How to calculate the fair value of a pay-as-produced PPA price?

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The waterfall chart in Figure 1 highlights the primary pillars that will impact the fair value of a PPA price. Please note that the values shown are only illustrative but exemplify the process. 

Firstly, the country-specific future baseload prices are used to compute a reference baseload price. Adjustments are then made by subtracting capture rate, volume risk, price risk, and cannibalization premiums from this reference In the final step, the projected future value of Guarantees of Origin (GoOs) over the contract duration is added, revealing the final fair value of the PPA price.

It is important to note that the methodology described here does not include soft drivers that impact the price, which depends on more in-depth PPA negotiation such as balancing cost, negative prices settlements, offtaker bankability, etc.

Baseload Futures

Futures contracts play a key role in hedging against market volatility. For PPA stakeholders, futures reflect the market's valorisation of electricity predictability. Our methodology utilises futures contracts for baseload calculations due to the following factors:

• Price Locking: Similar to PPAs, futures contracts allow buyers to lock in a fixed price for future energy supply, protecting against market fluctuations.
• Daily Settlement: Since it is traded on a daily basis, the market is compelled to update prices accordingly, ensuring that they closely reflect real-time market dynamics and trends.
• Market Expectations: Prices in the futures market incorporate broader supply-demand trends and fuel price dynamics. By factoring these expectations into PPA pricing, contract terms can better reflect anticipated market conditions, reducing exposure to future price volatility.

Capture rate discount

Capture prices represent the market price that producers can expect to earn for their electricity. This is a crucial input when calculating PPA prices, as it directly impacts a project's estimated revenue. These prices are based on several factors:

• Revenue Benchmark: High capture prices indicate favourable market conditions, allowing developers to anticipate better returns. On the other hand, low capture prices may indicate market cannibalisation for a specific technology, leading to lower PPA prices.
• Contract Structuring: The anticipated capture price serves as a foundation for the PPA, informing the negotiations between fixed and variable components of pricing. Stakeholders refer to this baseline to structure contracts that align market risk with level cash flow.

To tailor the PPA to each specific project, we use its specific production profile and the day-ahead prices to reflect how the average price earned by a power plant compares to the baseload price of electricity in the day-ahead market.

You can learn more about capture prices and calculate them for your asset by reading this article.

Volume risk discount

Volume risk is the uncertainty of predictability in forecasting how much energy will be generated or consumed within the PPA term. This unpredictability affects the price within the agreement on a wide range of levels:

• Revenue Uncertainty:  When actual energy production deviates from the projected volume, the expected revenue stream is significantly affected. PPAs typically account for this uncertainty through volume risk adjustments.
• Operation and Maintenance: Effective operation and maintenance can reduce volatility, but some uncertainty remains in generation, which impacts the production.
• Risk Allocation: PPAs can be structured to distribute volume risk between developers and off-takers, providing flexibility in managing discrepancies between forecasted and actual performance.

By using the asset’s location and its corresponding historical weather data, we can quantify the expected volatility of the power plant and reflect these risks in the price.

Price risk discount

Price risk discount accounts for the uncertainty in future electricity prices. This discount impacts PPA pricing and is influenced by several factors:

• Market Volatility: Fluctuations in wholesale electricity prices can significantly affect the financial performance of a PPA, leading to a higher price risk discount if prices are more volatile.
• Risk Allocation: The offtaker faces potential losses if prices fall, and the price risk discount compensates for this market uncertainty.
• Contract Structuring: The discount influences PPA negotiations, helping align pricing with market risk allocation from unfavourable price changes.

Cannibalisation risk discount

Cannibalisation risk discount reflects the risk that by adding more capacity of a specific technology to the electricity market it might further drive down the capture rates. To assess this risk, we use renowned databases describing expected future renewable installed capacity installations to quantify how much we expect the capture rate to depreciate over the PPA duration.

Guarantees of Origin

Guarantees of Origin (GoOs) are renewable energy certificates that certify that electricity was generated from renewable sources.This adds significant value to a PPA especially as sustainability targets become more stringent. The increasing demand for GoOs makes securing them through a PPA highly attractive for consumers.

• Added Value and Credibility:  GoOs enhance the perceived value of renewable energy by providing verifiable proof of its origin. This strengthens a developer’s ability to secure better pricing, particularly in markets where environmental credentials are a priority.
• Market Differentiation: In the competitive energy market, a certified renewable source may command a premium.  Buyers committed to sustainability are often willing to pay more for PPAs backed by GoOs.
• Regulatory and Investor Confidence: With increasing regulatory emphasis on environmental standards, GoOs help guarantee that projects are compliant with required guidelines. This not only builds investor confidence but also leads to long-term contract sustainability by keeping pace with evolving regulatory demands.

Similar to the futures market for electricity, the futures market for GoOs provides valuable insights into the pricing trends of these certificates. At Synertics, we analyze these trends to assess their impact on the final PPA price. To understand the fundamentals of Guarantees of Origin and other Renewable Energy Certificates, read this article, and for a deeper dive into their growing role in the European market, explore this article.

Conclusion

PPA pricing is shaped by a dynamic interplay of factors, including market-driven capture prices, hedging through futures contracts, the added value of Guarantees of Origin, volume and price risk uncertainties, and other soft driver factors. In the case of a pay-as-produced structure, the offtaker is bearing all risks and needs to account for them when computing a PPA price.

As the renewable energy market continues to evolve, understanding these price drivers is essential for securing long-term success in the PPA space. Depending on the desired PPA structure, quantifying each driver is essential to evaluate the fair price of a PPA.

If you're looking for expert guidance in navigating PPA pricing and structuring the right agreement for your needs, talk to our team at Synertics, we’re here to help you make informed, strategic decisions.