Virtual power purchase agreements: A net zero strategy

The current landscape

At COP26, the 2021 UN Climate Change Conference recently held in Glasgow, countries were asked to present ambitious 2030 greenhouse gas emissions reductions targets that would put them on a path to achieve net zero emissions by mid-century.

Many countries have already stepped forward with these commitments. According to the International Energy Agency (IEA), governmental net zero pledges to date cover around 70% of global GDP and carbon dioxide emissions¹. Canada, for example, recently passed the Canadian Net-Zero Emissions Accountability Act, formalizing the country’s target to achieve net-zero emissions by 2050.

Considerable work remains to implement these commitments, especially in the electricity sector. The IEA has estimated that a radical transformation of the global energy system will be necessary to achieve a net-zero emissions scenario by 2050, with substantial investments in low carbon electricity generation required to accommodate a contemplated 40% increase in electricity demand by 2030².

Many companies are working out targets and strategies to help achieve these commitments, with a focus on electricity sector emissions. Companies with electricity generation assets are considering ways to lower the carbon intensity of their power production over time, often driving investments towards renewable energy supply. Meanwhile, electricity end users are considering ways to reduce their Scope 2 emissions (i.e., those indirect emissions that result from their electricity use)³.

Scope 2 emissions can be reduced by decreasing energy use and improving energy efficiency. Yet as long as electricity use continues—or even rises in step with the growing electrification of vehicles fleets and other equipment—companies are also considering ways to either purchase renewable energy directly to displace their electricity use from the grid, or buy the environmental attributes associated with renewable power production to offset the emissions associated with their electricity use⁴. This has driven interest in private power purchase agreements (PPAs).

Private power purchase agreements

Private PPAs are agreements for purchase of electricity between a generator (the seller) and a private party purchaser (the buyer)⁵. They can be categorized as either physical or virtual PPAs.

In a physical PPA, the buyer obtains the actual electricity from the contract facility, which the buyer can use to power its own operations. The buyer will pay the seller an agreed-upon price per MW supplied. Physical PPAs may be the right choice where the buyer’s operations are in the same location as the generation facility, or where the buyer is an electricity retailer looking to offer renewable electricity to its customers.

In contrast, a virtual PPA is a financial agreement where the buyer does not acquire the electricity itself. Instead, the seller sells the electricity on the wholesale market at the market price. The virtual PPA functions as a contract for differences; it will set out a “strike price” per MW. Where the market price is below the strike price, the buyer pays the seller the difference between the market price and the strike price. However, where the market price is above the strike price, the seller pays the difference to the buyer. Since the buyer does not physically receive the electricity, it will still have to procure electricity from its local grid to power its operations.

Both physical and virtual PPAs allow sellers to hedge against volatility in future power prices and provide stable power prices over the term of the PPA. This can help provide certainty to both generators and financiers making investment and lending decisions relating to electricity projects.

PPAs, emissions offsets and renewable energy credits

In both physical and virtual PPAs for renewable electricity, the buyer will typically acquire the environmental attributes associated with the contracted electricity⁶. In physical PPAs, these attributes are typically “bundled” with the electricity itself—both are conveyed to the buyer. In virtual PPAs, these attributes are “unbundled”; although the buyer does not physically receive the electricity, it typically obtains the contractual rights to the environmental attributes of the renewable electricity produced and delivered to the grid.

In some cases, these environmental attributes can be used for compliance with regulatory regimes. For example, under some GHG reduction regimes, the carbon emissions displaced by a kilowatt hour (kWh) of renewable electricity can be credited as a carbon offset, which covered emitters can use to meet their obligations or otherwise monetize via sale to a third party. Similarly, in some jurisdictions, the green benefit of the renewable kWh can be certified as renewable energy credits (RECs), which can be used for compliance with a renewable portfolio standard (RPS) or sold to a third party. In these cases, the ability to convert any environmental attributes into compliance-grade offsets or RECs will depend on the rules establishing the GHG reduction regime or RPS, as well as the applicable technical methodologies, which vary by jurisdiction.

