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Power Purchase Agreement

Power Purchase Agreement

What is a Power Purchase Agreement?

A Power Purchase Agreement (PPA) is an arrangement in which a third-party developer installs, owns, and operates an energy system on a customer’s property. The customer then purchases the system's electric output for a predetermined period. A PPA allows the customer to receive stable and often low-cost electricity with no upfront cost, while also enabling the owner of the system to take advantage of tax credits and receive income from the sale of electricity. Though most commonly used for renewable energy systems, PPAs can also be applied to other energy technologies such as combined heat and power (CHP).

A PPA may be a good fit if your organization...

  • Wants to reduce energy costs, hedge against energy price increases, or improve the resiliency of your operations without spending your own capital
  • Wants a third party to own, install, and maintain an energy system
  • Is unable to take direct advantage of renewable energy tax incentives
  • Is located in a state or jurisdiction where third-party ownership of generation equipment is permitted

To compare PPAs to other financing options that might be a good fit, answer a few questions about your organization.

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How It Works

To be eligible for a PPA, a project must be located in a state or jurisdiction where third-party ownership of energy generation equipment is allowed. Some state regulations limit or restrict non-utility providers in regulated markets from selling electric power. For more information on where PPAs are available, see this map from Database of State Incentives for Renewable Energy (DSIRE).

Under a PPA, the customer signs a contract with a third-party developer to purchase power generated by solar panels, wind turbines, combined heat and power (CHP) equipment, or other forms of energy generation on a facility’s roof or nearby location. The customer is therefore also known as the offtaker, or the purchaser of power. While the customer/offtaker often provides the physical space to host the system, this is not a requirement and the host and customer/offtaker may be separate entities in leased spaces. The developer and its investors own the equipment for the duration of the PPA. The developer typically provides initial project coordination services such as bridge financing, design, and permitting with little-to-no cost to the customer. Equipment installation may be completed in-house by the developer or by a contracted installer.

The electric output generated by the energy system is then purchased by the customer at a rate that is generally lower than the utility’s retail rate, generating immediate cost savings. The PPA rate usually increases by 1-5% each year for the contract term (i.e. a price escalator) to account for gradual decreases in system operational efficiency, operating and maintenance costs, and increases in the retail rate of electricity. PPAs are generally long-term agreements of 10-25 years. At the end of the contract term, the customer may be able to extend the term, purchase the system from the developer, or have the equipment removed from the property.

The utility serving the customer provides an interconnection from the energy system to the power grid, and will continue service if the system does not produce enough power to meet the customer’s electrical needs. When the system produces excess power, it can be sold to the utility, typically at the retail electricity rate. This process is called net metering, and most states have adopted net metering policies. For more information on net metering, visit NCSL’s State Net-Metering Policy Overview.

The developer will typically create a special purpose entity (SPE) for each project that serves as the legal owner of the energy system. The SPE exists to raise debt and equity investment in the project, resulting in mutual ownership of the SPE (and therefore the project) by the developer and investor(s). The SPE allows for investment at the project level without subjecting investors to risks associated with the developer’s other projects, while also minimizing risk for the developer should the project default or experience other issues.

There are tax credits and rebates available at both the federal and state levels for renewable energy projects. Examples include the Solar Investment Tax Credit and the Production Tax Credit for wind energy. These incentives can be used by the developer and investors to reduce costs and make projects more attractive for potential investment. Visit DSIRE for more information on available incentives for renewable energy by location.

The system owner will generally retain all environmental benefits of putting clean energy onto the grid, such as Renewable Energy Certificates (RECs). RECs are tradable, non-tangible energy commodities that are issued when one megawatt-hour (MWh) of electricity is generated from a renewable energy source and delivered to the grid. These certificates are a way for businesses to verify carbon reductions from specific projects and count towards organizational targets for renewable energy use. Mandatory REC markets exist in states with renewable energy portfolio standards (RPS), but there are also voluntary REC markets available for those who want to purchase them. REC arbitrage, which is the near-instantaneous buying and selling of RECs in different markets, may be an option to decrease overall costs if the customer is located in a market with high REC prices. For more information on REC arbitrage, visit EPA’s REC Guide.

*NOTE*: This fact sheet describes PPAs for distributed generation projects specifically, but the term “power purchase agreement” can also refer to a much broader concept (i.e. any agreement to purchase power from a provider at an agreed-upon price).

An Alternative Approach: The Offsite PPA

An alternative to a direct PPA with onsite power generation is an offsite PPA, also referred to as a virtual or synthetic PPA. Under an offsite PPA, the customer and the renewable energy project do not need to be located in the same region. This gives customers more options when choosing projects and allows customers to take advantage of PPAs even in states where onsite PPAs are not available, or if there are physical space constraints that would prevent the installation of generation equipment.

