Power Purchase Agreement as an instrument for a long-term project financing

Explore the intricacies of Power Purchase Agreements (PPAs), long-term contracts between electricity providers and purchasers. Discover how these agreements facilitate the financing of large-scale renewable energy projects, and how they are regulated and categorized in the United States. Learn about the significant features of PPAs that make them unique financial instruments, and how they are used to manage and distribute risk in large-scale projects.

A Power Purchase Agreement (PPA) is a long-term legal contract between an electricity provider and power purchaser. During the contractual period, which typically lasts 20–25 years, the purchaser agrees to buy electrical energy from the electricity provider. Under such a contract agreement the electrical energy supplier is considered to be an independent power provider (IPP). Energy sales under PPA type contracts are regulated by state or local governments. Under a PPA contract agreement, the electrical energy provider is most often the developer and owner of solar power or sustainable energy production technology. However, the seller in some instances could be an entity that buys the energy from several sources and resells it to various purchasers.

In the United States Power Purchase Agreement contracts are regulated by the Federal Energy Regulatory Commission. Under the Energy Policy Act of 2005, solar or sustainable PPA providers are considered exempt from wholesale energy producer regulations. Most prevalent PPA contracts fall into two categories, namely, solar (SPPA) or wind (WPPA).

PPAs for renewable energy projects are a class of lease-option- to-buy financing plans that are specifically tailored to underwrite the heavy cost burden of the project. PPAs, which are also referred to as third party ownership contracts, differ from conventional loans in that they require significant land or property equity, which must be tied up for the duration of the lease. PPAs have the following significant features, which make them unique as financial instruments.

Unlike conventional financing of capital equipment or construction projects, long- term financing of industrial projects is based upon cash flow generated by the projects. This type of financing involves schemes in which private investors and their banks provide required loans for the project. Such loans are usually secured by revenue and income generated by the project operation as well as project assets. Furthermore, in the event of compliance with loan compliance terms and conditions, lenders are given the right to assume partial or total control of the project.

In order to avert risks and liabilities associated with failure of large-scale projects, lenders shield and protect their organizational assets by creating special purpose entity structures for each project. Since large projects are usually quite complex in nature, they may involve considerable technical, economic, and environmental challenges; as such, financing of large projects involves risk identification and feasibility studies that determine the fundamental basis for preventing unacceptable investment losses.

In large-scale programs, financing of projects is distributed in a consortium of multiple parties, so as to divide the associated risks among multiple stakeholders. In projects that involve large risks, financing of a project may necessitate so-called limited resource financing, which involves participation of surety or insurance companies.

Long-term industrial project financing as discussed earlier has been prevalent for several centuries and has been common in the construction of electrical power generation projects, mining, and transportation type projects worldwide. More recently the Public Utility Regulatory Policy Act of 1978, known as PURPA, was devised by the U.S. Congress to facilitate financing of utility and government type programs that have a long-term revenue stream.That policy provided the foundation for a new financing scheme, termed the Power Purchase Agreement (PPA), which encouraged domestic renewable energy development and conservation that resulted in deregulation of electric power generation and formation of private power generation entities. A subsequent policy enacted in 1994, referred to as the Public Utilities Holding Company Act, provided the foundation for lending organizations to finance alternative and sustainable energy generation projects worldwide.