Products for corporate offtakers

Products for corporate offtakers

October 09, 2020 | By Christine Brozynski in New York

Companies that are parties to virtual power purchase agreements may find themselves taking on more risk than they had originally anticipated.

The extra risk can be mitigated by two products designed by REsurety, working with Allianz and Nephila Climate: a volume firming agreement and a settlement guarantee agreement.


Companies often sign virtual power purchase agreements — called VPPAs — to meet internal clean energy goals.

Buying undifferentiated electricity from the grid does not work, and many companies find it difficult to purchase energy directly from renewable energy projects.

A VPPA is a way around that. It is called a “virtual” power purchase agreement because there is no physical delivery of electricity. It is a financial instrument that acts as a hedge for both the corporate offtaker and the renewable energy project on the other side of the trade. It may also provide another revenue stream to a project developer because corporates often buy the renewable energy credits to which the project is entitled.

VPPAs are typically structured as contracts for differences. A contract for differences is a type of financial hedge whereby the offtaker pays a fixed price and the project company pays a floating price that is linked to either the price at the node (the place where the project interconnects with the grid) or the hub price. The contract settles on the actual amount of electricity produced by the project.

As an example, let’s assume the fixed price is $20 a megawatt hour and that the VPPA settles at the node. (The node is a location on the electricity grid.) In hour one, the project produces 10 MWh of power that are sold at the node for $20 a MWh. In hour two, the project produces 15 MWh of power that are sold at the node for $25 a MWh. In hour three, the project produces 30 MWh of power that are sold at the node for $10 a MWh.

In this example, neither party owes the other party anything in hour one, as the nodal price matches the fixed price. In hour two, the project company owes the corporate $75 because the nodal price is higher than the fixed price, and that upside is passed along to the corporate (($25 x 15 MWh) - ($20 x 15 MWh) = 75). In hour three, the corporate owes the project company $150 because the nodal price is lower than the fixed price, and the corporate provides downside protection (($15 x 30 MWh) - ($20 x 30 MWh) = -150).

Typically, corporates enter into VPPAs in an effort to buy virtual electricity for a specific spot. For example, if a corporate has a data center in Texas, that corporate might enter into a VPPA settling at the hub closest to the data center. (The hub price is a liquid trading price determined by the regional transmission organization that manages the electricity grid based on nodal prices in the area.) In an ideal world, the VPPA would settle on an amount of power that approximates the data center’s usage.

The problem is that VPPAs settle on the amount of power produced by the project, not the amount of power used by the corporate.

Wind and sunlight are variable resources. On a windy day, the volume of power on which the VPPA settles may be far greater than the power used by the corporate offtaker; the converse may be true on a relatively windless day.

Because of this variability, the corporate offtaker is taking on shape risk (the risk that the times at which the project produces power do not align with the times at which the corporate uses power) as well as volume risk (the risk that overall production at the project over a period of time is either greater or less than overall electricity usage by the corporate).

Two products – a volume firming agreement and settlement guarantee agreement – are designed to mitigate some of that risk.

Volume Firming Agreement

Volume firming agreements are designed to “shape” the amount of power on which the VPPA settles in order to better align the transaction with the corporate’s electricity usage.

A volume firming agreement is a separate transaction entered into between the corporate and an insurance company or weather-risk investor that can be entered into concurrently with or at any time after execution of the VPPA. The project company is not involved with and, is typically not required to be made aware of the existence of, a volume firming agreement.

To understand how a volume firming agreement works, return to the example of a corporate that has entered into a VPPA to offset electricity usage at a data center near the project. A volume firming agreement lets the corporate craft a fixed shape that more closely resembles its power usage at the data center.

A fixed shape in this context is a chart with the months listed in the first column and the hourly quantity for each month in the second column. For example, if in January the corporate anticipates that its data center will consume an average of 10 megawatts of power per hour, then the number next to January will be 10.

The volume firming agreement operates like a slightly more complicated version of a contract for differences with respect to each hour, with the corporate owing one floating amount per hour and the counterparty owing a different floating amount per hour. The two floating amounts are netted for all hours across a calendar quarter, and the result is the settlement amount that one party pays to the other.

The corporate floating amount is structured to reflect the settlement under the VPPA. If the corporate owed money to the project company for a given hour under the VPPA, then the corporate floating amount under the volume firming agreement is the same dollar amount. If the corporate is owed money by the project company for a given hour under the VPPA, then under the volume firming agreement, the corporate floating amount is negative of that dollar amount.

There is one important nuance to the corporate floating amount, however. It does not track the VPPA settlement perfectly; rather, it reflects what the VPPA settlement would have been if the wind turbines or solar panels at the project had operated at a pre-determined fixed rate of efficiency. This revised electricity output is referred to as the proxy generation. It is a means of safeguarding the volume firming agreement counterparty from operating risk, which encompasses everything from mechanical issues with the turbines or panels to improper operation of the power plant by the project company.

The counterparty floating amount for each hour is calculated as the market price minus a “fixed volume price” per megawatt hour, the remainder of which is multiplied by the quantity for that hour in the fixed-shape schedule. The fixed volume price is negotiated between the corporate and the counterparty.

The settlement entails netting the corporate floating amount with the counterparty floating amount. Because the corporate is paying a floating amount based on the VPPA settlement and receiving a floating amount based on the fixed shape, the volume firming agreement has the effect of shaping the power for the corporate.

The end result for the corporate is that the combined volume of power on which it settles under the VPPA and volume firming agreement is roughly the amount of power used by the data center, office building or other electricity-consuming structure for which the VPPA was initially designed.

Settlement Guarantee Agreement

Unlike a volume firming agreement, which is designed for corporates that want to shape their power, a settlement guarantee agreement is designed for corporates that want to lock in a fixed cost with respect to a VPPA. For example, if a corporate enters into a 12-year VPPA designed to offset electricity usage at a data center that unexpectedly shuts down in year five, the corporate may wish to reduce its risk for the remaining life of the VPPA by exchanging gains and losses under the VPPA for a fixed price.

The settlement guarantee agreement is structured like a contract for differences with a corporate floating amount and a counterparty floating amount. The corporate floating amount is the same as in a volume firming agreement. In other words, it the same floating amount that the corporate receives or pays under a VPPA, adjusted for proxy generation.

The counterparty floating amount is different: it is simply a fixed lump sum per quarter. The lump sum is negotiated when the settlement guarantee agreement is signed.

If the corporate floating amount (designed roughly to reflect the amount paid or owed by the corporate under the VPPA) exceeds the lump sum, then the corporate pays the excess to the counterparty. If the corporate floating amount is less than the lump sum, then the counterparty pays the difference to the corporate.

In this way, the corporate is able to pass through a significant amount of risk it faces under the VPPA to the counterparty under the settlement guarantee agreement.

A corporate would not enter into both a volume firming agreement and a settlement guarantee agreement with respect to the same VPPA.

Entering into a second product would be expensive for the corporate and would not offer any incremental benefit to the corporate, as the risk would already be mitigated with the first product. If a corporate that is party to a volume firming agreement wishes several years later to enter into a settlement guarantee agreement, that corporate would probably terminate the volume firming agreement first.