29-10-2020

Corporate PPAs: on the way to implementation in Ukraine

Drawing upon the experience of developing the renewable energy sources (RES) sector in Europe and the United States of America we see that the countries are gradually shifting from the feed-in tariff system of renewable energy producers support to more competitive support schemes, such as auctions or tenders, and corporate power purchase agreements (corporate PPAs).

At the same time, competition in the electricity market is another important aspect. In accordance with Article 18 of the Treaty Establishing the Energy Community, any public aid is inadmissible which distorts or threatens to distort competition by favouring certain undertakings or certain energy resources. Moreover, Ukraine, assuming the obligation to implement the European Union’s Third Energy Package, must ensure efficient and proper regulation of competition in the electricity market, which will enable the consumer to choose the best offers on the market. It is the corporate PPAs, as well as auctions, that can positively influence competition in the electricity market in general and in the RES sector in particular.

What are Corporate PPAs?

Corporate PPAs are long-term agreements for purchase and sale of electricity produced from RES whereby a private company acts as the buyer rather than a public company designated by the state (i.e., State Enterprise “Guaranteed Buyer” at present in Ukraine).

Why do Private Companies Buy Green Electricity?

At present, major corporations across the globe, especially in the technology industry (e.g., Google, Microsoft, Facebook and others in Figure 1 below), implement development policies and strategies based on social responsibility and environment preservation principles. The use of green electricity in the day-to-day operations of such corporations has become a tendency.

As QUARTZ reports, Apple, having set a goal to have a net zero carbon footprint by 2030, plans to purchase all electricity from RES: not only for its own offices and stores, Apple requires that its suppliers too (in particular, plants manufacturing various parts for Apple products, which are scattered around the world) use green energy. It is this fact that was the reason for introduction of the corporate PPA scheme in Taiwan in general and execution by a Taiwan microprocessor manufacturer (which is a supplier of the said microprocessors to Apple) of a longest ever in Taiwan 20-year power purchase agreement for the entire output of a new wind power plant being built off Taiwan’s coast in particular. Other companies like Walmart, Amazon, Target and Google set themselves similar ambitious goals. Moreover, Google is buying green electricity from new power plants and not in those already built and generating green energy.

Figure 1

 

In view of the above, the corporate PPAs market has grown substantially over the past few years. In particular, according to BloombergNEF, in 2019 alone corporate PPAs were signed for the total capacity of 19.5 GW. The overall global dynamics of capacities that corporate PPAs were signed for in the period from 2009 to 2019 is broken down by regions in Figure 2 below.

Figure 2

Source: https://about.bnef.com/blog/corporate-clean-energy-buying-leapt-44-in-2019-sets-new-record/ 

What Types of Corporate PPAs are There?

Several types of corporate PPAs are commonly distinguished in theory, in particular:

  1. physical corporate PPAs; 
  2. “sleeved” PPAs; and
  3. virtual/synthetic PPAs.

Physical Corporate PPAs

Under a physical corporate PPA the buyer procures energy directly from a RES producer, which is possible where the power plant is in close proximity to the buyer’s facilities. Such corporate PPAs are marked by the following:

1. The buyer and the RES producer fix the cost of the produced electricity for the agreement term (typically 10 to 15 years).

2. The electricity producer generates and supplies via own networks electricity directly at the place of the buyer’s consumption without involving the networks of a distribution system operator/transmission system operator, which is possible due to the generating facilities being close to the place where the electricity is consumed.

“Sleeved” PPAs

If the consumer (buyer) of electricity is located at a distance from the RES producer’s generating facilities, and the consumer’s network cannot be directly connected to the RES producer’s network, there arises a need to involve a distribution system operator or a transmission system operator (i.e., a ‘sleeve’) to act as an intermediary. Where this is the case, the distribution system operator or the transmission system operator will be paid a fee for physical distribution and/or transmission of electricity from the electricity producer to the consumer. However, payments for the produced electricity under such scheme will be made directly between the RES producer and consumer.

Virtual/Synthetic PPAs

Virtual/synthetic corporate PPAs are a financial instrument (essentially, a form of derivative) that is used in the renewable energy market. The parties (renewable energy producer and electricity consumer) buy and sell electricity on the electricity market at market prices, each separately, and at the same time enter into a contract with each other, as described further, which secures price stability for these parties. One of the options to structure virtual/synthetic PPAs is execution of contracts for difference (Contract for Difference, CfD), i.e. the parties to such a contract agree on a specific ‘strike’ price of electricity and within a period specified in the Contract for Difference make the following mutual settlements: if the market price for electricity goes lower than the strike price stated in the Contract for Difference then the electricity consumer reimburses the RES producer for the difference between the strike price and the market price, and vice versa, if the market price for electricity goes higher than the strike price stated in the Contract for Difference then the RES producer reimburses the electricity consumer for the difference between the strike price and electricity price. This mechanism allows both the RES producer and the consumer (and their financing banks) to be confident of a stable revenue stream throughout the term of the Contract for Difference.

Moreover, in some jurisdictions (e.g. the Netherlands, France, Poland) Contracts for Difference are applied as a mechanism of state support for RES producers. In particular, the state (or a company that the state chooses) is a party to a Contract for Difference and if the market price goes lower than the price provided in the Contract for Difference then the state reimburses the RES producer for the electricity price difference. And vice versa, if the market price exceeds the price in the Contract for Difference the RES producers will reimburse the state for the difference.


