Are PPAs An Attractive Option In EMEA's Volatile 2023 Energy Market?

Renewable energy production is accelerating rapidly, breaking capacity records annually despite recent headwinds. Driven by ambitious governmental decarbonization policies and corporate commitments, as well as the recent global energy crisis, this unprecedented growth is expected to continue for the foreseeable future, as long as investments continue to increase.

Corporate power purchase agreements (PPAs) have become a key driver of investment in renewable energy and for good reason. Despite volatile markets and increasing PPA prices, the number of contracts signed in the EMEA region continues to rise. We observe that the increased price of PPAs can be justified on a case-by-case basis and that PPAs remain a comparatively affordable energy option delivering long-term benefits.

Corporate PPAs are medium- to long-term (5-20 years) contracts between a renewable energy developer and corporate off-taker (s) to purchase Energy Attribute Certificates (EACs) and/or electricity from an renewable energy installation according to a pre-negotiated price structure. These contracts limit the purchaser’s exposure to power price variability and ensure long-term renewable energy supply while providing capital for new renewables projects. In doing so, they also contribute to the fulfillment of corporate sustainability goals, as they help lower companies’ market-based Scope 2 carbon footprint by adding large-scale renewable electricity generation capacity to the grid.

These attributes have made PPAs an attractive way for companies looking to accelerate their decarbonization process. As we see in Figure 1, the number of PPA contracts closed in the EMEA region has steadily increased. However, an array of factors has conspired this past year to increase their price, and this has given rise to some questions. Is the higher price of PPAs in fact justified by the costs of producing renewable energy, or have providers been opportunistically taking advantage of an inflated energy market? And more to the point, given energy market conditions in H1 2023, is it a good time to contract a PPA?

Number of PPA Deals Signed, EMEA Region

The Recent Increase in PPA Prices

The cost of renewables, as determined by the levelized cost of electricity (LCOE), has fallen sharply during the last decade. The LCOE sums up the total costs of a power generation asset over the course of its lifetime. It is comprised of capital expenditure (CAPEX) and present value operational expenditure (OPEX). IRENA (International Renewable Energy Agency) found that the global weighted average LCOE of newly commissioned, utility‑scale solar PV projects declined by 88% between 2010 and 2021, while that of onshore wind fell by 68% and offshore wind by 60%.

The decline in renewable energy prices has made PPAs an attractive option for corporate decarbonization efforts, enabling companies around the globe to mitigate energy price volatility with long-term contracts that provide certainty about renewables supply and potentially reduce future electricity costs.

From 2021 to 2022, however, global factors such as post-COVID-19 pandemic effects on supply chains and the conflict in Ukraine created turbulence on the energy markets. Wholesale electricity prices in Europe increased by up to 700% from the longstanding average prior to late 2021, and PPA prices were pulled along into this trend. LevelTen, a major PPA platform, estimates the price of European PPAs increased over 50% year-over-year from Q3 2021 – Q3 2022.

The fact that PPA prices have followed the energy price surges in 2022 (see Figure 2) raises the question as to why PPA prices have risen over the past year. Corporate decision-makers are wondering:

1. Whether PPA prices have increased due to opportunistic behavior from developers looking to profit from high energy prices and strong PPA demand.
2. Whether PPAs are still an economical option in 2023.

While opportunistic behavior cannot be excluded per se, the price of energy on the wholesale market is not the only determining factor for the cost of a PPA. To further explore what companies should be aware of when considering a significant PPA commitment, we will look at the cost of solar farms in Spain between 2020 and 2022, as this major European PPA market provides a glimpse of the associated costs and enables companies to better understand PPA pricing, decode their recent price increases and find avenues for mitigating risks.

