There’s been growing interest in solar PPAs over the past few years, and they are now much more mainstream. However, you may still have some questions about PPAs and solar finance. What are PPAs, and how can they benefit your business? We’ve put together a definitive guide to help.
What is a solar PPA?
The term “PPA” is swung around quite a lot in the solar industry. PPA stands for “Power Purchase Agreement”, and it signifies a type of contract between an electricity generator (or Independent Power Producer – IPP) and an electricity consumer (or offtaker) – such as a commercial operation. A solar PPA is therefore a contract between a solar generator and an offtaker, stating that the generator will provide solar power and the offtaker will buy the solar power from them.
As a form of electricity, Solar PV is an easily-deployable, very safe option without any moving parts that produces electricity during light hours of the day, and therefore it often makes sense to embed the solar PV system directly into the factory, retail centre, warehouse, etc. where it will be consumed. As such, many commercial and industrial solar PPAs include the construction of an embedded generation solar facility on the site where the power will be used. In this instance, a solar PPA is a way for the customer to procure clean electricity and save on their electricity bills without deploying any CapEx, and only paying for the electricity that the system generates.
However, PPAs can also be entered into for clients where there is either too little space or too much energy demand to generate solar electricity directly on the site. In these situations, solar wheeling agreements can be entered into, which allow the purchase of solar power from a remote solar facility, such as a large solar farm, to be “wheeled” through the electricity grid and to the customer. Wheeling typically suits energy-intensive operations such as mines, smelters, data centres, and other large commercial operations.
Typically, the larger the size of the PV system, the lower the tariff. This is why solar PPAs are best suited to energy-intensive operations, where there is little chance of exporting excess energy. The most suitable size of the PV system depends on the client and type of operation, and is typically determined during a detailed feasibility process between the generator and offtaker.
What are the benefits of a solar PPA?
There are several benefits of entering into a solar PPA, but they can be summarised into four main points:
- Cost saving
The major reason for entering into a solar PPA is the significant cost saving that customers tend to encounter. While grid tariffs have been increasing, the cost of solar PV components has reduced dramatically over the past 10 years, meaning that the cost per kWh of solar electricity tends to be much cheaper than power from the grid and other forms of onsite generation (diesel genset etc.). In addition, the solar PPA tariff includes all expenses relating to the solar system: upfront installation costs, part replacement, comprehensive asset insurance and ongoing operations and maintenance, meaning that the client will not have any hidden or unexpected costs over the life of the PPA.
- Carbon emissions reduction
Solar PV systems generate energy by converting the sun’s rays directly into electricity, forming a low-carbon, renewable energy source. A solar PPA is an easily accessible way for businesses to decrease their carbon footprint and meet their sustainability targets.
- No outlay of CapEx or ongoing maintenance costs
If a customer wishes to procure their embedded solar PV facility outright, they will need to pay a supplier for the engineering, procurement and construction (EPC) of the project, which will have a large capital outlay. This is not always the best option for a business whose core operations are completely different to electricity generation, as the ongoing maintenance and performance of the plant will be their responsibility to manage. Whilst most EPC companies provide additional Operations and Maintenance services, it will be the responsibility of the client to ensure that those contracts are fully up to date and to log any issues with the service provider.
- Future electricity cost perspective
Typically PPAs will have fixed tariff increases baked into the contract, ensuring that the future costs of electricity will be predictable and manageable. Historically, Eskom tariffs have risen an average of over 11% annually over the last 20 years, with a 15% increase announced in 2021. A solar PPA will have an escalation that is fixed and typically well below Eskom’s average and can be set in consultation with the client.
How long is a solar PPA?
The main component of solar PV systems are the solar panels, with a market standard performance warranty of minimum 25 years. As such, typical PPAs range from 10 – 25 years. Although the length of the PPA is adaptable, the longer the PPA is, the lower the starting tariff will be.
