If there is any left-over electricity, the grid operator can be contacted, and such electricity can be supplied to the gird. 

All on-site PPAs are also corporate PPAs because the electricity produced by an on-site PPA lowers a company’s usage.

II. Off Site PPA

Off Site PPAs too are arrangements to buy specific amount of electricity for specified duration. However, unlike on-site PPAs, generator provides consumer with electricity via public grid networks. It is not necessary for the plant to be in proximity with consumer/(s). This gives generators more options because they can now pick areas with most suitable circumstances to establish their facility (usually, rural areas). Further, all generators have long-term price security because the PPA determines fixed tariff for electricity supply.

Virtual PPAs

A financial agreement known as ‘Virtual PPA’ (VPPA) requires buyers to buy electricity from developers at predetermined price, commonly known as ‘strike price.’ In VPPA, buyer does not physically receive power (unlike in case of standard PPA).  Instead, developer sells power at the wholesale market, or at ‘Indian Energy Exchange’ (IEX). If market price of energy traded at IEX is higher than the pre-determined price under VPPA, developer must reimburse the buyer for the difference. However, if market price is less that the pre-agreed price, balance amount is paid by buyer to the developer.

Thus, when the agreement terminates, both developer and off-taker will have successfully distributed or hedged their price risk and will not have suffered loss or earned profit from sale and purchase of power at the market.

There are few advantages of this arrangement to all sides. Purchasing company can buy electricity at fixed cost, while the developer has price security required to secure finance for its project. Further, buyers also receive certain ‘Renewable Energy Certificates’ (RECs) in exchange for purchase, which is similar to possessing specific quantity of Renewable Energy. [2]

Q) What are PPAs used for?

Funding of Project

Power plants frequently require outside investment, as from a bank or other sources. Nevertheless, a third party is not likely to lend without security. PPA offers that security even when there is no scope for government subsidy. PPA can offer the trust that lenders seek before initiating funding of a power project. This refers to the buyer’s promise to purchase power from that generating station at fixed price per megawatt hour (MWh) for a long-term tenor (about 10-20 years), indicating that fixed price will continue to flow towards the generator for a long duration.

One also needs to take competitor’s risk into account from the lender’s standpoint. Is the credit standing of this seller sufficient to guarantee continued operation over the following 10 to 20 years? Reliable or bankable competitors are those who lenders assess to be strong enough to fund the cash flows.

Hedging of Prices

By lowering uncertainty around cash flow, PPAs give investors the assurance that the project will, once completion, generate return on their capital investment.  PPAs allow for long-term sale of a share of a project’s projected energy production to a buyer. Before a project begins, parties often agree to a PPA contract and execute it. 

Any investor’s primary objective is to manage risk in investment. They manage the volatility risk by entering long term PPAs. Power market prices are quite unpredictable since and can fluctuate every 5 to 30 minutes. In such agreements, off-taker can offer a long-term fixed price. With minimal risk to predicted income, long term PPAs ensure a future return on investment.

Further, since electricity is being traded at fixed cost on long-term basis, there is long term predictability of price that is maintained.[3]

Q) What are the advantages and disadvantages of a PPA?

Advantages

A PPA enables renewable energy plants to increase certainty of their earnings. Normally, without government subsidy, this would not be feasible in the volatile electricity market.

PPA makes it possible for lenders to finance generator’s power project and similarly lowers the scope of loss by effectively dividing risk among all contracting parties.

As regards buyers and sellers, PPA guarantees fixed long-term expense towards the generator and in turn, enable generators to fund its power project while maintaining its Renewable Purchase Obligation (RPO). 

As regards the lenders, PPA provides revenue assurance because a particular volume of energy has been agreed to be sold at fixed price.

Disadvantages

PPAs are complicated contracts that frequently demand extensive discussion and negotiation before being settled. If price trends turn out to be unfavourable for one party, PPAs’ long duration may be a disadvantage. Actual output of electricity itself might fluctuate. The plant operator must offer monetary or physical compensation (or an arrangement for supply with a third party like an electrical trader) if the agreed-upon quantities of electricity are not available at the time of delivery.

Q) What are the important clauses in a PPA?

Central government is responsible for providing ‘draft PPA’ for long term purchase of power. Although every agreement is unique and can have different clauses based on mutually preferred arrangements, certain important clauses remain same and form part of almost all executed PPAs. Such important clauses of a PPA are discussed herewith.