Illustration of Drivers of Higher Solar Power Costs

The cost of a solar photovoltaic PPA is mainly determined by the LCOE. Over the past two years, the IEA estimates that investment costs of new utility-scale PV and onshore wind plants increased by 15% to 25% from 2020 to 2022. Price increases can be explained partly through fundamental drivers:

• Higher material costs: the cost of materials essential to produce PV panels has risen sharply, including steel, copper, aluminum and polysilicon — which increased roughly 300% from 2020 to 2022.
• Higher labor and transport costs: the costs involved in the engineering, procurement and construction (EPC) contracts of renewable assets are rising. The reversal of the declining cost of renewable energy is impacted by the higher prices of manufacturing and installing wind turbines and solar PV assets. A close correlation is found in the average offering price of a European PPA, which increased by 51% from October 2021-2022.
• Higher interest rates: it has become more expensive to finance a PV project, with interest rates rising 2% in 2022. Inflation also rose sharply (8-11% on average in Europe), further increasing the cost of building new assets.
• Higher balancing and shaping costs: some PPAs require costly balancing and volume shaping when fixed volumes are guaranteed to be delivered at specific intervals. Balancing the electricity delivery is needed if the PPA is under- or over-producing in the short term versus the forecasts, due to weather or forecasting errors. The electricity volumes might also need to be shaped into a baseload. Both these cost components are strongly connected with the underlying electricity wholesale market and are directly affected by higher energy-market volatility, leading to increases in the overall price of the PPA.

Finally, there are still other components that determine the price of a PPA: For instance, the price of EACs has increased by nearly 500% in Europe over the past two years, likely due to demand rising faster than supply, and developer fees are a standard part of the price.

Is it Reasonable for PPAs to Have Increased in Price?

As for the opportunity cost for renewables developers of selling energy to the grid at 2023’s inflated wholesale prices, they have indeed factored into the increase in European PPA prices. However, increases in the capital expenses needed to develop renewable assets have been shown to be the key determinants of the PPA price surge.

It is unclear whether costs for developing solar and wind assets will revert to the declining trend that held sway prior to 2022, but companies can still assess the cost-effectiveness of any particular PPA. The decision to sign a PPA must be analyzed on a case-by-case basis through clear valuation and risk assessments of offers, while sign-off from decision-makers needs to be ensured through careful stakeholder engagement.

Continue to Explore Opportunities in the PPA Market

Eligible companies should seize the opportunity to contract PPAs. Not only is it an economically sound decision even amid the volatile energy market, but companies still must act to achieve their carbon targets. They should reach out to the renewable energy market, so they don’t miss out on no-regret opportunities.

Given that the price of a PPA is driven by market dynamics, nobody can drastically change the price of a PPA in a contract negotiation. However, comprehensive analyses help mitigate the price risks associated with them. The tools ENGIE Impact uses enable us to navigate market complexity, tailor PPA contracts to a company’s needs and forge a deal that will withstand long-term variables. These include:

• Estimating the economic value of various PPAs based on electricity price forecasts for a specific market, and aligning it with the corporate procurement strategy.
• Monitoring the wholesale forward energy market to determine whether it’s a good time to enter the PPA market.
• Strategizing the decision-making process considering short-term PPA market trends, and aligning all internal stakeholders, creating a strong consensus.
• Negotiating risk-related costs such as cannibalization on a case-by-case basis, subject to market correlation, to decide from which country to source a virtual PPA.
• Evaluating and managing price volatility risk, choosing from different pricing structures, including discount-to-market with floor prices, which enables a company to access a discount compared to wholesale market prices whenever the floor is below the latter.
• Adapting the process to speed up or delay the sourcing effort and always keeping the key stakeholders informed on the process evolution to maintain consensus on the strategy.

As with any decarbonization strategy, the key to contracting an advantageous PPA deal is to first build consensus inside the company on whether it is a good time to enter the PPA market. This requires identifying the potential benefits and risks of a PPA contract, knowing the company’s risk aversion, and then finding the best PPA type and market from which to source. Once the market trend and risk mitigation strategies are established, start the acquisition process, keeping in mind that it will take time and that company-wide consensus will have to be maintained throughout the process. Managing all the above is what it takes to move from strategy to implementation.