The “volume firming agreement” could mitigate some of the risk and volatility of renewable energy power purchase agreements, helping to expand procurement beyond large corporate buyers.
Microsoft has remained a step behind other technology giants in contracting for renewables, but may be gaining ground. The company recently developed a deal-making strategy that makes contracts more user-friendly and Microsoft more active in the renewable energy market. Other corporate renewables buyers may soon follow.
Corporations like Google, Amazon, Apple and Facebook use power purchase agreements to buy wind and solar generation, which provide fixed prices for renewables. But renewables’ output varies with weather conditions, and PPA holders must, at times, purchase renewable MWs through power markets at prices higher or lower than the prices in their PPAs.
Microsoft’s volume firming agreement (VFA) transforms that fluctuating price into an unvarying, though slightly higher, price guaranteed by a third party insurer which relieves the buyer of the risk associated with renewables’ variable price and output.
The third party uses the detailed understanding of energy markets and weather variations provided by a company like Microsoft partner REsurety, a risk management and information services company specializing in renewable energy variability.
“Banks, power desks or utilities can buy a firm block of renewable power and shape it to follow a customer’s load. In some markets, it is now cheaper than a block of fossil generation.” Ken Davies, Director of Innovation, Microsoft Energy Strategies
With such an analysis, the third party can guarantee delivery of renewables-generated electricity for every hour of every day. In return, it charges a risk-management price, an insurance premium price and the PPA price, but that total price is often below market prices for more expensive fossil fuel-generated power.
REsurety CEO/Co-founder and VFA originator Lee Taylor has been working with Microsoft Energy Strategies Director of Innovation Ken Davies since 2010 to develop the VFA.
“This is a standardized energy product that enables trading of renewable power,” Davies told Utility Dive. “Banks, power desks or utilities can buy a firm block of renewable power and shape it to follow a customer’s load. In some markets, it is now cheaper than a block of fossil generation.”
The pairing of a PPA and a VFA “allows for much greater liquidity in certain markets,” Sustainable Power Group Senior VP of Power Marketing Hans Isern emailed Utility Dive. “It effectively converts a variable commodity stream into a known and more tradeable shape.”
Equally important, the price certainty it provides “better suits the needs of corporate buyers,” according to Director of Energy and Sustainability Services Erin Decker of Schneider Electric, a company that has acted as consultant on over half of all corporate PPAs since 2016.
The problem with PPAs
There were a record 4.81 GW of corporate utility-scale wind and solar PPAs signed in the first ten months of 2018, according to data provided to Utility Dive by the Renewable Energy Buyers Alliance.
PPAs were initially designed as contracts “between electric utilities and independent power producers (IPPs) for fossil fuel-powered projects,” according to Microsoft legal consultant group Orrick. PPAs were adapted for utility-IPP renewables deals in the early 2000s.
Earlier this decade, as PPAs were expanded for use in corporate-IPP deals, it became clear that their treatment of risk needed to be rethought. A set of legal tools were included in the Orrick-configured Proxy Generation PPA concept designed to account for renewables’ uncertainties and risks, including the VFA.
“The fuel of renewable energy is the weather, the wind blowing and the sun shining,” REsurety’s Taylor said. “That fuel is free, but it is unpredictable and volatile and traditional power markets players are ill-equipped and don’t want to manage that risk because it can’t be traded like natural gas price risk or coal price risk.”
“There is more economic efficiency in the [VFA] approach because the third-party vendor that manages the risk can do it for many corporate buyers.” Eric Gimon, Senior Fellow, Energy Innovations
It is “true but simplified” that a PPA locks in a long-term price for a renewables project, Taylor added. But weather can cause a project’s output to vary by 20% or more year-on-year. That creates volume risk, which is the aggregate uncertainty of generation, and shape risk, which is the uncertainty of generation from one time period to another. Together, they cause prices to vary in difficult-to-predict ways.
The PPA partially reduces risk, Taylor said. A corporate buyer pays the same for each MWh of the PPA, but the amount it buys from the market to fill in the gaps, and the prices it pays, vary. Some conditions make variability advantageous to the buyer, and others increase its power costs.
