While everyone likes a great deal, in some cases the "clearing price" in a competitive renewable energy solicitation can be too good to be true. Understanding the process developers go through when determining their offer prices during these competitive RFPs can help buyers address the associated risks through smart project selection and contracting terms.
One of the most significant risks of entering into a power purchase agreement (PPA) is its price and the uncertainty surrounding whether the developer can ultimately deliver the project at that price.
While a well-structured PPA can reduce your company's exposure to the risks of purchasing clean energy, fluctuations in construction costs from the time a PPA is signed to when the project goes to construction can significantly affect the likelihood of project delivery, as well as the eventual counterparty on the other side of the deal.
Learn how to spot overly-aggressive PPA offer prices, the factors your company should consider when evaluating pricing, and the steps you can take to ensure you've selected an offer you're comfortable with.
Pricing to Win
There are far more projects than buyers in the renewable energy market, which requires developers to price very aggressively to land that elusive PPA.
In addition, renewable procurement RFPs typically seek commercial operation dates (CODs) several years into the future - to plan ahead for corporate sustainability goals and to accommodate the long lead-time required to develop energy projects.
The combination of intense competition and long-dated CODs essentially requires developers to bid projects at prices much lower than would be required to build them today - if they don't, someone else will and they'll be left out of the game. Their gamble is to sign a PPA (and post financial security) for a project that is currently "out of the money," and to hope that they will be able to deliver at their offer price in the future - or sell the project to someone who can.
More specifically, developers are making a combination of four bets when they offer a price that doesn't currently "pencil" - rolling the dice that one or more of these will pan out by the time they must close financing and go to construction:
- That absolute project costs will decline.
- That technological improvements will boost energy production at current costs giving the developer more energy to sell at the same construction cost.
- That financing costs will decrease or, more likely, that with a PPA in hand the developer will be able to find another party with a cheaper cost of capital to whom they can flip the project.
- That existing regulatory incentives like tax credits won't go away and that new burdensome regulations won't be passed.
For example, the cost of solar modules may continue to decline into the future, making it easier for a developer to construct a project at the initial offer price.
Wind turbines may continue to grow taller and more efficient, allowing a developer to achieve the same project size with fewer turbines and therefore lower delivery costs.
Construction and assembly techniques may continue to become more streamlined, allowing a project to be built faster and cheaper. But all of these are bets that the developer is making when it offers a price that simply can't be financed today.
Doubling Down on Falling Energy Prices
This is by no means an indictment of how developers determine their offer prices - it's simply the reality of an extremely competitive marketplace in a world where input cost declines have been shattering records year after year. Developers have been making these same bets for the last decade of renewable energy development and in almost all cases they've hit the jackpot.
Looking back, actual price declines and technological improvements have far exceeded even the most optimistic projections.
For example, the cost of solar modules fell by 73 percent from 2010 to 2017, while wind turbine costs declined by 62 percent from 2008 to 2015, adjusting for increased capacity factors. Project labor and construction costs have also declined by roughly 80% over a similar period.
But future market conditions are always unpredictable and there is a constant tension between assuming that Moore's Law for renewables will continue and the possibility that the majority of cost efficiencies has already been harvested.
After all, there is (or "there must be") a point at which the cost of steel, silicon and the hundreds of thousands of labor hours required to construct a plant can no longer continue to approach $0. Every winning streak ultimately comes to an end - it's just a question of when.
Hedging the Developer's Bet
Of course, the primary reason you, a buyer, conducts a competitive solicitation is to find and select the cheapest project possible (taking key project quality metrics into account).
But the cheaper the price, the more likely the size of the developer's bet on the other side of the transaction.
Furthermore, developers' PPA offers are not typically very transparent in their cost assumptions and C&I buyers are not typically in the day-to-day business of understanding future renewable energy cost and technology curves.
You may not know everything behind a developer's price, but you can take several simple steps to mitigate the risks that go with gravitating towards the lowest price:
- Seller security. Including a pre-construction financial security due at PPA signing creates an incentive for developers to price within reason, and gives a buyer a financial backstop if delivery fails to materialize. For instance, a 100 megawatt (MW) solar PPA might include a security in the 5 to 10 million dollar range that the buyer would receive if the project falls through or is significantly delayed. This forces a developer to put her money where her mouth is when offering a smoking price. But while a 10 million dollar breakup fee may take some of the sting off, it won't reset the clock, and you may have lost one to two years towards meeting your sustainability targets.
- Project status. Choose projects in advanced development to minimize the risk of future, costly surprises. In some cases this may require a tradeoff with the price - very early stage projects are often priced the lowest, essentially because they're not far enough along to have uncovered all the expensive issues, so have the "luxury" of assuming optimistic, inexpensive outcomes.
- COD. Be cautious about being enticed towards late-stage COD projects due to apparent price drops in later years. There's a good chance these drops represent nothing more than an extra year of finger-crossing that a cost or technology bet will come through. Signing a "good" deal sooner may very well make more sense than holding out for what looks like an "amazing" deal down the road.
- Reputation. Look closely at each developer's history of delivering projects to construction on time, to requesting price adjustments, and to long-term ownership vs "flipping." There are many good reasons for energy assets to change hands, so this need not be a deal-breaker. But go into the RFP process with a clear understanding that the party signing the PPA may not end up being your long-term partner.
- Transparency. The more information you can collect regarding project status, input cost assumptions, existing vendor and supply contracts, and outstanding delivery risks, the better positioned your company will be to take a view on the specific bets being made and the likelihood of their coming to fruition.
- Diversification. Consider a multi-project portfolio approach to spread exposure across multiple projects and developers. Ultimately, this is the most effective avenue to reduce the risk of failed project delivery due to a mispriced offer.
- Let your corporate goals and culture be your guide. Weigh the tradeoffs above with your company's specific goals and culture in mind. A PPA is often a 10 to 15 year relationship - how important is it that the ultimate project owner is the same party with whom you inked a PPA? If you have very firm sustainability targets, it may be worth steering away from the absolute cheapest offer in favor of one with a more certain outcome. In the context of your sustainability objectives, does pocketing a seller security compensate for missing a target?
Despite the PPA complexities that make pricing a project very difficult, it's still possible to make a smart investment in renewables by understanding what goes into an offer price and the evaluation tools that will help your organization find the right match.What to do next?
- Beyond the pricing risks of a PPA, learn how to manage the project execution risks within a PPA like if the project will get completed on time, financial issues and more.
- Partner with LevelTen's wholesale market experts to find accurately priced renewable energy projects matched to your needs, contact us.
- Credentialed renewable energy buyers and developers can request access to the LevelTen Marketplace to review available projects.