Craig Noxon: Hi everybody. Welcome to Solar Tea Time. I’m Craig Noxon, the VP of Enterprise Sales at REC Solar and we have our first-ever returning guest. Drew Dickson, Managing Director of Business Development from Duke Energy Renewables. Welcome back Drew.
Drew Dickson: Thank you.
Craig Noxon: We’re going to follow up from the last discussion we had, which was a 101 series talking about our continued journey through offsite renewables with basically a 201 series focusing a little bit more on some of the strategies and purchasing vehicles for offsite renewables.
Drew, welcome back. We appreciate you joining us to dive a little deeper into offsite renewables. Let’s just jump right in. Basic questions here. Can you talk a little bit about the markets for offsite?
Why might customers pursue offsite energy, and what strategies might they deploy?
Drew Dickson: Happy to, Craig. In the 101 webinar last month, for those of you who participated, we talked a lot about different market structures, regulated utility markets versus organized markets. We’ll touch on a few of those points again here today in more detail. In general, when it comes to markets where these transactions are getting done, these offsite renewable energy transactions are getting done. There’s what I would differentiate between regulated markets and these organized markets.
To start with a little history: A number of years ago, due to customer interest, a lot of utilities launched what we would call green pricing programs, which enable their customers to procure renewable energy or buy RECs [renewable energy credits] essentially from the utility for an incremental cost on top of what they were already paying for retail electric service. These programs caught on and a number of utilities launched these programs around the country. Ultimately, whether the utility was buying those RECs from third party independent generators, or whether the utility was sourcing those RECs from wind and solar assets that they themselves owned and operated, essentially it was being passed through as as a cost-add to the rate base. The benefits of the fixed price energy that renewable energy projects can offer was not really shared with the ultimate end use customer.
The more recent structure we’ve seen in utility tariffs in these regulated markets for green energy has been these green tariffs. Sort of simply named. These work differently in different markets in different states. By and large, these green tariffs enable renewable energy to be passed from the generator through utility to an ultimate end-use customer. In a lot of the cases, the fixed price, longterm value of that renewable energy can be passed to the end-use customer as well. A great example of this is in Nevada, where NV energy has a nice green pricing tariff. Or, apologies, green tariff, which is basically slips through from the renewable energy developer all the way through the utility to the end-use customer. These green tariffs exist in probably about 13 states today. Not every utility in those states has a green tariff and not even every customer in those utility markets or in that state have access to that green tariff.
It’s still a very small percentage of load in the US can access a green tariff. Beyond green tariffs, there are a number of states, I think about six today, that have done some type of bilateral one-off renewable energy transaction between a renewable generator and an end customer. Maybe outside of a green tariff program. There’s a number of programs out there. They really vary state to state in these regulated markets. If this is something that you’re interested in, I would point you to WRI. The World Resources Institute puts out some issue briefs and papers occasionally on the development of these various tariff products that are helpful. Everything we’ve covered until this point has been in a regulated utility framework. Let me switch now to talk more about the organized markets. We covered this a lot in the 101 session. Organized markets that cover the whole center of the country and a lot of the markets up in the northeast and in California offer more tools, more ability for customers to buy renewable energy from offsite projects.
If you’re tuning into the webinar, the map that you’re seeing now shows you where these organized markets are around the country. They are called independent system operators. Sometimes, they’re called regional transmission organizations but I’ll just generically refer to them today as organized markets. These markets are where the preponderance of renewable energy transactions are taking place today in the US with offsite projects and offsite customers. These markets offer a few benefits. They offer access first and foremost. As an independent generator, we now have access to a market. We’re not relying on the sort of incumbent utility to buy that power. It opens up in a broad range of customers for us as a generator. On the flip, for those of you who are customers of energy, this opens up new avenues and new contracting structures for you as well in these markets.
These markets that are shaded on the map are markets where the structures exist. The fundamentals are in place for offsite renewable energy purchasing to take place at a large scale. But, I’ll caution that it doesn’t necessarily make economic sense in every one of these markets today. For example, New England, I’ll just point out, has the market structures in place to enable offsite virtual power purchase agreements. But because of relatively low wholesale energy rates and the relative higher costs of new build, wind and solar in these markets, New England is an example where we just haven’t seen a lot of renewable energy transactions done offsite. However, if you look at the center of the country – Texas, all throughout the Southwest power pool and into the Midwest, even in PJM in the Northeast. We’ve seen a lot of renewable energy transactions take place in these markets because the new levelized cost of wind and solar new build is very competitive today with wholesale power prices in a lot of those markets.
