Craig: Hello everyone. Welcome to Solar Tea Time. I’m Craig Noxon, VP of Enterprise Sales. Once again, we have a very special guest with us, Drew Dickson, managing director of business development at Duke Energy Renewables. Hello Drew.
Drew: Hello Craig.
Craig: Alright. So Drew and Duke Energy Renewables will be our guests. This is a 301 series. We have done a 101 and a 201 thus far on offsite renewables. Today, we are going to focus a little bit more on VPPAs. So, before we get started, a little housekeeping as always. Just wanted to make everyone aware that your line is going to be muted. However, you can type questions inside the web chat under the questions tab. We’ll try to get to those questions at the end of the webcast. If not, we would certainly get back to you after this. So Drew, welcome once again to Solar Tea Time. We appreciate you joining us. Today, we’re going to talk a little bit more about VPPAs. We’ll start with that acronym. Drew, let us know- Actually, maybe you can get us started with a little bit of a rundown of what we’ve covered thus far with 101 and 201 series.
Drew: Yeah. happy to. So, for the listeners who may not have heard our 101 and 201 Solar Tea Time sessions the last couple of months, I’ll give you a quick replay. The 101 session, we really covered energy market structures. So, we compared the more traditional vertically integrated utility market versus what we might call an organized market like an ISO or and RTO. We compared those. We talked about reasons customers could potentially buy renewable energy from an offsite project. Whether it’s solar or wind. Just a quick recap. Some of those reasons might be onsite economics don’t make sense. Or the logistics for onsite solar might not make sense in a particular location. We also covered some of the benefits of an offsite renewable energy projects. The scale. Just the large scale of these projects and then the large impact that can translate into in terms of renewable energy green house gas emission reduction goals. And just the simplicity of administering once contract or a handful of contracts versus potentially dozens or hundreds. Or a large multisite retailer as an example.
So that was 101. Then, in Solar Tea Time 201 on offsite renewables last month last month, we talked a little bit about energy markets but we talked about markets where offsite renewable energy transactions can work. We talked about some utility programs, such as green tariffs, where there are opportunities to buy offsite renewables through your local utility in a few markets. Then we spent the bulk of the 201 session really discussing what is a Virtual Power Purchase Agreement or a VPPA. So, an overview of mechanics time, how a VPPA works, what some of the critical components are and what some of the considerations are for buyers who are interested in entering into a VPPA.
Craig: So, just as a reminder, these webcasts are posted on our website. You can get to those through recsolar.com. Under resources and library. So, thanks for that Drew. Maybe let’s get into a topic of the day. Maybe you can help us.
What are some of the common issues around VPPA and how can our customers overcome some of those issues?
Drew: Sure. So, I’ll go back quickly again to our 201 session. At the end of 201, I talked about a few considerations that a buyer interested in a VPPA may want to consider. Walk over those again just quickly and then I’ll introduce a few new new considerations as well. So, previously, we talked about term. So, these tend to be longterm transactions, typically 12 to up to 20 years in term. So that, for a lot of companies tends to be a relatively long term and something that is often outside the planning horizon when they typically procure products or commodities. So the longterm nature is certainly a consideration. The credit is another one we touched on. Because these VPPAs really are the primary revenue vehicles for a new wind farm or a new solar farm, investors and lenders will look to the VPPA and the credit quality of the counter party staying behind that VPPA really as a critical piece of the total project. So, typically, we see the counter parties or the buyers entering into these VPPAs with investment grade credit ratings or in the absence of an investment grade credit rating, being able to provide a guarantee from an investment grade rated entity. Or a letter of credit. Or some other type of more liquid credit score that can be posted to back that party’s obligations. So, term, credit. Then, the third one we touched on was just the seller experience, seller capabilities. If the party you’re dealing with. Have they done this before? Right? Do they have the experience? The where with all? Do they have the financial to pull this off?
So, just knowing who your counter party is. Knowing who you trust in the transaction and whether or not that party will be there for the long haul as a long term owner operator. So those a few of the considerations we touched on previously. I’ll introduce a few new ones for the group as well. These are sort of, I’ll call them issues. But, they’re resolvable. They’re addressable. The industry has been able to come up with solutions for these issues. So, I don’t mean to scary anyone that there are major obstacles out there. I think these obstacles I’m talking about are well known. There are solutions to addressing them. So, the first couple of really have to do with accounting. Accounting issues in these Virtual Power Purchase Agreements. One of the first components of that would be derivative accounting. So, VPPAS, as we discussed, are contracts for differences. The parties exchange payments every month. One party is paying a fixed payment. The other party’s exchanging that for floating payment. If the contract were treated as a derivative for accounting rules, that could have an impact on the profit and loss as the price fluctuates every month or quarter. That gain or that loss could be reflected on the buyer’s financial statements, which most buyers don’t want to see.
