Lower priced fossil fuels over the past 18 months would generally indicate that investments in renewable energy would begin to decline. However, renewable energy investment was at an all-time high in 2015, and with December’s Paris Climate Agreement, it is not expected that this trend will revert anytime soon.
Given the volatile nature of power, investments in wind farms are generally accompanied by a long dated power purchase agreement (“PPA”) to provide a stabilized return for investors and to secure financing. Accounting for these PPAs can be tricky, and in practice, there are inconsistencies with the way companies are applying derivative accounting for these agreements.
Some questions companies face when applying derivative accounting to PPAs include:
- Does the PPA have a notional amount causing it to be a derivative?
- If so, how is the notional amount determined as the volume is often contingent on how much power the wind farm produces?
- If the PPA includes multiple services (i.e. energy and renewable energy credits), is the derivative assessment made on the contract as a whole or just based on the predominant characteristics of the contract?
- Is the forward sale of renewable energy credits considered a derivative?
It’s not just companies struggling with these questions. Big 4 audit firm opinions often vary on these issues. Perhaps with the increase in renewable energy investment and as the industry matures, some of these accounting practices will align. Until then, get ready for a bumpy ride.