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PPA and merchant are not exclusive strategies

AleaSoft, May 13, 2020. The exceptional nature of the current situation is also affecting the prices of PPA contracts that are currently being negotiated. Faced with this situation that may hinder the plans of some renewable and photovoltaic energy projects, the need for a robust and flexible energy buying and selling strategy based on reliable forecasts that provide a clear vision of the market in all horizons is more important than ever.

Evolution of the PPA prices

The prices agreed in a long‑term PPA contract reflect the long‑term view of the electricity market prices held by each of the parties of the agreement. This long‑term vision is inevitably influenced by the current conditions of the energy markets and, as expected, a clear relationship is observed between the PPA prices and the evolution of the long‑term electricity futures prices.

In a situation such as the current one of very low prices in the electricity spot markets in Europe and a state of uncertainty in the face of the recovery from the crisis caused by the COVID‑19 pandemic, the PPA prices are registering a downward trend. The estimates are that since the beginning of 2020 the PPA prices fell by around 9% in Europe and by around 5% in Spain. If we go back to the middle of the year 2019, the fall reaches 16%.

This downward trend in the PPA prices is marked by the drop that the gas prices are registering since the second half of September 2018 and which also impacted the drop in prices of the spot and electricity futures markets. The CO2 emission rights prices, which significantly affect the electricity futures markets, also regressed in recent months.

AleaSoft - Prices gas CO2Source: Prepared by AleaSoft using data from ICE and EEX.

In mid‑March, when the health crisis erupted in Europe and the governments began to take measures that paralysed much of the economic activity, the European CO2 emission rights futures and the Brent oil futures registered very severe falls. This drop had a major impact on the electricity futures and also on the prices of the PPA contracts that were being negotiated. Some estimates indicate falls in PPA prices of between 10% and 15% in Europe and somewhat less in Spain, between 8% and 10%.

Since the first days of April, the electricity futures prices began to recover. At the same time, a certain recovery in PPA prices of between 6% and 12%, between 5% and 8% in Spain, was also estimated, but they remain at levels prior to the March collapse.

Low prices in PPA contracts represent a difficult situation for the new renewable energy projects seeking financing, especially photovoltaic, since the income that can be secured through a PPA is now lower.

Beyond the PPA vs merchant debate

In general, but especially in a situation like the current one, at AleaSoft it was always considered that the disjunctive of PPA-based project vs merchant project does not make much sense. Selling all the energy through a PPA contract, depending on the conditions, allows practically all the risk of the market price to be eliminated, but, on the other hand, does not allow any flexibility to take advantage of the moments when the market prices are more favourable. Similarly, selling all the energy to the market ensures always receiving the best price, but it represents being exposed to episodes of very low prices, such as the current one.

From the point of view of an energy buyer, such as a large consumer, a retailer or an electro‑intensive industry, the situation is exactly the same, but with opposite interests. That is, it is possible to ensure the cost of the energy with a PPA contract, but not have the flexibility to take advantage of situations with favourable conditions of low prices.

According to AleaSoft, the key is in a strategy of energy purchase or sale and of risk coverage. In this sense, the best strategy is the diversification, which allows, for example, signing a PPA when there is the possibility of doing it under advantageous conditions, going to market when the prices are favourable and trading in the futures markets if attractive opportunities appear. All this in the short, medium and long term.

Obviously, the conditions at each moment are always more advantageous for one of the parties, the buyer or the seller, than for the other. Therefore, it is very important to have a clear vision of the market in all horizons, short, medium and long term, in order to know how to correctly identify and forecast those opportunities. For AleaSoft, the key is in a robust strategy based on reliable forecasting of the energy markets in all horizons. A flexible strategy that places amounts of energy at different horizons depending on the conditions of each moment and that has a remnant to be able to take advantage of exceptional or infrequent conditions, such as the current ones, when these are favourable.

AleaSoft - Power purchase strategy risk hedgingSource: AleaSoft.

Source: AleaSoft Energy Forecasting.

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