Large-scale renewable energy transactions can help your company join the ranks of sustainability leaders and responsibly decarbonize your operations. But there are also inherent financial and development risks involved in these transactions, and minimizing them is critical.
It may seem obvious, but it’s still worth stating: selecting the right energy project for your desired strategy is the best way to reduce your risk. Doing so involves understanding the risks themselves, the amount of mitigation you want, and knowing how risk is allocated in any contract you might enter. Thoughtfully designing a strategy which considers all these elements will help your organization embark on a lower-risk shift to green power.
Understanding Financial Risk
Buying renewable energy at commercial scale involves sizeable long-term contracts, most commonly in the form of Power Purchase Agreements, or PPAs, which can deliver great bottom-line benefits if carefully selected and managed. Because the risk of financial loss exists in large-scale PPAs, this includes managing downside risk. However, it is also important to be mindful of potential lost economic upside. Knowing the right moves at each stage of the deal-making process can improve your odds of a favorable outcome.
First, be sure you understand your organization’s financial priorities. For example, does the finance team care more about finding long-term cost savings, limiting exposure, or reducing short-term volatility? Rule out any projects that do not align.
Next, with any deals under consideration, perform a scenario analysis with special attention to the downside scenarios. Could your organization weather the deal in a perfect storm?
Explore Project Development Risk
Many large-scale renewable energy procurements involve the construction of new wind, solar, hydro, or other clean power generation facilities. “Development risk” refers to the possibility of the project not reaching commercial operations because it fails to get permits, interconnection agreements, financing, equipment, and/or other necessary inputs. These risks always exist for a renewable energy project, but they diminish as a project reaches more advanced stages and approaches commercial operations.
If a buyer signs a renewable energy contract but the project never reaches operations, the buyer may contractually receive financial damages but will not receive monthly settlements or renewable energy credits (RECs) as desired. As a result, to reach its sustainability goals, the buyer would have to start the process all over again and potentially contract for a new, less attractive project.
Although the project developer is best suited to mitigate or avoid these risks, large energy buyers should steer clear of overly risky projects. To do so, buyers must be keenly aware of the forms project development risks can take. In the United States, this includes understanding time- and location-specific risks across grid operators that administer and monitor electricity generation and transmission for various regions.
Here are the types of risks we track on the PPA deals we support, and the questions we ask to assess the risk level.
| Category & Description | Questions to Ask |
| Site Control: Developer fails to acquire site needed for the project and the grid tie-in. |
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| Interconnection: Project does not receive approval or must pay higher costs to connect to the grid. |
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| Project Studies: Key studies indicate fatal flaws of the site. |
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| Permitting: Developer fails to acquire necessary permits for the site. |
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| Community Support: Project fails to obtain community support needed for key permits and incentives. |
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| Financing: Project fails to obtain upfront financing for construction. |
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| Project Equipment Procurement: Developer fails to procure equipment on time to meet the commercial operation date and receive tax credits. |
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| Engineering, Procurement, and Construction: Issues prevent third party construction of the project. |
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When Negotiations Begin
Assuming you are exploring a PPA, remember the basic mechanics: The buyer (you) pays the project developer a fixed price for electricity generated by the project. This means when the floating market price is more than the fixed price, the project saves you money. Inversely, when the floating market price is less than the fixed price, the project costs you money.
Transfer some risk to the developer
One way to manage market price fluctuations is to negotiate with project developers that they take some of the market risk in exchange for a share of the upside.
This is an attractive approach for many, as the first-order goal is typically not to profit off a PPA, but rather to meet sustainability goals in a cost-neutral or better manner. This can be done in any grid region, with any technology.
You can negotiate certain structures into your power purchase agreement (PPA) to hedge against the risk of losses when the market price floats downwards. The most common variants are:
- Price floors: In today’s market, price floors are common, especially at $0 to protect buyers against negative floating market prices, which may be more prevalent in certain markets and times of day.
- Upside shares: Upside shares allow a buyer to pay a lower fixed price in exchange for sharing some percentage of the upside when market prices are high with the supplier.
Transfer some risk to a third party
There are a number of different third parties who can potentially absorb some of the floating price risk in renewable power agreements. That list includes insurance providers, retailers, and hedging providers. How appropriate a match these parties may be for your organization and situation comes down to the risk-return tradeoff. Additionally, it is important to know that these providers require payment to absorb the risk, so being well-informed is critical.
