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Power Purchase Agreements & Efficiency Services Agreements

Power Purchase Agreements

Power Purchasing Agreements (PPA) are primarily used for financing and implementing onsite renewable energy installations. A PPA is a contract between an independent power producer (provider) and private entity (buyer). The provider owns, operates and maintains a renewable energy system sited on buyer property for the life of the contract. The buyer essentially rents out a portion of their property, for example roof space, to the provider and agrees to purchase electricity generated by the system for an agreed upon price (often escalating) and time period. Where legal, a PPA can be established for almost any type of renewable electricity generation technology. Most commonly, PPAs have been used for rooftop solar photovoltaic arrays, although PPAs have also been utilized for windmill installations.

Buyers typically are property owners looking to reduce their energy costs over the long term. By entering into a PPA the buyer has a known price of electricity from a renewable source for the duration of the contract. At the end of the contract, the buyer owns a renewable system, and receives free electricity for the remaining lifetime of the system (excluding maintenance costs). In many cases buyers also are third parties such as utilities which need to supplement their load for reasons such as a requirement to purchase electricity from renewable sources, or private companies which need to meet a renewable portfolio standard (RPS), or other incentives to purchase electricity from renewable sources. Buyers always have the option of establishing a new and independent PPA to sell the electricity to a third party, such as a utility (selling the power back to the grid).

Benefits

  • Costs to the buyer are clearly established at the outset and fixed for the duration of the contract
    • No up-front cost to the buyer to install the renewables, as the PPA provider provides the necessary capital
    • Provider assumes responsibility for equipment operations and maintenance costs
    • Expected volume of electricity produced is stipulated, with various, predetermined, results for generation above and below agreed upon levels
    • Often is some combination of tax credits, rebates and carbon credits available to both parties, which can improve the investment profile of the renewable installation

Challenges

  • Buyer does not obtain the benefits of ownership of the asset (e.g. depreciation, tax)
    • Arrangement results in a long-term lease on the property
    • Contract terms can be long
    • All-in cost likely more expensive than typical bank financing

Efficiency Services Agreements

An Efficiency Services Agreement (ESA) is a pay-for-performance financing solution that allows building owners to implement energy efficiency projects without any upfront capital expenditure. Under this power purchase agreement (PPA)-like structure for energy efficiency, an ESA provider pays for all development and construction costs. After a project is operational, the building owner uses a portion of the cost savings associated with reduced energy consumption to make periodic service payments over the ESA term. ESA payments vary by billing period according to the actual amount of achieved savings.
Like a typical utility bill, ESA service payments are based on a measured quantity of energy units, i.e. kilowatt-hours of electricity and therms of natural gas. However, ESA service payments are based on energy units that are saved, enabling building owners to implement and repay energy efficiency measures with no additional capital or operational costs. The price per unit of energy savings is an output-based charge (e.g. $.08 per kWh of electricity saved) that is set at or below existing utility prices.

For each project, the ESA provider enters into the ESA directly with the building owner and pays a third-party contractor (for example, an ESCO) to engineer, implement and maintain the energy efficiency project. Although most ESA projects to date have been implemented with large ESCOs, the emergence of independent energy savings insurance products have opened the door for ESA providers to work with a broader range of contractors and energy service providers.

Key features of an ESA generally include:

  • ESA provider funds 100% of all design, engineering, and construction costs
  • Projects can include a broad range of energy efficiency technologies and measures
  • ESA provider owns and is responsible for ongoing maintenance services for all equipment, with customer buyout options available
  • ESA provider recommends efficiency improvement projects during the ESA term (i.e., the ESA provider adds in new sources of savings/efficiency measures over time)
  • After the ESA term expires, the customer has the option to purchase the equipment at fair market value

ESAs are designed to be treated as a services agreement and not as a lease, potentially allowing for off-balance sheet accounting treatment for the owner. Properly crafted ESAs are expected to maintain this treatment under future potential changes to lease accounting standards. However, each customer is responsible for making their own accounting review.

The ESA is similar to the shared savings model, in which an ESCO funds the cost of an energy efficiency project and the owner agrees to repay the ESCO using an agreed-upon percentage of measured and verified savings from the project. This model is not widely offered by ESCOs today.

Benefits

  • Owner can implement comprehensive efficiency upgrades with no upfront cost
  • Cost of maintaining equipment (as well as measurement and verification of savings) is borne by ESA provider
  • Owner has a significant degree of flexibility in negotiating the specific terms (e.g. contract length) of their ESA
  • Turnkey approach in which the ESA provider is responsible for the time and resources required to develop a comprehensive project
  • Owner is only responsible for making payments on savings that are realized
  • ESA payments are an operating expense similar in nature to a regular utility bill, although each owner is responsible for conducting their own accounting review
  • Treats energy efficiency as a resource; owners can redirect current utility expenses to cover ESA payments

Challenges

  • Limited number of ESA providers in the market; model still in the proof of concept stage
  • ESA terms generally do not exceed 12 years
  • Projects generally need to be greater than $1mm
  • Efficiency projects do not receive the same attractive tax benefits given to renewable energy projects
  • Limited available sources of debt for ESA projects
  • Lenders require a large ESCO performance guarantee or equivalent energy savings insurance

Source: American College & University President’s Climate Commitment