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Pricing structures in PPA: impact on leverage and the IRR

AleaSoft Energy Forecasting, October 20, 2023. Most lenders require long-term contracts, PPA, to finance renewable energy projects. The pricing structure of the PPA, whether fixed or with a guaranteed minimum, affects the amount of debt and the IRR. Market volatility influences the negotiation of PPA prices, so it is necessary to have reliable and stable price curves forecasts that provide a clear view of prices over the life of the contract.

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In the 37th edition of the monthly webinar series organized by AleaSoft Energy Forecasting and AleaGreen, Deloitte participated for the fourth time to offer professionals in the energy sector an analysis of the financing and valuation of renewable energy assets. The event aroused great interest in both its English and Spanish versions. The recording of the event is available to AleaSoft Energy Forecasting and Deloitte clients.

Financing of merchant projects and projects with PPA

Currently in Spain, most financial institutions require a long-term bilateral Power Purchase Agreement (PPA) to finance a solar photovoltaic or wind energy project. There are a few banks, between three and six according to Deloitte’s experts, that accept to finance full merchant projects without any bilateral contract and the resources they allocate to this type of project only allow the financing of projects of 100-150 MW at most.

The rest of the financial institutions are not prepared to take on this type of project and seek to mitigate the market price risk through PPA that ensure the sale of at least part of the energy at an agreed price. The type of PPA and its pricing structure will determine the leverage of the operation and the amount of debt that can be financed.

As for the duration of the PPA, the webinar speakers said that PPA are seen with horizons starting at 5 years, but in order to access bank financing, the minimum horizon required is around 10 years.

PPA prices, debt and project IRR

The pricing structure of a PPA determines the terms of the financing for which it is eligible. The most common structure is the swap type. In this structure, a fixed price is agreed at which the energy is remunerated over the life of the contract, although this price may be different or staggered for different years of the horizon. A fixed price makes it possible to maximize the amount of debt and leverage in the project, as it allows the cash flows to be estimated with virtually no uncertainty.

However, swap PPA are considered to “destroy” value by not being able to receive higher prices in case market prices rise. This condition affects the internal rate of return (IRR) of the project’s shareholders, which is usually lower.

On the other hand, there are PPA with a floor structure. In these PPA, there is a minimum price that will always be paid for the energy supplied. Even if the market price falls below this minimum price, the generator will always receive at least this price. The advantage over swaps is that if market prices rise above this level, the generator will receive the market price. In such cases, the generator must pay a premium for this protection against low prices.

PPA with a floor, as the cash flow depends on market prices, allow for lower debt and lower leverage. Nevertheless, by benefiting from high market prices, the IRR tends to be higher and usually offsets the premium payment, according to Deloitte.

Market price volatility and its impact on PPA prices

The price of a PPA is based on the value of the energy to be supplied. Therefore, according to the experts in the webinar, it is essential to have reliable energy price forecasts for the entire contract period.

In the current environment of high market price volatility, the price at which a PPA is traded can vary significantly between the start of trading and the time the contract is signed. It is therefore important to have reliable and stable forecasts that provide a clear and stable view of prices over the life of the contract, so that their valuation does not change during contract negotiation.

AleaSoft - Deloitte PPA

PPA in Spain in the last year

Deloitte has been involved in around 50 PPA in the last year and the vast majority have been financial PPA and very few physical PPA. Most of the PPA have been swap-type structures with terms between 5 and 10 years, although they are seeing more and more floor-type structures, or combined structures with swap tranches and floor tranches, or collar-type structures with a cap and a floor.

In recent months, prices for baseload PPA have increased and are now starting to exceed €60/MWh. Prices for PPA with a floor are around €30-40/MWh, with premiums between €5/MWh and €6/MWh.

AleaSoft Energy Forecasting’s analysis on the prospects for energy markets in Europe and the energy transition

Next Thursday, November 16, the next webinar in the monthly webinar series organized by AleaSoft Energy Forecasting and AleaGreen will take place. On this occasion, AEPIBAL, the Business Association of Batteries and Energy Storage, will participate to discuss the prospects of energy storage as a key element in the energy transition.

Source: AleaSoft Energy Forecasting.

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