Much like the rest of the clean energy industry, we are excited about corporate and institutional (C&I) customers taking meaningful action by directly purchasing renewable energy to reduce their carbon footprint, contribute to cleaning up the grid, manage volatile energy costs and get in front of regulatory changes. Indeed, gigawatts' worth of power-purchase agreements (PPAs) have been signed by organizations over the past several years. However, while we absolutely encourage C&I customers to dip their toes into the PPA pool, we advise that these customers do so with their eyes wide open. These deals are regularly framed as moneymakers, but we know from experience that there is little certainty in the world of wholesale energy markets and energy development is rarely black and white. Therefore, this article focuses on the many shades of gray, pewter and slate so that C&I customers can assess the full picture and take a long-term view when considering the potential value of direct renewable energy procurement.
The rise of corporate renewable energy procurement
In 2002, C&I customers were in the early days of exploring ways to “green” their electricity usage. The establishment of U.S. markets for renewable energy certificates (RECs) provided an important enabling mechanism for these customers, as well as for the broader industry. These markets created a way to claim environmental benefits and monetize the value customers place on the associated attributes of renewable projects. Even today, RECs continue to serve an important role in enabling customers to match their electricity usage with renewable energy. However, the market has moved in recent years, due to two trends.
First, many C&I customers are seeking to demonstrate a more significant environmental impact -- often by bringing new projects on-line, a process also known as "additionality." Unlike the carbon-offset world, where there are specific criteria for additionality, there is no legal or widely accepted criteria for determining what constitutes "additionality" for renewable energy project development. Commonly, corporate customers link additionality to directly causing a new project to come on-line. With this view, purchasing unbundled RECs (i.e., the environmental attributes but not the energy) generally will not have any additionality value. On the other hand, PPAs, both physical and financial, do.
The second trend is that C&I customers interested in purchasing renewable energy want to see a financial benefit. Purchasing unbundled RECs (or purchasing electricity through a green tariff) is a cost -- albeit a modest one, and one without other commodity-related risks. However, solar and wind costs are at historically low levels, allowing for very competitive PPA pricing and offering an intriguing economic opportunity for C&I customers. In short, PPAs promise to reduce costs, as well as to provide a long-term hedge against rising and volatile energy prices, future REC prices, and any eventual price on carbon.
If you’ve attended a renewable energy conference recently, you’ve likely seen charts documenting tremendous cost declines in the wind and solar sector. And it’s true: there is a lot to celebrate across the industry. Onshore wind costs have declined 50 percent since 2009, while solar module costs have fallen 80 percent since 2008, according to Bloomberg New Energy Finance. Similarly, in 2015, clean energy investment ($329 billion) outpaced investment by oil and gas companies, and for the first time there was more solar than natural-gas capacity added in the U.S. With the extension of the federal Production Tax Credit and Investment Tax Credit, there is significant reason to believe that high levels of investment will continue.
Amid this landscape of favorable cost and policy trends, it is no surprise that C&I customers are interested in renewable energy, and it is clear that corporate procurement is an emerging driver for significant new demand. Consider that 2015 was a record-setting year for corporate renewables: 3.2 gigawatts of utility-scale renewable transactions were signed by corporate buyers, and the capacity of wind PPAs signed by corporate customers exceeded that associated with utility purchases. Project developers, facing a slowdown in utility sales, have leapt at the opportunity to sell to a new market segment and are marketing both physical and financial energy products.
So clearly, instead of paying a green premium, C&I customers can now go green and save green. However, as these organizations consider entering renewable PPAs, they must realize they are entering the wholesale energy market and make sure to fully understand the potential benefits, as well as the risks associated with the potential value proposition.
A reality check
Despite the momentum gained during 2015, there have been only 430 megawatts of corporate procurement announcements through June 1, 2016, according to the BRC Deal Tracker. BRC noted that this apparent slowdown is most likely related to the rush of deals signed at the end of 2015 to beat the expiration of the PTC/ITC deadline, so we may see similar activity in the coming years as the PTC is set to decline. At present, though, we believe it is important for customers to proceed with caution and carefully consider potential opportunities, especially the ones that seem too good to be true.