Now the good news is that, for accounting purposes, most derivatives have to have a specified volume or a minimum volume. So you can structure the VPPA in a way where you avoid volumes and therefore you can avoid derivative treatment. So, I’ll give you an example of that.
Most VPPAs, virtual or otherwise, have some kind of production requirement. Or some kind of production standards. So the wind farm or the solar project has to deliver a certain quantity of energy, certain percentage of what’s expected every year. If the project owner fails to deliver that quantity, then there’s some kind of penalty or some kind of liquidated damage that gets paid. But rather than structuring that with a megawatt hour volume, you could structure that in a different way. You can use generally what we refer to as availability percentage. Get to that same concept but just doing it in a different way.
For those of you who don’t have as much experience in the power industry and may not be as familiar with availability. It’s basically just a concept that we use and it applies to fossil plants that have fostered renewable plants. It’s basically the percentage of hours of the year that a plant was capable, online, available and capable of generating. So, there’s sort of different ways you can structure to the same results so that the seller or the owner of a project has some obligation to deliver energy of a certain quantity. Or for a certain number of hours. But, doing it in a way that avoids the derivative accounting treatment. Another accounting issue is consolidation. So these projects are large. They’re large capital investments. There’s typically equity and debt associated with raising the capital to build these wind and solar facilities. That’s always on the seller’s side of the books, right?
The project owner’s side of the books. But, if the project or the VPPA were consolidated, it’s possible that that capital and that debt could be translated onto the VPPA buyers books. Which, again, most VPPA buyers want to avoid that. Consolidation can be triggered by a number of things. Mostly through operational rights to control the facility. So, if the buyer of the VPPA could dictate when the maintenance was performed or how the energy was sold into the market. Things like that. Or, potentially, if the VPPA were treated as a lease for lease accounting purposes. Or as a capital lease that can also lead to potential consolidation. So, there are known issues. The good news is you can structure around them by leaving those material project risks with the project owner that you can avoid consolidation. So, as I said, these are things that can be structurally resolved the way that VPPA is entered into.
They’re pretty well known in the accounting and the auditing community. So, it’s something you should be aware of as you think about a VPPA. As you work in your organization to potentially implement a VPPA. But they’re not things that aren’t necessarily deal killers. Instruction proper. I guess Craig, the other thing I’ll touch on in terms of risks or issues in a VPPA is it’s just what I’ll generally call risk management. So because these are longer term transactions, as a buyer, you need to ultimately get comfortable that you hold this longterm position. That position is influenced by future market energy prices. If those future market energy prices fall, you could potentially lose money. That’s the risk management item. I think the critical thing there is to get your treasury team. Get your CFO or your risk management team involved in the transaction early. Work with them to help analyze that risk.
And you know, the good news is there are experts out there. There’s a handful of firms out there that do market price forecasts. Their fundamental forecasts are based on assumptions about supply and demand and interest rates and the cost of natural gas and any other number of assumptions and variables. They can predict with some margin of error, obviously, what they believe the market energy prices will be in the future on kind of a base case scenario. But, then, also on different upside or downside cases. So, I think as a buyer interested in entering into a VPPA, understanding what some of those downside cases look like for you. If marketing energy prices do fall. Working with your organization, discussing that with your treasury and your risk management team to make sure you can appreciate that, you’re able to budget for that and accommodate that in a downside case. That I think is one of the most critical issues in a VPPA. Getting that through an organization, getting comfortable with that. So, really, the key for these is communication, right? So, there are a number of complex issues that we’ve touched on. Engaging your team and your organization to review these issues, to come up with resolutions. And reporting out those findings, your stakeholders, whether they be internal or external, will minimize surprises. It’ll be much more beneficial in the future for your organization to identify these issues, to communicate that out rather than keep your folks in the dark if you’re looking at implementing a VPPA. So, all these issues can be addressed. Just different ways to do them.
Craig: Yeah, certainly. So you’re saying don’t just be like Genghis Khan and take over everybody. Build some consensus. Make some sense. You talked a little bit of a treasury and CFO. Can you talk a little bit more about different people that they should be reaching out to internally?
What resources should people be talking about to help them with this type of a decision and that consensus building?
Drew: So, again, every organization is going to be different. So, for the folks on the call, they’ll appreciate some of these organizations. Or some of these parts of their organization may apply, may not apply. You’ll know which of these are important in your organization. If I were to come up with a checklist of teams or groups that you would want involved in a VPPA transaction, I’ll start with treasury, right? And someone senior, like a treasurer or a CFO, is typically involved in these types of transactions within an organization implementing these because of the financial impact, because of the risk management actually we discussed. Accounting, right? So we’ve talked about some of the accounting issues that can be structured around. So. having your accountants or your auditors engaged, I think would be very important.
