On 16 March 2018, Vattenfall won the first tender for a project to build an offshore wind farm in the Netherlands with zero-subsidy, and the first question on everyone’s mind was where the return on investment would come from.
The increase in building renewable assets since 2010 came along due to incentives in the form of healthy subsidies, which made locking in value by selling generation in the mid- and long-term not essential since most (and sometimes all) return on investment was guaranteed by the subsidy. Unlike thermal assets owners, owners of subsidized renewable assets were not worried about unfavorable market prices, and the focus on ensuring that the assets generated enough power as the subsidy was set as a value per MWh generation.
Governments have long indicated to renewable power producers that subsidies will not last forever. Combined with the fact that winning the zero-subsidy project at a time when the power mid-term prices were at historically low values, we can conclude that the era of subsidies is nearing its end, and that new renewable builds should generate their value from the market. There will be more urgency from the owners to look at locking in part of the value of the asset in the mid- and long-term market. These new conditions bring the previously dormant long-term wind Power Purchase Agreement (PPAs) back on to the scene.
A wind PPA allows:
- Producers to lock in part of the value of the asset at a fixed or indexed-to-market price and reduce the exposure to future unknown low market prices
- Buyers (generally big industrial customers) to purchase their power demand at a fixed, or indexed to, market price and reduce exposure to prospective future unknown high market prices. More importantly, it gives them a green label for using green energy for their production
When Vattenfall acquired the zero-subsidy tender of 2018, the Dutch mid-term market price for power hovered around 38 Eur/MWh, well below the subsidy level renewable asset owners were used to. The prognosis of the long-term market indicated an expectation of higher prices in the long term due to the expected phase-out of coal plants in the Netherlands, and the commitment of the EU to lowering CO2 levels.
This was the expectation of power producers, and from the buyer/consumer’s perspective, there was a psychological dilemma to acquire a PPA at an unobserved price of around 50 Eur/MWh (a reference price that would produce a healthy return on the investment).
Now, a year later, power mid-term market prices are picking up and wind asset owners are more comfortable approaching potential buyers with PPAs at levels they expect to generate when they accept a zero-subsidy project. Potential buyers will be willing to accept such levels as these are currently observed in the market, and to gain protection from a prospective future increase in market prices. In addition, the green label attached to wind PPAs will always be attractive to industrial customers. The market conditions for both seller and buyer make wind PPAs a very hot topic.
Wind PPAs are also interesting from the analytical perspective as the value generation of the wind asset and the risks associated with it occur across the whole lifetime of an asset, covering the long- and mid-term market, day-ahead market, and balancing market.
With the removal of high subsidies, every euro generated from the asset matters for the sellers. Buyers, on the other hand, need to see and understand the detailed components of the price they are paying. Figure 3 below shows the historic values of the average monthly price of German power and what we call the ‘wind price’ from our EPSI platform, which is the wind generation weighted price in the same market. This shows that the wind price is always lower than the straight average price. Renewable generation is leading in the merit order and for a certain level of demand, higher renewable generation leads to lower power prices. This inverse correlation explains why the wind weighted average price is lower than the straight average price.
What does that mean for a PPA? A knowledgeable buyer should expect a discount on the market average price. For the seller, this difference between market price and wind price is only observed historically, and they need to quantify this expected difference in the future to come up with a discount which does not affect the competitiveness, but still covers the risk of the variation in this spread.
Another risk is the balancing risk. Wind generation forecasts are not 100 percent accurate, and the discrepancy between the forecast and real generation settles in the intraday market and/or the balancing market. Earlier we described that wind generation on average is inversely correlated with power prices. This also applies to the intraday and balancing markets, meaning that, when the power producer overshoots their forecast, they need to sell the extra generation at a low price and, if they produce less than what is forecast, they will have to buy the difference at a higher price. This risk must be quantified and incorporated in a PPA by the power producer.
We conclude that PPAs will be appearing around countries in the process of building zero-subsidy renewable assets. Therefore, there will be a need for analytical data driven tools able to forecast long term prices, and to quantify the day ahead and balancing risk of wind generation assets.
For the long-term prices, which is the main component of the asset value generation, Genscape’s modelling platform, EPSI, includes fundamental data across Europe with the necessary tools to generate reliable long-term price forecasts along with sensitivities, including scenarios for different commodity prices, forecasted wind generation and capacity, and geopolitical scenarios. Our platform allows users to generate scenarios with input from their own expectations of the different markets. This helps prospective PPA buyers and sellers to quantify their business cases and the risk associated with it.
For the short-term value and its risks, Genscape’s PowerRT platform has a comprehensive set of data of short-term forecasted and realized generation, demand and prices, which allows buyers and sellers to quantify the short-term risk from day-ahead, intraday and balancing variations. To learn more about our EPSI and PowerRT platform’s, please click here.