Most corporations that have signed PPAs did so based upon the assumption that wholesale power prices will rise over time like a “hockey stick” (slowly initially and then faster later), but find themselves out of the money today. This concern was echoed in comments made by Brian Janous, director of energy strategy at Microsoft, during Bloomberg New Energy Finance’s Future of Energy Summit in New York. Janous commented, “If you're signing a [power-purchase agreement] deal this year, you're losing money.” He shared that he had to go to his CFO and explain to her that the original forward energy price curves that he had shown were off. It is important to note that being out of the money in today’s market may be completely expected based on the pricing structure of the specific deal and the expected timeframe to realize the value from the contract, but customers must still understand the potential value and risks of proposed transactions.
The last decade has certainly disproved the conventional wisdom that wholesale power prices will go up forever. The discovery of large (and cheap) supplies of shale gas, coupled with flat or declining electric load growth, has created a dismal picture for wholesale power prices in the U.S. To put it in perspective, when we ran financial models for renewable energy projects 10 years ago, we benchmarked forward price curves against natural-gas spot prices at Henry Hub in excess of $10/MMbtu. By comparison, natural-gas prices today are <$2/MMbtu. In addition, as the grid continues to dispatch an increasing volume of renewables at low marginal costs, there will remain downward pressure on wholesale market prices, especially in areas with higher concentrations of renewables.
It is critical to understand regional differences across energy markets -- particularly as it relates to the correlation of market pricing with energy production, and potential congestion and curtailment risks. For example, renewable energy PPA pricing in parts of the Southwest Power Pool (SPP) and Electric Reliability Council of Texas (ERCOT) territory are currently on par with market hub prices. However, financial models for such long-term PPAs will show varying valuations based on assumed forward price curves. So, if it looks too good to be true, question the forward price curve and other model assumptions. Often, these models do not take into consideration the gigawatts' worth of new wind capacity to be added in the region of the PPA project, all ultimately generating at the same time in the same location, dramatically lowering the price during those hours. Furthermore, many models do not fully analyze the impacts of regional transmission planning and planned power plant additions and closures. There is a lomg history of overbuilding projects in markets where supply did not match actual load demand (e.g., the massive installation of new wind capacity in West Texas in the early 2000s required the extensive development of new transmission over the following decade in order to alleviate curtailment and negative pricing).
Recent events further support taking extra time approaching the virtual power-purchase agreement market opportunity. In May, the U.S. Department of the Treasury released guidance for the PTC that gives developers more time and leeway regarding the "beginning of construction” and “continuous construction” requirements and also favorably modifies several key factors of both requirements. As a result, customers have a little more time to execute wind PPAs to secure the full value of the PTC. The ITC for solar remains at full value until 2020. Other market changes -- for example, the proposed California ISO expansion -- could also have dramatic impacts on the cost of renewables in the West, as California-based customers would be able to procure from a broader market, taking advantage of higher capacity factor wind and solar projects from other western states, according to the results of Senate Bill 350 preliminary studies. Bottom line: There is time to heed the flashing yellow and still arrive at the desired destination safely and surely.
Take a long-term view and proceed cautiously
Thankfully, many of the early corporate renewable energy pioneers are sophisticated in their appreciation of the dynamics described above. Microsoft’s CFO recognizes that clean energy is critical to the company's overall corporate strategy and told Janous to stay the course. They may not be making money today -- though they hope to with time; again, this may be because the majority of the value from the deal is to be realized after the first few years of the transaction. Regardless, Janous’ comments highlight the importance of taking a long-term view. It’s also important to remember that PPAs or “fixed-for-floating swaps” were initially about additionality, hedging costs and locking in certainty and value, not about making money. It seems, though, that the rush to sell to new corporate buyers has served to morph PPAs from what is fundamentally a risk-reduction instrument into a get-rich-quick scheme. Instead, if these PPAs are approached, framed and internally sold on their key benefits of 1) cleaning the larger grid by replacing coal and gas with zero-emissions renewable energy, 2) offsetting one’s carbon footprint, 3) hedging against rising energy and REC costs, and 4) potential cost savings, and not as a new revenue stream, then expectations will be aligned with reality and risk. With eyes wide open, companies can successfully incorporate PPAs into their energy procurement and sustainability portfolios -- while helping meet their respective triple bottom lines to be good for people, planet and profits.***