Craig Noxon: Interestingly because from an outside perspective, Massachusetts, for example, is great. Mostly because they have such a great incentive program. You really have to look at what site you’re in and what makes the most sense for you. That’s going to differ for each customer based on location. Let me ask you, Drew.
What does the offsite renewable transaction structure look like?
Drew Dickson: Great question. There’s not one easy answer to that question. So I’ll address it in a couple of ways. There’s basically two ways a customer can buy renewable energy from an offsite project. Again, I’m greatly simplifying here. The first way, and this is a pretty rare type of transaction, would be the purchase of physical electricity. A physically delivered power purchase agreement. Really only the largest and most sophisticated buyers have been able to execute these physically delivered contracts. An example would be Google or Apple or even Walmart have gone through the effort and gone through the steps and the cost of setting up essentially a wholesale power trading business. Getting the regulatory approvals necessary from FERC and others to transact wholesale electricity is not really for the faint of heart. It is relatively expensive. And the expertise required to build this capability is difficult. The very giant energy consumers around the country – the data center guys and retailers like Walmart – have occasionally done these types of transactions. But, they’re definitely in the minority of the transactions that have been done to date.
That takes me to the easier and perhaps the simpler transaction. And the one that’s much more common today. That is not taking physical delivery of the electricity from an offsite project, but taking what we would call financial settlement. You’ll hear us refer to this in the industry as a virtual PPA or a Virtual Power Purchase Agreement. We throw around the word virtual. All it really means that it’s a financially settled contract between the buyer and the seller. The buyer, the corporate customer or the institution on the buying end of the transaction is not actually taking physical delivery of electricity. We’ll walk through an example of that shortly. As real energy generators, we are in the wholesale markets everyday transacting wholesale power in an organized market. That’s our daily business. It makes sense for us to manage that wholesale daily power interaction in the wholesale market. And for a customer to focus on their core business, which for most of you is not buying wholesale electricity for a long time.
What exactly does a Virtual Power Purchase Agreement, or VPPA, look like?
I’ll break this up into components that I think will help walk everyone through and make this pretty straightforward. I’m actually going to start on the bottom. Particularly the bottom right of this graphic. So you have a customer. Here I’ve titled it a corporate buyer but, again, the same would apply to an institution or a university or someone that’s not necessarily a corporation. You have a transaction between a corporation or a buyer and utility. This is your daily electricity consumption at the retail level, right? Every time you flip on a light switch or turn on a manufacturing process, you’re burning electricity, you’re buying that electricity from your regulated utility or in markets that are deregulated, you might have a retail electric supplier that you’ve chosen to serve your retail load. That’s the transaction at the bottom right of this graphic. That ought to be familiar to everyone. A VPPA does not change that. I’ll come back and talk about that in a moment.
Now, if you look at the bottom left of this graphic, your utility company is either generating electricity themselves from power plants that they own and operate. Or, perhaps, they’re buying it in a wholesale market from other independent generators. The utility itself is either generating or purchasing electricity from a wholesale market and eventually passing electricity through to a customer at the retail level. The bottom half of this graphic is pretty straightforward. That’s kind of status quo. How most folks purchase their electricity today.
Let me switch and talk a little bit about the top of the graphic. I’ll start at the top left and that’s between the Renewal Energy Project, the wind farm or the solar farm and the wholesale market itself. Recall the graphic earlier with all the colored regions of the country. ERCOT, SPP, MISO, these organized markets. The Renewal Energy Project sells its electricity at the hourly level into that market and the Renewal Energy Project receives that market price for the energy in that interval, whether it’s hourly or even sub hourly on many markets. We call that the floating price. Depending on supply and demand, the market clearing price for that electricity in that interval will be priced differently. That is the floating price that the renewable energy project receives from the wholesale market. As a generator, that’s our core business, right? That’s how we interact with the market and that’s how we traditionally get paid. Nothing I’ve told you to date or till now is a VPPA, right? That’s all just sort of setting the stage for what is the actual VPPA itself. That’s essentially what’s in the box that’s in the top right of the graph.
The Renewal Energy Project receives the floating price from the system operator in the market and it passes that floating price directly through to the customer, to the corporate buyer, right? So that’s a direct pass through. In exchange, the corporate buyer pays the renewable energy project a fixed price per megawatt hour. So corporate buyer receives a floating price and they pay a fixed price. That’s the financial settlement that we talk about in a VPPA. This is also referred to as a contract for dif-ferences or maybe even a financially settled contract for differences. The terminology changes a fair amount between VPPA and and these other tools. But by and large it’s the exchange of a fixed payment for floating payment or vice versa depending on what end of the transaction you’re sitting on. The most important part of all of this, and the reason we’re do-ing all of this in the first place, is that the RECS, the renewable energy benefits apply to the corporate buyer.
