What Does a Power Purchase Agreement Mean in the Utilities Sector?

Reviewed by Khadija KhartitFact checked by Vikki VelasquezReviewed by Khadija KhartitFact checked by Vikki Velasquez

Traditionally, a power purchase agreement, or PPA, is a contract between a government agency and a private utility company. The private company agrees to produce electricity, or some other power source, for the government agency over a long period of time.

Most PPA partners are locked into contracts that last between 15 and 25 years. Still, they can otherwise vary dramatically in terms of the commissioning process, curtailments, transmission issue resolution, credit, insurance, and environmental regulations.

Key Takeaways

• A power purchase agreement (PPA) is a contract between a government agency and a private energy company to provide electricity or another form of power over a long period of time.
• The time frame of a PPA is usually between 15 and 25 years but can vary.
• Other factors to consider in an agreement include the commission process, curtailments, credit, insurance, and regulations.
• A PPA operates through third-party ownership whereby the project is funded by third-party investors who seek a return from the project.

PPA Financing

A PPA is an example of “third-party” ownership. The government agency becomes the sole client of the private energy company, but there is often a separate investor to act as the system owner.

This system owner offers investment capital to the project in return for tax benefits or other favors. In the United States, most system owners are limited liability corporations, or LLCs, controlled by financial institutions.

This system is designed to mitigate costs and provide access to capital where it otherwise would not exist in a single-provider, government-monopolized utility arrangement.

The developer receives access to capital and a competition-free consumer base, the investor receives returns and tax benefits, and the government agency maintains control over the distribution of energy in its jurisdiction.

Note

In emerging markets, where capital is limited and hard currencies present exchange rate risk, PPAs help governments meet the rising demand for electricity from their people by securing international partners to fund and develop power plants.

Energy Policy Act of 2005 and FERC

Every power purchase agreement is regulated by the Federal Energy Regulatory Commission or FERC. In 2005, the Energy Policy Act concentrated control of natural gas, electricity, hydropower, and oil pipelines to FERC.

FERC is one of the least-known yet most influential economic regulatory bodies in the United States. It has the power to set prices, award contracts, punish power companies, and instigate/delay lawsuits.

Environmental activists have roundly criticized it for being overrun by energy company lobbyists and economists and smaller power providers for contributing to a lack of competition in the industry through its PPA process.

Is a PPA for Solar a Good Idea?

Yes, a PPA for solar can be a good idea to save money. It is particularly beneficial for those who can’t afford to make an outright purchase of a solar power system for their own home. By utilizing a PPA, homeowners can save on the upfront costs while still benefiting from energy savings on their monthly bills. Under a solar PPA, the homeowner is not paying for the installation and does not own the solar power system. The installer pays for the installation and owns the system while the homeowner pays the installer a fixed fee.

What Are the Benefits of a Power Purchase Agreement?

The main benefit of a power purchase agreement (PPA) between consumers and an energy provider is that it locks in a fixed monthly rate you pay for energy. Energy costs can fluctuate due to a variety of factors, making it hard to budget for monthly energy bills. By utilizing a PPA with an energy provider, you know what your energy costs will always be.

What Are the Disadvantages of a PPA?

The disadvantages of a PPA between consumers and an energy provider include a lack of energy savings, long-term commitments, lack of ownership benefits, and complications in a home sale due to the PPA arrangement.

The Bottom Line

A power purchase agreement (PPA) is a long-term contract between a government agency and a private energy company to produce electricity. PPAs generally last anywhere from 15 to 25 years but will vary by every agreement.

The agreements allow for stable energy distribution as well as capital access since such projects are funded by third-party investors seeking profits.

Read the original article on Investopedia.