Just a few years ago, almost all European renewable energy power purchase agreements (PPA) were based on fixed prices and an off-take obligation by the grid operator. Most still are, but we see more and more alternative structures both within and outside Europe.
The well-known German fixed-price and long-term PPA with an off-take obligation for the grid operator, a model which has been copied by several other countries, has over the years been a great catalyst for investors' and financiers' appetite for renewable energy projects as an otherwise significant risk had been eliminated from the equation.
However, as renewable energy sources have become more efficient, as the capacity price has fallen and as the production cost of a green kWh has come close to parity, the legislators have taken the chance to reduce subsidies and some jurisdictions have offered other models than the German fixed-price and long-term PPA model.
Such new models may involve a market price risk, a grid capacity risk, a Co2 certificate and power price market risk, etc. Models and changes which seem natural as the capacity price is getting close to parity, but also changes which the market (both investors and banks) must get used to as it adds new risks that should to be assessed, mitigated and priced.
Most commonly, financiers ask for a hedge of the market risks or for the investors to enter into PPAs with a minimum term in order to obtain some certainty and a chance to seek a remedial plan, should the market price fall below an agreed minimum level.
The most common structure seen so far has been a five-year rolling PPA combined with a cash sweep triggered by the price level offered in the 5th year as the PPA is rolled every year. Generally, the cash sweep has multiple levels depending on the fall in the price for year 5 and depending on whether the price falls below the minimum price for more than 1 year.
However, such contracts are often expensive because the power trader offering the PPA will have to deduct a risk premium and possible guarantee costs of securing its future payment obligations.
Investors should therefore consider whether they would be better off by offering their financiers a higher DSCR, an increase of the debt service reserve and a downside cash sweep in consideration of entering into a five-year rolling PPA.
Depending on the amount deducted by the power trader from the expected spot price to compensate for the risk of offering a minimum price for 5 years and its possible guarantee costs, the higher alternative price may very well more than compensate for the costs of the higher reserve and the leverage level (in absolute numbers) may be close to the same.
If the market structure in the relevant jurisdiction allows for direct marketing or off-grid sales, such structures could also be an alternative way forward. About a year ago (1 January 2012) Germany introduced rules allowing direct marketing (still with a subsidy attached) and as we get closer to true grid parity, a bigger European market could offer great opportunities and direct marketing could help to ensure a better allocation of peak power.
We believe that alternative structures will become increasingly common. Therefore, investors as well as banks may just as well get used to them and try to find common grounds that offer the needed comfort without wasting too much value on guarantee provisions, hedge arrangements, etc.