For example, Texas wind and California solar are less valuable than the simple average value when production falls and prices spike, and more valuable when production rises and prices drop, he said. For renewable energy deals to grow beyond large corporate buyers, dealing with this risk must be simplified. The VFA increases the total cost, but solidifies the price and transfers risk management to a third party.
Advantages of Volume Firming Agreements
“There is more economic efficiency in the [VFA] approach because the third-party vendor that manages the risk can do it for many corporate buyers,” Senior Fellow Eric Gimon of power sector consultant Energy Innovations told Utility Dive. “And it can draw on a wider range of resources across a more diverse geography and the full range of market possibilities.”
The first three applications of the PPA-VFA structure, on three existing wind projects, is the culmination of a long collaboration by Davies and Taylor. Microsoft is the off-taker. REsurety acted as intermediary for the insurers, Allianz Global’s Alternative Risk Transfer and weather and climate risk specialist Nephila Climate.
REsurety’s analysis of renewables’ risk allows it to understand what the corporate buyer is likely to make or lose and advise the insurer on the lowest VFA and premium prices that relieve the buyer of price volatility, Taylor said.
“A vertically integrated utility can and often does hedge its own risk because it has assets it can turn on, like a natural gas peaker, when variable renewable generation is not available.” Ken Davies, Director of Innovation, Microsoft Energy Strategies
The REsurety-calculated adder and premium, plus the PPA price, are what the buyer pays for renewable power, and it is as firm as the purchase price of baseload power, Davies said.
The summed price turns renewable energy into a standard block of tradeable power that could be used for risk management or sold on the retail market.
“A vertically integrated utility can and often does hedge its own risk because it has assets it can turn on, like a natural gas peaker, when variable renewable generation is not available,” Davies said. But, he added, the VFA can be a solution for getting regulatory approval for specially designed green tariffs.
A utility can use a PPA-plus-VFA product from the market with a clear, specific cost to build the green tariff, he said, and can then “charge its corporate customer based on that block of renewables, without using assets procured for all customers. And regulators can be clear other customers are not involved, and the transaction shifts no costs to them.”
Another advantage of purchasing blocks of renewable energy is their liquidity and tradeability, Davies said, which “makes it possible to use them in a green tariff to serve a group of smaller commercial-industrial off-takers instead of a single large off-taker.”
The product has begun winning the most important kind of recognition in the marketplace. It is being considered for deal-making.
Breaking into the market
Tradeable blocks of fossil fuel power have always been used in wholesale markets, according to Davies. “This product allows blocks of green power to fit into power markets in the same way.”
Though it adds legal complexity to initial negotiations, the VFA has become a standard part of renewables deal-making for Microsoft, he said. “It removes a lot of the risk complexity, which simplifies renewable energy. And we think it is better to address the contractual complexity once, up front, than to face price and weather risks for 15 years.”
This is also a better approach for smaller business customers because they do not need to be energy market experts to buy renewables generation, and economies of scale in a transparent marketplace will make their renewables procurements more affordable, Davies said.
“Anything that reduces risk for corporates is a good thing, and this is a real innovation in the marketplace.” Erin Decker, Director of Energy and Sustainability Services, Schneider Electric
As a standalone, a VFA is not overly complicated, but differing regional markets could make it difficult to include it in a high volume of transactions, Sustainable Power Group’s Isern said. “It is unlikely to be a standard part of deal-making, but it can be a useful and commonly-used tool.”
He could be under-estimating the VFA’s appeal.
Schneider Electric just added a 200 MW wind PPA between global cruise ship operator Royal Caribbean and Southern Power to its long list of completed corporate renewables deals and is working on a similar solution for clients, Decker said. “Anything that reduces risk for corporates is a good thing, and this is a real innovation in the marketplace.”
But existing deals, though admirable because they secure renewable energy MWs to match corporate buyers’ total loads, “fail to take advantage of the grid and power markets,” Energy Innovations’ Gimon said. The Microsoft plan “takes renewables procurement to the next level by adding the efficiency of being connected.”
This is, however, just the first step toward “a much more plug-and-play deal structure,” Gimon said. “We need a multilateral entity that can create blocks of green power by obtaining PPAs and smoothing and firming them with VFAs. Right now, the process begins with a corporate buyer’s PPA. A central entity could turn any renewables generation into tradeable blocks of green power.”
Read more: Utility Dive