Make sure they understand those issues. Make sure that they’re comfortable with the VPPA as you’ve structured it. Does it have any undesirable accounting treatments or outcomes? Certainly your attorneys. Your law firm. Your in house folks. These VPPAs are complex legal documents like many others. So, having your attorneys review them. Having their input on particular terms and conditions I think is very important and will help you streamline your approval process. The next one, I’ll call generically sort of facilities/ operations. This, depending on your organization, can vary quite a bit. The folks within your group that are managing your energy decisions today. Whether that’s a plant manager who has P&L responsibility for his energy costs. Or whether that’s an operations group. Whoever’s managing your energy today, utility billing, etc. That organization, having someone represented, I think will be very helpful to implement a VPPA in a way that works for your organization, and helps you accomplish your objectives. The next one might be a procurement. So you know whether you’re buying a commodity. Whether you’re buying staples and paperclips. Most large organizations have some kind of procurement process or supply chain organization. That’s a group that depending on your status, may or may not need to get involved in this type of transaction.
Sustainability, I think, is really critical. So again, the reason most organizations are considering a Virtual Power Purchase Agreement is for some type of sustainability focused effort. Whether that’s the greenhouse gas emissions reduction goal. Whether that’s the renewable energy goal. Whether that’s some other target you’re tryIng to solve. So your sustainability team who understands those orders, those goals. Whether it’s the way you report your different scope of GHG targets. Whether it’s the commitments you’ve made publicly about your sustainability objectives and targets. Having that team involved and understanding what you’re doing and how you’re structuring the VPPA. I think will be very critical to satisfy those larger corporate objectives that you might have already communicated to the street. Which takes me to the next group which would be public relations, right? So, most organizations who do a VPPA really want to broadcast what they’ve done.
It’s an exciting transaction. It’s certainly newsworthy. I think most organizations want to communicate the goodwill and good efforts they’ve done to their stakeholders, whether it’s employees, whether it’s supply chain partners or the general public. So, your PR organization I think would be helpful to have involved. And, finally, I’ll end the checklist with an executive sponsor. That could honestly be anyone from the above groups we’ve talked about. It could be the treasurer or CFO. But, generally having an executive sponsor who can throw some weight behind a project like this, demonstrate that this is of importance to the organization, will help implement these VPPAs in a much faster and more streamlined manner.
What kind of support can people turn to, external to their own organization?
Drew: The good news is there’s a lot of resources out there. You will not be the first one doing this VPPA transaction. There’s a lot of others who have come before you. Solved of these same issues and overcome some of these same obstacles. So, I’ll rattle off a list of external resources that I think would be helpful for anyone looking at this for the first time.
So, first one I’ll mention is the BRC, Business Renewable Center. It’s a nonprofit organization. It’s an outgrowth of the Rocky Mountain Institute. And BRC is really an association of interested parties. Whether they be buyers. Whether they be sellers. Or other service providers. That are all focused on these types of transactions and advancing this market. Trying to address issues and break down barriers to the wider adaptation of large scale renewable purchases by corporate entities. So BRC is a great resource. I would check them out if you’re not familiar with them.
The second one I would look at is what I’ll generically call renewable energy advisors and consultants. There’s a handful of these folks out there. I won’t name any by name because I don’t want to necessarily endorse or not endorse any of them. But these are folks that you might already be doing with your organization on things like utility bill management or sustainability target development or renewable energy credit purchasing. So, a number of these organizations have sort of shifted into this offsite VPPA advisory role as this market has matured. So, there’s a number of those folks out there that can provide sort of consultancy and advisory work almost exclusively for buyers in these types of transactions. External legal counsel. Right? As more and more law firms work on these transactions, there’s a lot of attorneys out there who have sort of built a knowledge base of these transactions. The terms and conditions that are acceptable in the market.
Finally, I would just say someone who can be a trusted energy partner. Someone like Duke Energy and REC Solar. Someone who’s done these transactions. Has the experience with the wherewithal to back them up. Someone who can work with you to help address your challenges and meet your objectives. Make the process of putting onsite or offsite renewables as simple and as streamlined as we can for you to meet your objectives.
Craig: Thanks Drew. So, with that, we’ll wrap up. So thanks so much for your time and helping us better understand VPPAs. And for the whole series about offsite renewables. It’s been great. I think we’re going to wrap this moth’s Solar Tea Time up. I believe we’re going to take a slight hiatus in July. But be back August with Solar Tea Time. Again, if you have any questions, you want to reach out to us on this topic or any others. Please email us at email@example.com. We’ll be sure to get back to you. So thanks Drew. Cheers. Thanks a lot. Take care. Bye.