Utilizing a Power Purchase Agreement (PPA) is suitable where the hydro project is owned and/or operated by one entity, and the offtaker with load (the entity that is using the electricity) is a different entity. The offtaker entity purchases the energy output from the generator entity and the revenue from the energy sale is used to finance the construction of the project, sometimes by a third-party investor.
A Power Purchase Agreement (PPA) is a contract that secures a payment stream from an electricity buyer to finance the construction and operation of an independently owned power plant. In a sense, a PPA is a service contract, where one party is seeking the service of electricity to be provided by the other party. The PPA establishes obligations between the parties relating to the sale and purchase of the power generated, and sets out the required design, construction, permitting, operation and maintenance specifications for the generating plant.
PPAs are long-term contracts (typically 15-25 years) where the party buying the power, who may also be the owner of the hydro-site, commits to buy 100% of the energy produced by the hydro plant. The price that the buyer pays for the energy is set at a per kWh rate for the full term which escalates annually.
The Figure above explains the basic PPA structure, where the hydro-site owner (host site) is also the entity that consumes the energy output (offtaker). The hydro-site owner enters into an agreement with the developer, who constructs and operates the microhydro plant.
The plant is interconnected with the utility so that any excess generation that is not used by the offtaker can be sent to the grid to be used elsewhere. If the plant shuts down for maintenance or doesn’t operate for any reason, the offtaker is still connected to the grid and able to receive electricity from the utility. The offtaker pays the developer an agreed upon price on a monthly basis, which serves as a revenue stream to recover the cost of construction.
Let’s dive in a bit deeper. Because in reality, the PPA model involves numerous legally binding contracts. For example, there may be loan agreements, investor agreements, and the PPA may also include site lease terms and access rights to the site, or these may be detailed in inter-related agreements. The figure below demonstrates the level of complexity that can be associated with PPA structures.
In the scenario above, a PPA developer (named MicroHydro) has numerous projects under construction, with separate subsidiaries for construction (MH BuildCo) and ownership of the asset after construction (MH HoldCo) at numerous host sites. Additional parties include construction lenders, PPA investors, various subcontractors and more.
With most PPA structures, no upfront payment is required from the offtaker. Power produced by the plant may be sold to the offtaker at a lower rate than the commercial utility rate the offtaker is accustomed to. This can be very appealing for an offtaker, who instead pays a monthly agreed upon price for the electricity per kWh for a fixed number of years. Operation and maintenance costs are built into the agreed upon per kWh price. There may be early buyout options and the offtaker may have a choice to renew, purchase the system or have it removed at the end of the term.
In a PPA, financing is structured so that the only recourse to the lender is the project revenue, in other words, the PPA itself is the source of loan repayment.
Thanks to current energy policy in New York and the United States, renewable energy sources are often able to monetize government incentives to improve project economics. These incentives may include federal, state and local tax credits, rebates, renewable energy certificates (RECs) and tax abatement programs, which vary by location and technology. Incentives are exploited by the developer or investor and used to help finance the construction of the project.
The benefits to the offtaker are price stability, affordability and a hedge on volatile electricity prices. The offtaker will know what their power will cost for the full term of the agreement, which is very different from purchasing electricity from the utility, who can raise rates at virtually any time. There is usually an economic savings to the offtaker and the environmental claim for using renewable energy. The offtaker doesn’t have to make a large capital outlay and they don’t have to be an expert in microhydro technology to choose microhydro using a PPA.
After this rather complex introduction, our next post will talk about the different parties that could potentially be involved a PPA.
You can also download our full Microhydro PPA Report.