Covid-19 to slow PPA negotiations in the short term

GlobalData Energy 23 April 2020 (Last Updated April 23rd, 2020 17:10)

Covid-19 to slow PPA negotiations in the short term

The rapid growth of renewables has been supported by progressive technology advancements, intense competition between developers and suppliers, innovative business models and market structures and favourable subsidies, which resulted in substantial cost savings and enhanced its economic viability against conventional power generation sources.

Early adoption of renewables was backed by generous government support such as quotas, tax breaks and feed-in-tariffs. Consequently, the rapid expansion of the technology-enabled developers and manufacturers to enhance operational efficiencies resulted in cost decline. With costs falling, governments reduced their support for the sector and moved towards employing auctions mechanisms to drive market deployment.

With government subsidies fading, developers had to seek other avenues for stable revenues to enhance the project’s bankability and gain access to capital for development. Power purchase agreements (PPAs) emerged as a vital market instrument that insulated involved stakeholders from the fluctuations of the power market and promoted the construction of new capacities.

A PPA is a contract between a buyer or off-taker and the power producer for the purchase electricity at pre-agreed prices for pre-agreed tenure, which includes other terms such as delivery point, beginning date and volume. PPAs enabled plant developers to secure future incomes and provide assurance to credit lenders / investors that loans can be repaid in the absence of government support schemes.

Traditionally, developers signed a contract with utilities known as ‘utility PPA’, but with the energy market evolving, companies are now seeking to purchase electricity directly from renewable developers known as ‘corporate PPAs’ as a means of managing their energy costs and reducing carbon footprint with little to no dependence on the utility grid service provider. Renewable power sourced under corporate PPAs reached 19.5GW, increasing by 44% from 2018 and was largely driven by tech companies in the US. There is significant upside for this market instrument, benefitting the developer, buyer and other involved stakeholders.

Prior to the Covid-19 outbreak, there was a strong demand for clean energy, which boded well for renewable energy developers. The declining costs and perception of low risks drove more investments and prompted developers to deploy additional capacities and even develop ‘merchant projects’ that rely on selling electricity on the spot and forward electricity markets rather than via long-term PPAs.

Now, due to the ongoing pandemic, governments have imposed drastic measures to curb the spread of the virus, which has required temporary closures of offices and manufacturing plants, resulting in a decline in power consumption and electricity prices. This, in turn, would impact existing and upcoming PPAs with the likelihood of derailing the construction of upcoming renewable projects.

Existing PPAs

With the pandemic contributing to stringent confinement measures, commercial and industrial facilities have limited or halted activity, leading to a decline in the electricity demand. Commercial and industrial sectors form the largest consumer base and a change in demand requirements could have a significant impact on a country’s power demand.

In India, the lockdown has brought all non-essential commercial activities to a halt and the electricity demand from industrial and commercial customers has fallen significantly. According to the Power System Operation Corporation of India (POSOCO), power supplied on 11 April was 2,800 million units (MU) compared to the average supply of 3,615MU in February (pre-Covid-19), which corresponds to a decline of 22.5%.

The decline in power consumption represents a loss in revenue for developers as projects are now vulnerable to default risks with buyers unable to make payments, which can impact the developer’s revenues and their credibility in the eyes of the lender. The lack of payments would create a capital issue for developers, putting them in a weak position during the renegotiation of obligation terms. There is a high likelihood that involved stakeholders could resort to legal battles or complex damage mitigation negotiations, which could continue long after the Covid-19 pandemic ends.

New PPAs

The drop in energy prices and emerging market uncertainties are significant impediments for PPA negotiations. Under construction projects with negotiated PPAs face significant hurdles due to supply chain disruptions and lack of personnel, which increases project costs and squeezes developer margins.

With power prices at unreasonably low levels, most developers would remain cautious in negotiating new PPAs, which risks disrupting the momentum of project development. PPAs are typically negotiated at discounts to the wholesale electricity price, and therefore, the reduction in wholesale prices impacts the PPA pricing structure and, consequently, the viability of projects in the short term.

With the extent of the ongoing Covid-19 restrictions unknown, it is difficult to estimate a suitable pricing structure that would offer good terms for developers in the current environment. At the buyers’ end, companies would be hesitant to commit until the volatility in the market subdues as some companies may be facing office closures and worker lay-offs.

Companies with significant debt could defer from making new investments and move to take a cautious position as their demand for energy and other goods and revenues will decrease. Moreover, the current downturn will result in the creditworthiness of certain companies dropping, which would increase counterparty risks and could result in projects being stalled in the short term.

Global corporations and industries are expected to continue focusing on managing their energy needs, which include sourcing electricity directly from renewable sources. The unprecedented impact of Covid-19 on the PPA market is likely to result in PPAs becoming more comprehensive and complex. Clauses are likely to be introduced to mitigate damages and establish suitable mechanisms that would commensurate the emerging risks and obligations to both parties equally during pandemics and other unexpected circumstances. Nevertheless, with government support for renewables slowly receding, PPAs remain an essential tool to support the transition to a low-carbon global economy.