There may also be a voluntary market for the environmental attributes in jurisdictions that do not have regulatory GHG reduction regimes or RPS. For example, there are several voluntary standards that award credits to qualifying projects. Corporate buyers may wish to purchase these credits or the underlying attributes to help meet their net zero commitments. Under the GHG Protocol, the world’s leading corporate GHG accounting standard, companies can take a market-based approach to determining their Scope 2 emissions. In other words, whereas companies would normally determine their electricity use emissions with reference to the carbon intensity of the local electrical grid, the market-based approach allows those companies to claim emissions reductions that reflect any environmental attributes they own, provided they meet various carbon accounting criteria, such as the rule against double counting those attributes. Therefore, under GHG accounting rules, the contractual right to environmental attributes may help companies in achieving their Scope 2 emissions reduction commitments.

Market trends in Canada

The increasing number of corporate net-zero commitments, and the corresponding demand for carbon offsets, RECs and environmental attributes, is driving renewed interest in private PPAs with renewable energy developers. Currently, the greatest opportunity for sellers is in jurisdictions like Alberta, which have deregulated electricity markets. Because the Alberta market allows for open competition in generating electricity, which is then sold on the open market to multiple buyers, generators may enter private PPAs with buyers looking to secure renewable electricity or its attributes to meet regulatory requirements and corporate commitments⁷.

The flexibility offered by virtual PPAs means that these opportunities are open to buyers with operations in other jurisdictions. Since virtual PPAs are financial transactions, a buyer can enter into agreements with renewable electricity projects in different jurisdictions from their operations, and obtain environmental attributes that may, subject to the applicable regulatory or accounting criteria, be used to offset its own emissions.

The Alberta electricity market has seen a significant increase in private PPAs over the past few years. In January 2016, the Government of Alberta launched its Renewable Electricity Program (REP), which resulted in the Government of Alberta entering into virtual PPAs with 12 different renewable electricity projects totaling over 1,300 MW of electricity, with strike prices ranging from $30.90 to $43.30 per MW. The Government announced in June 2019 that it would not be proceeding with any further rounds of competitions in REP. However, the market takeaway from the successful REP projects is that the cost of renewable electricity projects in Alberta has fallen enough to make private PPAs attractive to corporate buyers.

As a result, private PPA buyers have picked up where the Government of Alberta left off. In 2017 there was just one utility-scale solar project in Alberta. As of October 2021, there are 11 grid-scale solar projects, with many more in various stages of development and construction. Private PPAs have been instrumental in supporting the growth of renewables in Alberta. For example:

• In 2020, Torys acted for one of the developers of the Claresholm Solar Project, Canada’s largest operational solar power plant, which has entered into a PPA to sell TC Energy the majority of the power produced by the project⁸.
• In 2020, Torys acted for the lender in financing of the Yellow Lake Solar Project and the Burdett Solar Project, which entered into a PPA to sell solar power to RBC⁹.
• In 2021, TC Energy also announced it had entered into a PPA for the purchase of all the output of the Sharp Hills Wind Farm¹⁰.
• In 2021, Torys acted for Pembina Pipeline Corporation on its long-term PPA with TransAlta Corporation for the offtake of 100MW of renewable electricity and environmental attributes from TransAlta’s proposed 130 MW Garden Plain Wind Power Project to be located 30 km north of Hanna, Alberta¹¹.
• In June 2021, Amazon announced it has agreed to purchase up to 400 MW from the Travers Solar Project¹².
• Torys is acting for several other buyers, sellers and lenders in respect of other private PPAs that are currently under negotiation.
• Torys acted for National Bank on the project financing of the 17 MW Brooks I Solar Project, the first utility-scale solar project in Western Canada. Brought online in 2017 by Elemental Energy, Brooks Solar is an innovative project with a long-term corporate power purchase agreement with Telus. Torys is also representing National Bank on the 2021 project financing of the 28 MW Brooks II Solar Project, which sits adjacent to Brooks I and is also a party to a corporate PPA with Telus. Both Projects are located in the County of Newell, Alberta.

What’s next

Activity in this area will continue to grow. As companies and governments continue to set ambitious net-zero emissions reduction targets alongside the rising price of carbon, companies will increasingly look for opportunities to reduce and offset their own emissions, including through entering virtual PPAs. As this trend continues, companies will want to ensure that these PPAs—which function as both price hedges and emissions trading agreements—are structured and negotiated to ensure that they support the buyer, seller and lender’s commercial objectives, regulatory requirements and corporate ESG commitments.