5 Things Sustainability Leaders Should Know About VPPAs
The landscape for renewable energy purchasing is evolving rapidly.
In 2020 alone, commitments to eliminating emissions altogether from operations nearly doubled (UNFCC). Worldwide over 2000 commercial, industrial and governmental organizations, including large power users who have adopted Science Based Targets or have gone a step further to enroll in the RE100, whose members have committed to shifting to 100% renewables over the next 10 to 20 years.
As the targets become more aggressive, companies are seeking new approaches to procuring clean energy. For Ball Corporation – a maker of metal packaging for beverages/foods and household products, aerospace, and other technologies that announced a deal for 161 MW of wind power in 2019 – and other large power users, virtual power purchase agreements (VPPAs) have emerged as a popular way to decarbonize corporate energy consumption rapidly and at scale.
Why choose VPPAs?
There are three primary reasons enterprises choose VPPAs.
Achieving renewable energy and greenhouse gas emissions reduction goals quickly is the primary driver. VPPAs secure large amounts of carbon-free electricity at scale. Transactions typically can range anywhere from 20 to over 200 MW. To put it into perspective, a 100-MW wind agreement equates to emissions-free electricity needed by over 27,000 homes annually or carbon that nearly 270,000 acres of forest can sequester each year (EPA). Compared to other sustainable energy opportunities, there may be no faster pathway for driving down carbon emissions than a VPPA.
Second, VPPAs typically result in additionality, meaning that they add new renewable energy facilities to the grid. VPPAs also generate local jobs and economic growth, particularly in rural and low-income communities, and increase state and local tax revenues. Each agreement pushes the U.S. energy system closer to a low-carbon future and helps finance new renewable energy generation, which in turn improves your performance to sustainability goals.
Finally, VPPAs can help insulate companies against rising electricity costs over time by locking in a fixed price at today’s rates, usually for a period of 10 to 20 years. Electricity prices are currently at historic lows, and while nobody can predict the future, many analysts expect them to increase over time. Hedging against this scenario through a VPPA can provide financial benefits for your company.
How does a VPPA work?
The good news is that a VPPA requires no changes in any existing contracts or relationships with your company’s current energy suppliers. A VPPA is a purely financial contract that provides Renewable Energy Credits or Certificates (RECs) from a specific renewable energy project located off your company’s property.
In the U.S., each REC represents proof that 1 megawatt-hour (MWh) of electricity was generated from an eligible renewable energy resource. The energy is fed into the local power grid for use. RECs are tradeable and have significant variable value based on market demand, energy demand fluctuations, etc.
As a rule of thumb, VPPA buyers:
- Gain a financial boost when the wholesale price of energy is higher than the contracted PPA price.
- Pay developers the difference when wholesale prices are less than the PPA price
- No change in payments required when the wholesale and PPA prices are equivalent.
At the heart of a VPPA is what’s commonly called a “contract for differences.”
Under a contract for differences, you and the project developer agree on a fixed rate for wholesale electricity. If the market price of electricity is higher than the contracted price, the developer pays your company the difference. In such a situation, the contract is said to be “in the money.” If the market price falls below the contracted price, your company must pay the difference and the contract is “out of the money.” Most VPPAs set the fixed price below prevailing market rates so that contracts start off in the money, with your company receiving payments along with renewable energy benefits at the outset.
Physical electricity is not delivered to your facilities under a VPPA. Rather, the electricity from the contracted facility is delivered to the grid. The contract is “virtual” because it is not tied to any specific facility consuming physical electricity, which provides enormous flexibility. The contract is not affected should corporate facilities open, close, or move. Since your company receives RECs, it can claim credit for the use of renewable energy no matter where it is consuming physical electricity.
1. Customer signs VPPA with renewable energy generator for wind power at a fixed rate (i.e., strike price). Term is typically 10-20 years.
2. Renewable energy generator sells customer’s null power into wholesale market and receives market price.
3. Renewable energy generator sends/receives settlement to/from customer (settlement = wholesale price – strike price).
4. Customer counterbalances utility payment for power with settlement transfer and uses RECs to reduce scope 2 emissions.
Which types of companies are best suited for VPPAs?
VPPAs are appealing to an increasingly wide variety of companies and industries. In the earliest days, tech companies with large energy consumption tied to data centers were the primary beneficiaries. In recent years, however, companies in the health care, entertainment, manufacturing, retail, pharmaceutical, agriculture, food and beverage, and even oil and gas sectors have all taken advantage of the VPPA model.
The VPPA is well-suited to connect high-energy-consuming facilities – such as large data centers and manufacturing plants with renewable energy, but they are also an option if you have multiple smaller energy demand facilities. Retail store chains or service operations, for example, with many locations can pool the energy consumption from across the facilities and connect them with renewable energy through a VPPA.
For example, a Fortune 100 company that is also committed as an RE100, has entered into a VPPA agreement with Duke Energy Renewables. The VPPA provides 75 MW of wind energy via its Frontier I wind farm located in Oklahoma. This wind-wealthy area provides local jobs and much-needed income to farmers and rural communities, while also producing 50% of the corporation’s annual electricity needs.
Companies with investment-grade credit (BBB- or better as rated by S&P) will find it easier to implement VPPAs than those that don’t. Sub-investment-grade companies should expect to post collateral in the multimillion-dollar range, which typically comes in the form of a letter of credit. Talk to your finance organization or advisors to understand your company’s tolerances and procedures for posting collateral.
Is now a good time to pursue a VPPA?
Several factors make now a good time to pursue VPPAs. The first is declining solar and wind costs. As technology improves, wind and solar generation are becoming more and more attractive over time.
Equipment costs aren’t everything, however. Wind and solar benefit from federal tax credits that are scheduled to phase down over time, and the value of these tax credits is passed along to the buyer in the form of a lower PPA rate.
The financial value of a VPPA is highly dependent on wholesale electricity price dynamics. If your company signs a contract and prices go up, it could generally expect to gain more revenue from the deal. If wholesale prices go down, the opposite would be true. Wholesale electricity is generally close to historic lows currently, and many analysts expect prices to rise over time. Should this dynamic play out as many expect, companies that contract today will be well-positioned to take advantage.
If a VPPA sounds right, what are your next steps?
Every company has different processes and procedures, but here are some general tips to get you started:
- Do your research. Numerous educational resources are available online through the U.S. Environmental Protection Agency (EPA), Business Renewables Center (BRC), and more.
- Form a team. Most companies find success building a cross-functional working group with leaders from finance, sustainability, energy procurement, marketing, communications and legal. Convening early with the various stakeholders covers potential issues as well as benefits that improve brand and operations alike.
- Gather data. You will want to determine how much electricity your company is consuming today and where. Note any major planned changes that will affect energy consumption across your portfolio of assets.
- Develop a strategy. Work with your cross-functional stakeholder group to establish goals and determine how you want to pursue VPPAs.
- Act. Tap experts, developers and others to identify projects and begin evaluating options.