They are issued in some kind of tracking system to the renewable energy project owner and they get passed through under this VPPA to the corporate buyer. So, they ultimately can make the claim that they bought renewable energy. That really, in simplicity, is what a virtual power purchase agreement is and how it works. I guess one of the things that I can touch on here is that we started at the bottom of the diagram taking out how your meters are actually served with retail power from your utility. That really doesn’t change, right? You’re still served by your retail supplier, by your company utility, at the retail level, monthly. That doesn’t change in a VPPA. It’s really the financial settlement you have with the renewable generator that gives you a head potentially against rising electricity costs. You can then apply towards your retail rate and basically have an offsetting long to your short position as a retail right there.
Craig Noxon: It’s important to note, in your box up here, while it may look like energy may be passing from the renewable project to the corporate buyer, that it’s not. The actual energy, the electrons are not directly flowing and that’s the distinction between the PPA and the virtual PPA. We’re really now just dealing with, as you said, there’s contractor differences.
Drew Dickson: Yeah.
Craig Noxon: That’s great Drew. Appreciate that. My last question here is:
What are some other factors that a corporate buyer should consider?
You kind of mentioned earlier that some VPPAs are only for some of the largest corporations in the country, but there are ways that others can take advantage of this. What else should they be thinking about?
Drew Dickson: Absolutely. I know in our next session, the 301 session, we’ll cover some more nuanced topics. But, I think there’s three today that I’ll touch on that are probably the biggest factors or the biggest considerations that a prospective purchaser of renewable energy from offsite should take into consideration.
The first one is term. These VPPAs from the Renewal Energy Project’s perspective are the primary revenue contract, right? They describe how we get paid; for how long we get paid. They really are the cornerstone of a renewable energy project. It’s the basis for how we would finance the construction of a new solar farm or a new wind farm. In that context, I’ll bring up the term of the VPPA because the term can be an issue for a number of buyers because they tend to be relatively long. Most VPPAs we’re seeing today are between 12 and 20 years in duration. A 15 year term is very common. Even in terms as long as 25 years are not unheard of. This 12 to 20 year time horizon tends to be where the most overlap between buyer interest and seller interest lies and that’s because of that longterm revenue certainty that the renewable energy project requires to raise financing and justify the expenditure of the capital investment to build the facility.
I know a lot of buyers probably don’t purchase anything for 12 years or 20 years into the future. Certainly that is a consideration and these transactions that a buyer should consider. The next one I’ll touch on is credit. Kind of goes hand in hand with term, right? So this is a financially settled transaction. One party is going to be paying the other party in any given month for the duration of this contract. That raises credit issues, right? On both sides of the transaction, to be perfectly frank. We’re relying on the buyer to be there to make these payments. In the same vein, the buyer is relying on us as the project owner or the seller to be there and to live up to our obligations in the contract as well.
We’re each taking credit exposure to the other. As a result, generally these transactions are structured with some level of credit support being provided from one party to the other. Usually that’s reciprocal. Both parties are providing credit support to the other. From the buyer’s perspective, the consideration they should have there is are they investment-grade credit rated? If not, do they have a parent company or an affiliate there can provide guarantee from an investment-grade rated entity? And if they’re not investment-grade rated, well that’s not necessarily a deal killer. There are other other tools and other techniques we can use. There’s letters of credit. There’s performance bonds. There’s other other packages and instruments we can use to provide credit support to one another, just to make sure that the contract will be fully settled for the term.
Finally Craig, I’ll leave with experience. Quite frankly, there are a number of sellers in this market. Some are experienced. Some are not as experienced. This is a longterm relationship. Whether it’s the front end, the construction, the negotiating the contract. Or the long end and the back end, the operations and maintenance and settlement of the contract for the term. You want to know who you’re doing business with and who your counter party is and do they have the financial and technical wherewithal to do what they say they’re going to do. I think that’s another serious consideration for buyers. Knowing who your supplier is and getting comfortable with their experience and their credit and their wherewithal.
Craig Noxon: That’s great Drew. Thanks. That wraps up this session. It’s been great. We received a lot of interest in how corporates can employ offsite renewables as part of their overall energy strategy. As with the last session, if we didn’t get to your questions, please email us at a email@example.com. We’ll be sure to get back to you and, as Drew mentioned, we will have a 301 in an upcoming Solar Tea Time. Please stay tuned. Drew, enjoy your tea. Enjoy your rest of the day. Thanks everybody. Take care. Bye.
Drew Dickson: Thank you. Thank you all.