European offshore wind operators face a dilemma. With the price of the power they produce falling and the energy market as a whole becoming decentralised, governments are increasingly reluctant to subsidise new projects, forcing clean energy companies to get creative to secure future revenue.
Power purchase agreements (PPAs) offer a potential solution. Relatively common in the US, they are finally gaining traction in the increasingly volatile and cost-competitive European wind power sector.
Cheaper wind energy and recent zero-subsidy bids in Europe by the likes of DONG Energy and ENBW have boosted investor confidence and the deployment of large (6MW-9MW) new-generation turbines.
These two factors combined have contributed to rapid growth in the offshore wind market, setting the stage for a round of large investments, not only in Europe, but also in Asia and North America.
“The wind market is currently driven by the increasing competitiveness of wind power pricing,” says Swagath Navin Manohar, senior research analyst – energy and environment, at Frost & Sullivan.
“Motivated by this, the global energy market is witnessing a shift from standard electricity model, where the major utilities decide the generation source and technology for consumers.
“Independent power producers (IPPs) like DONG are finding PPAs to be a promising option to supply power to large companies, rather than relying on subsidies.
Supply and demand: power purchase agreements explained
Put simply, PPAs are contracts that sell energy directly to large corporate and industrial customers through multi-year supply contracts – typically ten to 20 years – rather than to the wholesale market.
They not only provide renewable energy companies with a guaranteed revenue stream; they also allow corporate customers to capture the best energy price on the market, reduce costs and boost their sustainability credentials, as Manohar explains.
“Prices for electricity produced from wind energy are subject to market variability,” he says. “IPPs may, therefore, have to sell the electricity in the market at negative prices and curtail MWs of wind power to balance the load, creating unfavourable financial conditions for IPPs and their investors.
“PPAs protect IPPs from these financial fluctuations and maintain a steady stream of revenue where the prices are fixed. In addition, during times of surplus production, the IPPs can still trade the extra electricity produced in the market and earn additional revenue.
“Also, as one of the fastest ways for corporates to reach sustainability goals and add new renewable energy to the grid in a cost-effective way, PPAs indirectly add brand value. This enhances their image and brand as forward-thinking environmental stewards focused on their customers’ interests.”
As importantly, in a market characterised by price volatility, the financial certainty afforded by PPAs allows IPPs to attract credible investment and offset offshore wind’s high upfront capital costs.
“There are no system risks associated with PPAs as the IPP sells all the power to a single customer who pays for it,” explains Manohar. “This, again, maintains a constant revenue stream and avoids volatility in the future. Also, considering high installation costs, ROI is guaranteed within a certain time span, facilitating investment in utility-scale projects and helping to bring new renewable capacity online.
“Also, unlike the old business model of purchasing electricity from a local utility, PPAs help large corporate buyers to access a much wider range of energy providers and create job opportunities.”
Continental drift: is Europe switching on to PPAs?
In 2016, Eneco, with project partners Royal Dutch Shell, Van Oord and Mitsubishi/DGE, won a tender to build 700MW of wind capacity across two sites, called Borssele 3 and 4, offshore of the Netherlands.
The Dutch power producer already counts Dutch Railways, Google, FujiFilm and Amsterdam’s airport Royal Schiphol Group among its renewable energy buyers, and may soon add Microsoft to its portfolio after the US technology giant built a €2bn data centre at Agriport near Amsterdam.
PPAs with corporates are common practice in the US where securing a big-name electricity customer has helped make projects attractive to investors. Why has it taken so long for Europe to catch up?
“The electricity market in the US has evolved from a multitude of isolated centralised utilities to a highly integrated network of IPPs and local-scale utilities with multiple wholesale buyers and sellers,” Manohar explains. “The guidelines for forming and creating a PPA in the US are well regulated and already existed.
“Europe has only witnessed the transition from centralised to decentralised in recent years, with increasing penetration from renewables and increasing IPPs. With multiple countries having their own regulations, the growth of PPAs has been slow over the last half-decade.
“However, with reduced wind prices there are positive signs the European energy market is moving toward PPAs. In 2016, the volume of corporate PPAs almost tripled in Europe compared to 2015 and, in the US, PPAs accounted for almost half of the installed renewable energy capacity in 2016.”
Hurdles to growth: global offshore market outlook
Despite the rapid growth of the offshore wind market, driven in part by alternatives to traditional funding models, Manohar identifies a number of potential hurdles, both in Europe and worldwide.
“Despite this progress, there are still challenges the offshore wind industry needs to address, among them the need for larger vessels and complex logistics to transport large structures and turbines, limited expertise in planning and construction and high capital costs compared with onshore wind.
“These challenges may inhibit investment in new offshore projects. However, researchers, alongside wind OEMs, are constantly working towards experimenting and developing on project design life, turbine performance, and on improving operation efficiency to reduce the overall investment.
“This could create huge opportunities globally and set a path toward cheaper wind energy.”
With this in mind, how does Manohar envisage the market evolving in the short to medium term?
“Currently, the global renewables energy industry is slowing moving toward more market-based mechanisms, and investments in wind energy related projects will be exposed to both volume and price risk,” he says.
“The revenues of a power plant depend on the produced quantity of electricity and the average price at which that electricity is sold. The uncertainty on both unit and price, which make up the merchant risk, will become an issue for wind power projects.
“With prices in wind energy going down, it is evident that corporate renewable PPAs will boost new global wind energy projects for the next three to five years. However, in the longer run, the countries have to collaborate and have common regulations that could boost the investments for new wind projects.”