The popularity of PPAs in the electricity market has grown for several reasons. The rapid increase in renewable energy construction has led producers to wanting to pre-sell the majority of a specific wind or solar farm’s production before making the final investment decision. On the other hand, the electricity market is currently more volatile than ever, and thus large industrial buyers want more stability in energy costs also in the long term.
In addition, the Nordic countries are currently facing an unprecedented amount of new electricity demand from a variety of potential industrial projects. The financing of these projects often requires PPAs or letters of intent to prove the viability of the project. An example of such projects are the various hydrogen economy projects in which EU regulations require PPAs for renewable generation forms to produce green hydrogen.
Wind and solar energy as PPA ingredients and enablers of growth
When comparing different technologies, onshore wind power still has the lowest electricity production costs (€/MWh) when taking into account all investment and operating costs of a wind farm up to decommissioning. This is followed by solar power. However, the difference in the price of the actual PPA between these forms of generation may be smaller than the difference in production costs because the production profile also has an impact on the pricing of the actual contract. In other words, a solar power producer can expect a better return on non-hedged energy sold to the spot market, since the massive construction of wind power has lowered the price of electricity during windy periods.
In the Nordic countries, wind and solar power generation complement each other quite well, as windy periods are more concentrated to autumn and winter, while the sun shines mainly in spring and summer. Weather dependency is a challenge for the energy system. Another challenge worth mentioning is related to the uncertainty in completion schedules, as the permitting and grid connection processes can significantly delay the completion of wind and solar farms.
However, there is still huge potential for new wind and solar power in the Nordics as a whole. Fortum is currently investing significantly in the development of these projects with a demand-driven strategy. At the time of this writing, Fortum has about 3 gigawatts (GW) of wind and solar projects in the permit process in the Nordic countries.
Identifying risks as an added spice to PPAs
Large power producers are often able to tailor from their diverse production portfolio precisely the kind of PPAs that buyers want based on their electricity consumption. The basic elements that most influence the content and price of the contract are the price range of the purchase, the year of commencement, duration, origin, consumption profile, balancing responsibility, and the possible inclusion of physical electricity in the delivery. PPAs also generally deal with termination clauses, penal damages and other details.
A PPA is also responsible for identifying, assessing and sharing the various risks between the contractual parties. In recent public discourse, there have been various disputes over the realisation of production profile risk (e.g. Markbygden Ett). On the other hand, inflation, which has been high in recent years, is also a significant risk in long-term contracts, and it can be taken into account between the contractual parties, for example by indexing the contract price. The unprecedented volatility of hourly electricity prices has also increased the risk of balance errors. The cost of imbalance, which was relatively low before the energy crisis, has now in practice at least doubled, which also has a significant impact on its pricing in contracts.
At the same time, the high volatility of hourly rates has increased the risk of negative prices. In principle, it would be good for the electricity system as a whole if electricity were not produced during periods of negative prices, as this makes it even more difficult to introduce new weather-dependent generation to the market. However, in PPAs, avoiding production during negative prices often means a higher contract price in pay-as-produced contracts.
Credit risk is also a factor that must be taken into account from the point of view of both contractual parties. Separate guarantee arrangements may increase the actual contract price. Therefore, solvent operators are often able to cover their own obligations, for example with guarantees from the parent company, without additional costs.
Flexibility from the bridge agreement and opportunities from the reserve market while the PPA is cooking
Schedule risks must also always be taken into account in renewable energy PPAs. If the PPA is not due to start until a long time after the contract has been signed, it may also be a good option to discuss a kind of bridge agreement. In this case, the producer would first supply energy from its existing generation portfolio, and the contract would automatically switch to new forms of generation when, for example, the wind or solar farm under the contract becomes operational.
In addition to the risks, a PPA often takes a position on the various opportunities and on how the benefits gained from them are distributed. For example, when optimising generation in various reserve markets for the benefit of society and to balance the grid, unexpected opportunities for economic benefits can arise through cooperation. Therefore, such revenue distribution can also be agreed separately. A PPA can also cover the use of battery systems, for example to minimise balance errors or to operate on the reserve market. At the time of this writing, Fortum is currently exploring different solutions combining wind, solar and battery technologies to provide a more balanced generation profile from renewable energy sources.
The soup is not yet fully cooked - What will the market look like in 2030?
In the context of PPAs, it is interesting to look to the future. Few of us can predict the future, but the growing demand for electricity is already clearly visible in various scenarios. According to the latest projections by the grid operator Fingrid, electricity consumption in Finland as a whole would rise to around 130 terawatt hours (TWh) in 2030, an increase of around 60% compared to 2024. If this happens, the pace of electrification will be ferocious and will pose unprecedented challenges for the entire energy system.
The challenge is compounded by the fact that new nuclear power is unlikely to be operational in the Nordic countries before the late 2030s. It is also highly unlikely that the ongoing pumped storage projects will be operational before the late 2020s. Consequently, wind and solar power are in essence the only possible sources of energy to meet the massive new industrial demand in its early stages.
A big change in the way demand and production are matched is on the horizon, and that will also require a lot more flexibility in the electricity system. Storage of electricity in batteries and demand response have been presented as solutions. As a result, many new industrial demand projects are already designing their own production processes to be flexible and heavily reliant on hourly electricity prices. Heating is also rapidly electrifying, which will also help to smooth out price fluctuations. With the investment decisions already taken in Finland alone, the number of electric boilers will increase to a total capacity of more than 2 gigawatts in the coming years.
A very complex soup is simmering on the stove, and, in fact, this is the time of year many people are hoping to receive a cookbook for Christmas. In the near future, there are many unanswered questions about the matching of electricity supply and demand and the electricity market in general. In any case, PPAs between producers and buyers will continue to play a key role in delivering clean and affordable electricity. So, let’s get cooking with these recipes!
