A Practical Guide to Renewable Energy Terms: What are PPAs, Virtual PPAs, and RECs?
With an increasing number of companies focused on going 100% renewable, driven in large part by the recent push to set science-based carbon reduction goals, PPAs, Virtual PPAs, and RECs are three acronyms that are thrown round a lot in conversations related to enterprise energy strategies. But I admit it—despite being entrenched in the energy industry for the last decade, my command of what these acronyms really meant was limited at best. Sure, I could tell you that PPA stood for Power Purchase Agreement or that a REC was a renewable energy certificate, but I didn’t really understand what they were. I asked a few people to explain it to me, but mostly what I got was a lot of super technical, highly wonky, mostly incomprehensible answers—a byproduct of working with a lot of exceptionally smart people. So I googled, and well, that wasn’t exactly helpful either (as demonstrated below).
Fortunately, my colleague George Favaloro, Managing Director of Sustainable Business Solutions at PwC and co-author of our recently released strategy brief, has a lot of experience explaining really technical concepts to people like me, and he was able to fill in the blanks.
The definitions below are purposefully meant to be comprehensible, not comprehensive. It won’t make you an expert, but at least the next time you hear these terms in conversation, you can nod along without feeling totally out of the loop.
Power Purchase Agreement, or PPA
A power purchase agreement (PPA), or electricity power agreement, is a contract between two parties, one which generates electricity (the seller) and one which is looking to purchase electricity (the buyer). The PPA defines all of the commercial terms for the sale of electricity between the two parties, including when the project will begin commercial operation, schedule for delivery of electricity, penalties for under delivery, payment terms, and termination. A PPA is the principal agreement that defines the revenue and credit quality of a generating project and is thus a key instrument of project finance.
Instead of investing your own capital and resources to install renewable technology, you can buy power via a PPA from a company that will handle all aspects of getting the project up and running, including the financing. In a PPA, the “seller” builds or installs the technology (e.g., a solar array or a wind farm) and the “buyer” buys the power on a per kWh basis.
Virtual Power Purchase Agreement, or virtual PPA
A virtual PPA is basically a form of price hedge. A company enters into a contract to pay a renewable energy project on an agreed take-off price. The renewable energy project sells the generated power into the local wholesale market on a merchant basis. The project pays the company if the electricity is sold into the market above the agreed contract price, and the company pays the project the difference if the electricity falls below the agreed price.
In a virtual PPA, the company developing the renewable project sells the power to the grid when the project is complete. In order to get financing, the developer enters into a Virtual PPA with a third party—let’s call that party ACME Co. ACME Co. guarantees the owner of the renewable project a certain fixed price for the electricity it sells to the grid. If the electricity sells for less than the guaranteed amount, ACME Co. will pay the difference; if the electricity sells to the grid for more than the fixed price, ACME Co. will actually make money. In this arrangement, there are a few benefits for all parties: The developer of the solar array or wind farm has the price security it needs to get financing for the project, and ACME Co. has the opportunity to make money.
However, the bigger (and more common) value proposition to ACME is that by virtue of the VPPA, ACME Co. can claim credit for bringing renewable energy onto the grid. This is one way that companies can go “100% renewable” without ever having to put in onsite renewable generation or directly source energy from renewable power. Importantly—in this scenario, only the company that holds and “retires” the renewable energy certificates can take credit for the carbon reductions. Even if someone else actually buys the power generated from that particular wind or solar installation, ACME Co. can claim the carbon reduction if it retires the RECs.
RECs, or Renewable Energy Certificates
Renewable Energy Certificates (RECs) are tradable, non-tangible energy commodities in the United States that represent proof that 1 megawatt-hour (MWh) of electricity was generated from an eligible renewable energy resource (renewable electricity) and was fed into the shared system of power lines which transport energy. Renewable Energy Certificates provide a mechanism for the purchase of renewable energy that is added to and pulled from the electrical grid.
Power on the grid comes from all sorts of sources: coal, nuclear, natural gas, renewables. Once it’s on the grid, it’s all blended together. So, as an end user, you can’t really tell where that exact megawatt hour you’re using comes from. RECs are a way for businesses to certify that they have a valid claim to the carbon reductions from a specific project. These certificates provide verification that a business’ support for renewable energy had an impact on the grid.
Even if your business has yet to start the conversation around renewables, it won’t be long until outside factors force the issue. Pressure from consumers, business partners, employees, and investors are all pushing businesses to aggressively pursue sustainability goals. And with the recent extension of Production Tax Credit (PTC) and Investment Tax Credit (ITC) that have benefited wind and solar, respectively, companies can save money and lock in low energy rates, and companies that don’t could be at a disadvantage over the long term.