Warehouse the risk
This can be accomplished in two ways. The first option is to replace your retail power contract with a long-term retail-delivered contract tied to a specific new-build renewable energy asset, also known as “structured retail.” Some Coho clients have helped pioneer the use of this innovative structure; for example, Wells Fargo signed an agreement in 2020 with Shell Energy for 150,000 MWhs of renewable energy annually. Structured retail can reduce your organization’s exposure to energy prices by fixing (or largely fixing) power prices for 7-12 years.
Your organization can create this dynamic synthetically as well, by lining up its brown power purchases to act as a natural offset to your large-scale renewable energy transaction. Doing this requires two conditions: your organization’s load must be located in a state which offers retail choice (allowing you to customize your brown power procurement strategy), and a renewable energy project that settles at a market point highly correlated to the one where your brown power purchases originate. Remember, however, your electricity usage profile will look different than a renewable energy asset’s production profile, meaning some price risk may still be present.
In many regulated markets there is also the option of next-generation green tariffs, where bill credits based on the avoided cost of generation act as a natural hedge against your variable power price for current consumption.
Don’t concede upside potential
With PPAs and other “fixed for floating” commercial structures, most finance teams prudently focus on the downside risks. However, organizations should also be thinking about lost upside risks as well.
Your financial savings from a PPA may result from a concentrated number of intervals when floating market prices increase significantly. Make sure that you are receiving the economic benefits during these intervals, to help protect against other intervals where the floating market price may fall beneath your fixed price.
In PPAs, most buyers opt for “hub-settled” settlements (an average of multiple price points on the grid) as opposed to “node-settled” settlements (the potentially more volatile local price point on the grid where the project physically injects electricity). This effectively means that the floating market price the supplier receives (the node price) may differ from the floating market price the supplier pays you as the buyer (the hub price).
At times when the cash inflow received by the supplier (the node price plus the PPA price you, the buyer, pay) is less than the cash outflow paid to you as the buyer (the hub price), the supplier is incentivized against generating electricity. These situations happen often when the hub price is high and therefore attractive to the buyer. As much as possible, you should prevent this from affecting your economics.
Buyers can and should explicitly address how to handle these kinds of situations in renewable energy contracts. An experienced advisor should be well informed to help you negotiate an achievable outcome that reduces your risk. Additionally, addressing things such as the timing of scheduled non-emergency maintenance and negotiating a strong availability guaranty clause can be helpful in protecting against lost upside risks.
Because suppliers offer different price risk mitigants for each project, it’s important to know what’s available as soon as possible. Explore those options early with your finance team to decide what works best for your organization. Keep the team involved as you receive pricing for different structures and decide together if the extra risk protection is worth what you give up in return.
Some Basic Reminders
- Be sure any project you consider is in alignment with your organization’s financial priorities
- Perform a scenario analysis for any project under consideration, with special attention to the downside scenarios
- Become more familiar and conversant in project development risks.
- Create a framework for evaluating and prioritizing development risks (if you’re not sure where to start, Coho can help).
- During a buyer’s competitive process, ask questions on each RE project, using both written questions and interviews.
- Request project documentation for review, including results of studies, proof of agreements, etc.
- Understand the construction financing plans and progress of any project you’re considering
- Negotiate structures into your contracts to mitigate the risk of losses
- Get second opinions on project selection decisions as needed.
All preparation aside, you may find the renewable energy markets difficult to navigate alone. Remember, with important, high-stakes negotiations, it’s never a wrong move to bring in an advisor or team of advisors to lend their experience and insights. Coho’ s team of experts is available to help you find the best path to renewable energy procurement and decarbonization.
Coho, an ERM group company, is registered with the U.S. Commodity Futures Trading Commission as a commodity trading adviser and is a member of the National Futures Association (NFA ID: 0542152). Information in this article is provided for general informational purposes only and should not be considered legal or commodity trading advice or as forming the basis of any advisory relationship with Coho. Trading in commodity interests and financially settled energy contracts, such as virtual power purchase agreements, can be complex and involves risk of loss that can be substantial. At a minimum, you should consult with your own legal and accounting advisors in considering whether to enter into any such contract.
