Power Purchase Agreement: Definition, How It Works

What is a Power Purchase Agreement?

A power purchase agreement, sometimes called an electricity power agreement, is a legal contract between a power producer who generates electricity and a customer who uses electricity.

In this arrangement, the power producer installs and owns an energy system on a customer's property. The customer is then able to purchase electricity, usually at a very low price, without any upfront costs. The power producer is able to sell the electricity and take advantage of tax credits.

The power purchase agreement, often abbreviated to PPA, lays out the commercial terms for the sale of electricity between the two signing parties.

Some terms that can be found in a PPA include:

• When the project will begin
• Schedule for delivery of electricity
• Amount of electricity to be supplied
• Negotiated prices of electricity
• Accounting
• Penalties for non-compliance
• Termination clause

The terms of a PPA usually last between five years and twenty years, and because PPAs take many different forms, they can be negotiated and tailored to suit the needs of the buyer and the seller.

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How Do Power Purchase Agreements Work?

In a power purchase agreement, a customer, also called an offtaker, provides a physical space for an energy producer to install some kind of energy-generating systems like solar panels or wind turbines. The producer owns the equipment for the duration of the PPA and covers all costs of installation. The customer can then purchase the energy at a reduced rate.

There are several steps necessary to execute an effective power purchase agreement.

• Step 1: A project must be implemented, developed, or refinance. A power purchase agreement is only necessary when a renewable project is ready to be built or refinanced, and it has a connection to the electricity grid.
• Step 2: Determine the structure of the contract. Power purchase agreements can be either physical or virtual. A physical PPA refers to purchasing energy at the meter point. A customer will receive physical delivery of the energy through the grid. A virtual PPA or a financial PPA allows a company to purchase renewable energy in the form of energy credits virtually.
• Step 3: Request for proposal or quotation. The energy producer must receive buying offers. This is done through a request for proposal or a request for quotation in which interested buyers make an offer for purchase.
• Step 4: Compare offers. Once the energy producer has received offers, they must compare the offers. This can be a highly complex process because the proposals do not contain specific details, only a price, tenor, and PPA structure.
• Step 5: Enter negotiations. Contract negotiations can take between six and twelve months in which sellers and buyers work out the specifics of the power purchase agreement.
• Step 6: Sign the PPA. After both parties have reached an agreement and all necessary terms have been negotiated, both the buyer and the seller can sign the PPA.
• Step 7: Management of the PPA. PPA's often have terms of five years or more. Both the buyer and the seller should manage the energy sales and risks throughout the duration of the agreement. This includes being aware of when the contract ends and options to re-negotiate and extend.

Laws relating to PPAs, and third-party energy generation equipment ownership vary by state. If you are unsure about the regulation or limitations on buying and selling power in your state, it is best to consult with an environmental lawyer .

Read this article for more information about power purchase agreements and how they work.

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What's Included in a Power Purchase Agreement?

Power purchase agreements are complex legal contracts and must include a variety of different terms agreed upon by the seller and the buyer. PPAs are tailored to fit the specific needs of the two parties involved; however, most effective PPAs will include the following terms:

1. Length of the Agreement. PPAs are usually five years or more but could be subject to early termination rights.
2. Price terms will vary greatly depending on the two parties and may include the project's renewable energy credits and carbon credits.
3. Constraints on the transmission system may curtail the production of energy. The PPA should document who is at risk financially if curtailment rights are exercised.
4. Development milestones are used to track the progress of the project.
5. Defaults and Credit. Sellers are usually required to provide credit enhancement in the event that the project doesn't meet milestones or isn't operational on the agreed upon date.
6. The PPA typically includes a clause about what kind of insurance the seller must maintain.

Types of Power Purchase Agreements

There are several different types of power purchase agreements, like physical PPAs and virtual PPAs, but because there are so many different variations for these agreements, it is difficult to list them all.

The three most common power purchase agreement types include:

• Physical power purchase agreement
• Virtual power purchase agreement (also called financial power purchase agreement)
• Sleeved power purchase agreement

One of the most popular power purchase agreements is PPAs for solar energy. Solar technology is low in cost and risk, so it is one of the least expensive renewable energies available on the market.

In a solar power purchase agreement, the developer funds the installation of a solar energy system on the customer's property at little to no cost to the customer. The customer benefits from purchasing the power at a fixed rate less than the utility's rate, and the developer can sell the electricity and also benefit from tax benefits.

Solar PPAs terms are usually between ten and twenty-five years. During this period, the developer is responsible for the operation and the maintenance of the solar energy system. At the end of the agreement, the customer usually has the option to either end the contract, extend the contract, or purchase the energy system.

Benefits of a solar PPA include:

• Little to no upfront costs
• Reduced energy bill
• Very little risk
• Tax credits
• Potential increase in property value

Image via Pexels by Pok Rie

Who Signs a Power Purchase Agreement?

The two parties who sign the power purchase agreement are the seller and the buyer.

The seller is the producer of energy who owns the project. Sellers can include:

• Investment companies
• Independent producers of electricity
• Renewable energy asset managers
• Utilities and energy companies building their own renewables assets
• Infrastructure funds investing in renewables

The buyer is the entity purchasing the electricity produced by the seller. Buyers can include:

• The occupant of the building, like a homeowner
• Utility companies who need additional power to supply their customers
• Large corporations with large energy consumption need like Google or Amazon
• Companies looking to reduce their carbon footprint
• Industrial companies who require a large amount of energy for manufacturing

A PPA is an excellent way for buyers to reduce their energy costs, protect themselves against price increases, and take advantage of tax incentives.

Get Help with a Power Purchase Agreement

Do you have questions about power purchase agreements and want to speak to an expert? Post a project today on ContractsCounsel and receive bids from environmental lawyers who specialize in power purchase agreements.