(A) Terms of Contract Clause

PPA compels the generator company to provide electricity in line with its terms as well as make certain amount of capacity at the plant available to the buyer. A PPA clause can also obligate the generating company to design, build, manage, and maintain the power plant in conformity with agreed upon standards. 

(B) Pricing Structure Clause

PPA’s pricing structure normally consists of two elements –

I. Availability Price:

This amount must be paid by off-taker (regardless of whether it off-takes electricity from the plant) in exchange for the plant operator making power capacity available to the off-taker. Each generator would primarily recover its fixed expenses through this element, which is often intended to create a revenue floor for the power project.

II. Output Price:

This typically refers to the price for actual amount of electricity supplied to buyer.

Pricing structure is essential as to how the private generator and its lenders evaluate the project’s commercial feasibility and bankability because it is the main method for dividing both the project revenue and market risk between the public and private sectors. To ensure investment recovery, private generators and financiers frequently demand that the PPA be in place for a considerable amount of time.

(C) Sale to Third Party Clause

A flexibility clause to sell to third parties can increase the project’s financial sustainability and give it some protection from demand-side uncertainties under the main long-term PPA. Due to primary PPA’s long-term structure, this flexibility also has benefit of allowing the power plant to engage in deregulated market (if it happens in future) without fully dissolving the primary PPA.

However, this does not go in best interest of buyers who want to ensure that full capacity is always accessible to them. Thereby, they can mandate including an exclusivity clause in PPA stating that all power produced is to be supplied to the purchaser.

(D) Clause for Maintaining Standard of Performance

If generating company does not maintain stipulated standard of performance, a PPA clause can impose sanctions or demand that it pays the liquidated damages. Some examples for this could be that if the project is not constructed on time, generating company will be required to pay liquidated damages, or in case the power plant fails to achieve stipulated standard of performance, electricity tariff can be reduced.

(E) Testing Clause

The testing clause needs to be impartial and should verify if agreed degree of consistency and efficiency of a power plant is maintained. It should be the responsibility of an assigned impartial engineer to certify the test results.

(H) Operation and Maintenance Clause

Such a clause in PPA addresses issues like operation and maintenance of the power station, operating procedures, inspections, fuel purchasing, emergency situations, record-keeping etc.   

(E) Force Majeure Clause

A Force Majeure event or occurrence happens when by an act of God, or other means the performance of contract becomes practically impossible to execute. For disruptions brought in by force majeure occurrences, generating company can use the relevant clause in PPA to discharge itself from fulfilling contractual commitments and its obligation to pay damages. However, because it is a crucial mechanism for dividing risk between public and private sectors, the extent of force majeure relief that is possible can frequently be an important issue for negotiation. It may also be necessary to modify the scope of relief towards technological advances being brought into the sector. Force majeure clause and the ‘change in law’ clause are frequently related to each other. 

(F) Change in Law Clause

PPA must discuss process for tariff revision and impact on tariff resulting from a change in law. Private generators and their financiers will have to make sure that in event of change in law, project’s cash flows are suitably maintained.

However, situation can differ if the buyer is non-government entity. Compared to a government body, private buyer has far lower capacity to absorb risks arising out of legal change.

(G) Termination of Contract Clause

PPA must specify what will happen in event of termination of contract (either at end of term of agreement or early termination for default etc). This should cover the power generator’s duties to transfer assets to government off-taker (who paid for establishment of the plant), upon termination of contract period. Further, what will happen to employees of the plant upon such termination should also be addressed.[4]

Reference

Central Regulatory Commission (CERC) is the body responsible to draft and develop sample PPA to be used by parties before executing agreements. Parties are free to make deviations from draft PPA, provided they present a reasonable justification for desired deviations.

A draft sample of PPA developed by CERC for procurement of power on either medium or long term basis through tariff-based bidding process can be found by clicking here here.[5]

[1] https://www.seia.org/research-resources/solar-power-purchase-agreements

[2] https://pexapark.com/solar-power-purchase-agreement-ppa/

[3] https://www.next-kraftwerke.com/knowledge/ppa-power-purchase-agreement

[4] https://ppp.worldbank.org/public-private-partnership/sector/energy/energy-power-agreements/power-purchase-agreements

[5] https://powermin.gov.in/sites/default/files/uploads/standard_bidding_doc_PPA.pdf