In an offsite PPA, the customer enters into a long-term PPA with the owner of a renewable energy project but does not take physical delivery of the power generated, which is instead sold to the local grid at market price. The customer and project owner agree on a fixed rate for the cost of the generated power, which is also referred to as a strike price. The project owner then sends the customer funds in a settlement transfer for the difference between the revenue from energy sold at the market price minus the customer’s fixed rate amount. The amount of this settlement transfer depends on the market price for energy, and in cases where the PPA strike price exceeds the market price for electricity, the customer is required to pay the difference to the project owner. The customer continues to make normal payments to its utility, but some of these costs will be offset by the funds received in the PPA settlement transfers. This payment arrangement between the customer and the project owner is referred to as a fixed-for-floating swap or contract for differences. 

Offsite PPAs are often used as an energy price hedge. In addition to the financial benefits of offsite PPAs, the customer will generally retain the rights to any RECs associated with the PPA.

Advantages and Disadvantages

POSITIVE CASH FLOWS

PPAs can cover 100% of project cost, and the price of power purchased through the provider is typically less than the retail rate for electricity. This often makes the PPA cash flow positive for the customer from day one.

THIRD-PARTY OWNERSHIP AND OPERATION

Under a PPA, a third party installs, owns, and maintains the energy system, allowing the customer to avoid the risks and complexity of equipment ownership.

OFF BALANCE SHEET

The PPA is designed to be an off-balance sheet financing solution, with regular payments that are treated as an operating expense similar to a standard utility bill.

PREDICTABLE ENERGY PRICES

PPAs lock-in energy prices at an agreed-upon rate and protect the customer from utility rate fluctuations over time.

RISK OF OVERPAYMENT

The annual price escalator under a PPA (usually 1-5%) may result in the customer paying a rate higher than the market rate, if retail electricity prices decline or increase more slowly than the escalator.

LIMITED AVAILABILITY

Laws surrounding PPAs vary by state. Some states have laws that create barriers for PPAs or outlaw them entirely.

CONTRACT COMPLEXITY

PPAs can have complex contracts and higher transaction costs than buying a system outright.

State of the Market

Power purchase agreements as a financing mechanism for distributed generation systems came into existence around 2006 and quickly gained market traction within a few years. A report from the National Renewable Energy Laboratory (NREL) found that in 2015, PPAs brought on nearly 2 gigawatts (GW) of signed capacity in the United States after significant yearly increases since 2012. According to the Database of State Incentives for Renewable Energy (DSIRE), PPAs are available in 26 states plus Washington, D.C. To see details on which states allow PPAs, view this map from DSIRE or search their database.

Better Buildings Implementation Models

Power Purchase Agreement for the D.C. Department of General Services

In 2015, the District of Columbia Department of General Services engaged Sol Systems to develop one of the largest municipal portfolios of onsite solar energy projects in the U.S., using a power purchase agreement.

Regency Centers - Landlord-Retailer PPA (RILA Retail Energy Management Program)

Landlord-Owner Solar Helps Retailer Offset More than 65% of Energy Use.

Learn more about PPAs

PPAs At-A-Glance

The following table will give you an at-a-glance summary of a typical PPA, including a basic description, contract structure, tax and balance sheet implications, contract terms, and market information. Mouse over the ‘?’ next to each attribute for more information.
Basic Attributes Project Types?Which project types can be financed using this option? Renewable Energy, Other Generation
Applicable Sectors?Which economic sectors does this option commonly serve? All
Geographic Scope?Is the financing option available throughout the U.S., or limited to certain areas that have the appropriate policies and programs in place? Limited by state regulation
Building Ownership?Does this option work well for projects in leased space, owned space, or both? Owned or Leased
Typical Project Size?What range of project sizes does this option typically serve? Any
 
Contract Structure Contract Complexity?How complex is the financing option from the customer’s perspective, in terms of the size and complexity of the financing contract, the number of parties involved, and other factors? Medium
Parties Involved?Which types of organizations are typically involved in executing the financing option? Customer, Building Owner (if customer doesn’t own building), Provider, Utility
Payment Type?Are customer payments fixed over time or might they be variable based on factors such as energy savings or utility rates? Variable based on system output; predetermined rate of electricity typically increases by 1-5% annually
Performance Risk?Which party bears the risk that the installed equipment may not perform as expected? Borne by provider
 
Tax & Balance Sheet Budget Source?Do customer payments made on this financing option typically come from an operating budget ("opex") or capital budget ("capex")? Opex
Balance Sheet Treatment?According to industry best practices, does the financing option typically appear as a liability on the customer’s balance sheet, or is it off-balance sheet? Off balance sheet
Tax Deductions?Which amounts can a customer typically deduct from its taxes under this financing option? In some cases all payments are deductible, and in other cases only interest and depreciation are deductible. All Payments
Equipment Ownership?During the financing term, is the efficiency equipment typically owned by the customer (internal) or by an outside party such as the lender or contractor (external)? External
Collateral Source?Which customer assets can the lender use as collateral to secure repayment? Equipment
 
Contract Terms Typical Duration?How long does a typical financing contract last? 10-25 years
Typical Close Time?How long does it typically take to secure financing once you start speaking with providers? Medium (3-9 months)
 
Market Attributes Market Size?What is the total cumulative dollar value of projects financed under this option? 2 GW in 2015
Time in Market?How long has this financing option been available in the market? Since mid-2000s