The ABCs of PPAs
Many of our public sector clients have been approached by wind and solar developers over the years about signing a power purchase agreement (PPA). Developers promise to provide electricity at a fixed or reduced cost with no up-front payment, financing, construction or maintenance burdens. Is it too good to be true, they ask? Maybe not.
PPAs are a strong and viable tool when structured effectively. A PPA can enable municipalities, schools, townships and other political subdivisions to benefit from renewable energy while minimizing up-front expenditures and outsourcing operation and maintenance costs. Additionally, a PPA provides a predictable electricity cost over the term of the contract, often a period of 15-25 years. But political subdivisions need to carefully weigh all of the options, and risks before moving forward. Here is what you need to know:
I. Overview of PPA Financing
Under a PPA financing model, a private energy company (provider) procures, installs, operates and owns the system on local government premises. The political subdivision enters into a long-term contract, the PPA, to purchase the electricity generated by the system from the provider. The expected cash flow from the PPA helps the provider secure financing to build the project. In addition to the revenue generated from electricity sales, the provider can benefit from federal tax incentives, depreciation, or other incentives or programs that may be available to fund such projects. For example, the Federal Investment Tax Credit offers tax-paying entities a 30 percent tax credit of the total cost of their system.
Renewable energy certificates (RECs) are also an important component of an energy project, and they can be lucrative, but are risky. Weighing that risk and deciding who should bear it is critical. Ohio requires that at least 12.5 percent of the electricity provided by electric utilities to their customers come from renewable sources by 2025. 1 Utilities typically comply with this requirement by using RECs, which represent one megawatt-hour of electricity produced from a renewable source. Under most PPAs, the RECs remain with the provider, which then sells the RECs to utilities on the compliance market. The projected value of RECs, as well as other tax or grant incentives, should offset the overall project cost and result in lower cost of power to the political subdivision.
II. Interconnection and Net Metering
Interconnection and net metering are also important for local governments to understand when exploring a PPA. Our clients often have questions about these processes and their roles in each. While providers generally prepare the necessary applications and take care of associated costs, it is the political subdivision — not the provider — that is the utility’s customer. As a result, the political subdivision should understand its role in interconnection and net metering.
Interconnection is the process by which renewable energy systems are connected to the electrical grid. Before a political subdivision can start generating power through a system, which is connected to the grid, the political subdivision and utility must enter into an interconnection agreement that spells out the conditions, equipment and processes for generating power and connecting to the grid. Ohio law establishes uniform requirements for interconnection, including application requirements, expedited procedures, uniform requirements for interconnection agreements and backup electricity supply. In addition to the law, political subdivisions should review any contracts they have with utilities or other electricity providers to be certain that purchasing power from alternative sources is allowed.
Net metering allows utility customers to receive credit on their electricity bill if surplus electricity is sent back to the utility. The law establishes the state’s net metering provisions, including the amount of excess electricity that may be credited and the value of the credit. 2 It is important to know that the law does not apply to all utilities. Rural electric co-ops are not legally required to allow net metering, and political subdivisions served by co-ops should make sure that the provider has checked with the co-op to ascertain if a project is possible. Finally, the rate of the net metering credit offered by the utility should be carefully considered when sizing a system and considering the economic benefits.
III. Top 5 Critical Early Decisions
There are many things a political subdivision should consider when moving forward with a PPA. However, there are a few decisions that can make or break your project. Getting those items resolved as soon as possible will result in a better project and fewer headaches for you.
- Work with a Reputable Provider with a Proven Track Record: Ask for references and follow up on them. It is not unusual for each project to be set up through a separate LLC, which will not independently have any track record. But the LLC’s parent company, the provider, should be able to establish that they are capable, experienced and have the financial capacity to get your project completed. An RFP or formal bidding process may not be legally required, but might be a good idea in some cases.
- Identify Future Energy Needs: A system that is either too small or too large will not be cost effective. There is an art to sizing your project to achieve optimal return on investment and meet your long-term energy needs. A good provider should be able to calculate, and explain to you, what system size is best and how it may be impacted by future technology developments, planned energy efficiency projects or possible infrastructure changes.
- Identify Potential Locations: This is a very long-term proposition and having a good assessment of the current condition of the project location and your future property needs is important. Moving a system is possible, but expensive. If the project is not in an investor-owned utility territory, additional up-front work with your rural electric co-op may be needed.
- Nail Down the Financing Structure: Understanding how the provider intends to finance the project is very important. If the provider is depending on the political subdivision to provide security for the deal or use its authority to obtain a tax-exempt loan or bond, that needs to be discussed and decided as soon as possible. Providers also need to understand the unique legal limitations related to annual appropriation requirements and long-term property leases by political subdivisions. More importantly, the provider’s lender needs to understand and agree with these legal requirements.
- Nail Down the Major Expenses and Responsibilities: Political subdivisions should have a clear understanding of which party is responsible for filing permits, zoning applications, interconnection and net metering applications, and applying for rebates or state incentives. Responsibility for the cost and maintenance of the project property, including security features such as fencing, should also be decided. Check with your insurance carrier to determine if there is any added cost involved with insuring the system. Most of all, make sure you understand exactly what the provider will pay for, and what the Provider expects you to cover.
Financing a system through a PPA carries a number of advantages: 1) no/low up-front cost; 2) ability for tax-exempt entity to enjoy lower electricity prices thanks to savings passed on from federal tax incentives; 3) a predictable cost of electricity over 15-25 years; 4) no need to deal with complex system design and permitting process; and 5) no operating and maintenance responsibilities.
However, implementing a PPA inevitably requires the engagement of multiple skillsets and roles: decision maker, energy manager, facilities manager, contracting officer, attorney, budget official, real estate manager, and environmental and safety experts. Although a single individual may hold several of these roles, it is important that all roles and skillsets are engaged early in the process.
- Ohio Revised Code § 4928.64.
- Note, the provisions for both interconnection and met-metering are under the final stage of a review. New rules will be released sometime in 2014.