Review the Financial Risks - American Cities Climate Challenge

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Off-Site Physical PPA

Review the Financial Risks

For a comprehensive overview of financial and technical risks associated with PPAs, see A Local Government’s Guide to Off-Site Renewable PPA Risk Mitigation.

Physical power purchase agreements (PPAs) allow cities to stabilize their energy costs by fixing their electricity rate for 10–25 years. As a result, a PPA, by definition, reduces a city’s financial uncertainty (i.e., risk). That being said, cities that sign a PPA face a different type of uncertainty, namely whether signing a PPA will ultimately increase or decrease their energy expenses as compared to what they would have paid otherwise. This is known as “price risk.”

To illustrate this uncertainty, imagine that a city is choosing between signing a fixed-price PPA or purchasing electricity from the wholesale market. As illustrated in Example 1 below, if wholesale electricity market prices (shown in $/MWh) were to rise above the PPA price, signing the PPA would have resulted in significant savings for the city. However, if wholesale market prices were to remain below the PPA price, the city would have been financially better off simply buying electricity from the market. We will explore strategies to evaluate this risk in the “Develop a Business-as-Usual Forecast” section.

If this financial risk is a concern for your city, you may want to consider diversifying your city’s purchasing by entering into several small PPAs over time rather than one large PPA. Alternatively, if you want to reduce potential buyer’s remorse, you could sign a PPA with a shorter duration (e.g., 10 years instead of 15–20) so that if market prices fall, you won’t have to pay the higher price for as long. However, this strategy is not generally recommended as it not only limits your city’s potential upside, but also usually results in higher PPA prices (for further discussion on this, visit Understand the Developer’s Needs).