Corporate PPAs Are Turning Project Finance on Its Head

Government-backed subsidies for renewable energy projects have been diluted and removed in recent years. This put a temporary break on project development in markets such as the UK. However, as solar panel prices continue to fall and as wind turbines continue to grow in capacity—coupled with rising energy prices—there has been a resurgence in the new projects being connected to the grid.

The use of government subsidies established a project finance model that was simple and low risk: lenders could size debt based on the guaranteed earnings provided by the subsidy, plus a heavily discounted view of the future energy price. Even with conservative assumptions banks could offer up to 70% leverage. Removing subsidies created a new project finance puzzle for project developers in Europe and North America. 

How Was the Project Finance Puzzle Solved? 

Enter the corporate power purchase agreement (PPA), a new energy purchasing contract that enables companies and utilities to buy power direct from generators. The corporate PPA is an offtake agreement that confirms the term, price, and creditworthiness of the offtaker. The contract allows parties to agree to purchase terms themselves without necessarily being linked to the wholesale power price. 

This model provides corporates with stable, predictable pricing and provides asset owners with reliable, long-term revenue streams. The financial model must now absorb merchant wholesale energy pricing and counterparty offtake risk. The corporate PPA has upended the traditional financing model, introduced merchant risk into the lending equation, and created slimmer returns for equity investors.

In a recent interview with Bloomberg, Nico Escallon of Actis said “It’s not necessarily inherently risky to be exposed to the market, assuming you’re underwriting an investment with very conservative assumptions and the price you’re paying to build the asset is conservative.” 

What Corporate PPAs Offer, and What They Don’t 

While the goal is to sign a 20-year PPA, unless a developer strikes a deal with a company like Google, contract terms tend to be struck with 5-10-year tenures, providing only short-term income protection. Pricing is often struck at a 15%-35% discount to the wholesale market forecast. While such a pricing model will effect equity returns, the predictable income model ensures affordable senior debt can be raised. Banks must assess the creditworthiness of the PPA offtaker (i.e., will they be around in 10 years) and have a view on the long-term wholesale price of power. 

In the oil & gas futures market there is no minimum price for a barrel of crude. And hence no benchmark to establish lending levels. Instead banks link loan repayment requirements to energy prices. For example, taking fixed interest and principal repayments while prices are between a minimum and maximum range. Once prices exceed the maximum, payments are made to equity. While this is a traditional finance tool in the oil & gas market, such lending requirements radically change how equity returns are predicted and the terms on which developers green light new project builds. 

Developers can continue to finance their projects by taking more notes out of the oil & gas playbook. And oil producers have the ability to control their OPEX and overall returns by benefit from being able to ramp up and ramp down their output in response to the market price for crude. 

The more a developer can add storage solution at the project design stage, secure innovative PPA deals with reliable counter-parties, and reimagine each component of the project’s profit and loss (e.g., grid connection costs), the easier it will be for debt providers to step in on competitive terms. The sooner renewables projects have the same flexibility as oil & gas players, the better the terms they will command in the debt markets. 

Expect more radical change in the project finance model in the coming years.