What are the Advantages of Corporate PPAs?

Today in Ukraine RES producers sell electricity directly to SE “Guaranteed Buyer”, which has significant liquidity issues and debts to the RES producers for the electricity they had already generated and delivered. In the case of corporate PPAs RES producers will sell electricity directly on the electricity market and receive the funds for the produced electricity. Hence, for RES producers this is a financially less risky instrument.

Global experience of corporate PPAs evidences that, typically, they are entered into for 10 to 15 years, i.e. they are long-term agreements, which enables the parties to plan their operations, and have a stable electricity price for the buyer and stable income for the RES producer.

To meet sustainable development and environmental preservation commitments many countries introduce special regulation envisaging that a certain percentage of electricity consumed by companies (mostly industrial) must be green. Such regulation requires companies either to start producing green electricity or, which is more often the case, search for RES producers in the market and enter into corporate PPAs with them. In most countries, in particular, in the United Kingdom, Germany, Norway, there exists a possibility to enter into different types of PPAs with private companies and participate in auctions for the award of corporate PPAs with a state-owned company. There is a number of companies that internally made a decision to use clean energy in their operations (as mentioned earlier).

Corporate PPAs in Ukrainian Realities

Ukrainian law does not have dedicated regulation of corporate PPAs.

In accordance with the Law of Ukraine “On Electricity Market” RES producers may sell the produced green electricity on various market segments: (1) under bilateral agreements, (2) in the “day ahead” market, (3) in the intraday market and (4) in the balancing market at prices that have formed in the relevant markets. And this ability is the prerequisite for the development of corporate PPAs in Ukraine.  However, on the way to the full establishment of the corporate PPAs practice in Ukraine certain regulations needs to be improved and changed. 

In particular, the first issue is that at present RES producers are part of the balancing group of SE “Guaranteed Buyer”, which is responsible for imbalances of such producers (starting from 1 January 2021 electricity producers that are part of the balancing group of SE “Guaranteed Buyer” will be responsible for their own imbalances in the amount of 50%). To ensure fully efficient operation in different market segments Ukrainian law requires RES producers to bear full responsibility for their own imbalances. However, there is no mechanism to leave the balancing group of SE “Guaranteed Buyer” as of today.

As ExPro reports in its publication of 6 October 2020, the Ministry of Energy plans soon to present a methodology for independent operation for RES producers in the electricity market outside the only one balancing group currently available for them – the one of the “Guaranteed Buyer”.

On 9 October 2020, at the 1st Energy Law Conference of the Ukrainian Bar Association, Vladyslav Maksakov, a state expert in the expert group for the development of the renewable electrical energy sector of the Directorate for the development of the electrical energy complex, noted that the Ministry of Energy had formed a working group, which is developing amendments to legislation (in particular, the Law of Ukraine “On Electricity Market”) and subordinate legislation enabling RES producers to exit from the balancing group of SE “Guaranteed Buyer”, sell electricity in other market segments and be further reimbursed for the difference in the price of the electricity sold in the market and their FITs. As of today, the Ministry sees that SE “Guaranteed Buyer” will be reimbursing the difference. From the sound of it, it sounds like the Ministry of Energy is developing a mechanism for the introduction and application of virtual/synthetic corporate PPAs. However, given that the amendments to the legislation are at the discussion and development stage, more details regarding such mechanism will be available once the draft amendments are published. Relevant draft law is planned to be developed and submitted for review to Parliament of Ukraine by the end of 2020.

Another issue that needs to be resolved in order that corporate PPAs become functional in Ukraine is the guarantees of (electricity) origin for RES producers, which may be necessary for statistic reporting or provision by a RES producer to a consumer of a confirmation that the electricity was truly produced from RES. Such guarantees are widely used in foreign jurisdictions as proof that electricity originated from RES where the same is sold under bilateral agreements or in other market segments. Despite the fact that as far back as in 2013 the Cabinet of Ministers of Ukraine approved the Procedure for the issue, use and termination of a guarantee of electricity origin for business entities that produce electricity from alternative energy sources, dated 24 July 2013, No. 771, for the State Agency for Energy Efficiency and Energy Saving of Ukraine to issue such guarantees, in practice they are still not issued for technical reasons, and the register is not operative.

Finally, it remains to be seen and tested in practice, how Ukrainian authorities would treat Contracts for Differences, which are considered to be derivatives, that envisage payments going back and forth between the energy producers and buyers of green electricity, without physical delivery of underlying commodity, but we hope that after full kick-off of Ukraine’s capital market reform, adopted recently, it would not pose a problem.

Hence, corporate PPAs offer a number of advantages and are an alternative to those mechanisms of RES support that are already in place in Ukraine, as it is the auctions and corporate PPAs that increase competition in the RES sector, which gives the electricity market incentives to develop, expand and provide consumers with better and more flexible offers. Given that the Ministry of Energy of Ukraine is already working towards adjusting the legislation in order to make implementation of corporate PPAs possible, we will be monitoring the relevant draft amendments and, hopefully, will be able to make certain conclusions and forecasts regarding the future of corporate PPAs in Ukraine as early as by the end of the year.

 

Vitaliy Radchenko, Partner at CMS
Kateryna Kornelyuk, Associate at CMS
Maryna Ilchuk, Senior Associate at CMS

Before
29-10-2020

Корпоративні РРА: на шляху до впровадження в Україні