If your business is looking to procure sustainable power quickly, then the time of procurement should also be taken into consideration. For a simple solar PPA to take effect, there is typically a 5 – 6 month procurement time before the site establishment and construction, which incorporates the negotiation and signing of the commercial PPA as well as the design and licensing of the solar PV system. Here’s an example of the typical timeline of a solar PPA negotiation period:
Off-site PPAs that include a wheeling agreement may take longer to initiate because a solar generating site needs to be identified and permitted in addition to the normal PPA process.
What’s the difference between a solar PPA and a solar lease?
Over the years, the terms “solar PPA”, “solar finance”, and “solar lease” have come to be used interchangeably, so what is the actual difference between these terms? The answer has to do with the history of energy legislation in South Africa and the allocation of risk.
Before November 2017, it was not possible in South Africa for Independent Power Producers to sell energy directly to consumers without a generation licence. As such, solar leases were utilised as a way for a private energy consumer to make use of a solar PV system by leasing the system instead of paying per unit of electricity the system generates. Then, in November 2017, an amendment to Schedule 2 of the Electricity Regulation Act allowed for private energy sale without the need for generation licence of projects less than a 1MW in size, which opened up the opportunity for Power Purchase Agreements to take effect.
So the main difference between a solar lease and a solar PPA is contractual, and dependent on where the performance risk of the asset lies. In a solar lease, the performance risk lies with the customer or user of the solar PV system as they pay a fixed monthly fee for the system not linked to the output it generates. Whereas in a solar PPA the entire risk of the asset lies with the solar PV operator as only energy generated is paid for on a take-or-pay basis, making it a purely cost-saving mechanism for businesses.
Are there risks associated with a solar PPA?
As with any large commercial decision, the risks need to be understood up front. The main risks in entering into a PPA agreement include:
- The length of the contract
Whilst most business contracts are typically renewed on an annual basis, a PPA term is typically 10 years and longer to ensure the most cost effective solar tariff. As such, senior management will want to ensure that the cost and carbon savings associated with procuring clean electricity are worth the risk of entering into such a contract. This can be mitigated through various exit options including an option to purchase the system, which can be a condition of PPAs that allows the client to buy the solar PV system after a set amount of time for a periodic price that is agreed upfront, should the operational requirements of the business change.
- Changing operational requirements
The risk of changes to the business’ operational requirements is a standard business risk that should be considered for every new venture and/or product that is introduced, as it will have an impact on the overall efficacy of the plant or operation. If, for example, a product is no longer required and its manufacturing operation suddenly starts to use less electricity, this could impact on the cost-saving aspects of the PPA. Most PPAs are arranged on a “take-or-pay” basis, meaning that the client is responsible for paying for all the electricity that the system generates, including instances where the customer cannot take the energy not at the fault of the generator. In addition to careful business management, this risk is also mitigated through careful feasibility and design phases, which look in detail at the electricity requirements of the building or facility before suggesting the total size of the solar PV system to the client. Similarly, a PPA has a fixed tariff increase each year, meaning that electricity costs will be very predictable into the future, allowing for better business planning.
Is a solar PPA right for my company?
Understanding if a solar PPA is the right option for your company is a decision that comes down to business management decisions around cost saving and sustainability. On cost saving, does your business have energy-intensive operation(s) around South Africa, and is a large amount of your company’s operational budget spent on electricity procurement? If so, a solar PPA is a great way to reduce electricity costs quickly, with low risk to the business, improving the profitability of your operations. Similarly, a PPA also ensures that future electricity costs are predictable, hedging against unpredictable Eskom increases.
From a sustainability perspective, does your business have sustainability targets that require a reduction in carbon emissions or a requirement to procure renewable energy? If so, a solar PPA is a great capex-free way to reduce reliance on grid-supplied electricity, which in South Africa is highly carbon-intensive. For example, the CO2eq for South Africa’s grid is just under 1 kg per kWh, whilst solar is less than 0.01kg per kWh. From a procurement perspective, solar PV is considered 100% renewable, so the more solar PV that fuels your operation, the closer you will be to your renewable energy procurement target.