Renewable energy and virtual PPAs

Chris Christopher (00:06): Hi, I am Chris Christopher, a Partner in Torys’ Infrastructure and Energy Practice. Today with my colleagues Taylor Campbell, an Associate in our Regulatory Group, and Scott Kraag, the Head of our Private Financing Group, we're going to talk about private power purchase agreements or private PPAs and their rising importance in helping companies meet their emission reduction commitments. In 2022, we've definitely seen an uptick in working alongside clients who, like many companies around the world, are exploring strategies to achieve net zero, or otherwise meet their ESG and reduced carbon commitments. Rural Canada carbon emitters are considering how to reduce their carbon footprint and obtain environmental attributes such as emission offsets, carbon credits or recs to offset their carbon footprint. This has driven interest in private PPAs throughout Canada, and particularly in Alberta, where oil patch participants looking to offset their carbon footprint are driving demand for emission offsets, which in turn is driving interest in private PPAs with renewable energy developers. Now what are private PPAs? They’re agreements for purchase of electricity between a generator or the seller, and a private party purchaser. They can be further categorized into what's known as a physical PPA or a virtual PPA. In a physical PPA, the buyer panes actual electricity from a contracted facility, which the buyer can use to power its own operations. The buyer will pay the seller an agreed upon price per megawatt of electricity supplied. Physical PPA is maybe the right choice where the buyer's operations are in the same or near the location. In contrast, the virtual PPA is a financial agreement where the buyer does not acquire the electricity itself. Instead, the seller sells the electricity on the wholesale market, such as the Alberta Power Pool at the market price. Virtual PPAs function as a contract for differences in market price, where strike price is per megawatt, and where the market price is below the strike price, the buyer pays the seller the difference between the market price and the strike price. Where the market price is above the strike price, the seller pays the difference to the buyer. Since the buyer does not physically receive the electricity, it will still have to procure electricity from its local grid to power its operations. Virtual PPAs offer flexibility in that these opportunities are open to buyers with operations in other jurisdictions, and virtual PPAs are financial transactions. A buyer can enter into agreements with renewable electricity projects in different jurisdictions from their operations and obtain environmental attributes that may be used to offset its own emissions. Now, Taylor will speak to environmental attributes in the context of Alberta's deregulated electricity market, and Scott will address the PPA financing considerations. Right now, I'll turn it over to Taylor.

Taylor Campbell (03:12): Thanks, Chris. I'm going to talk about the environmental attributes for just a minute here. As Chris mentioned, this is something that you can purchase as part of your PPA. And when you're talking about renewable PPAs, the environmental attributes are typically a significant portion of what you're looking to purchase. How exactly these get used depends on what jurisdiction you're in. So in some jurisdictions, environmental attributes can be used or converted into a form that's used for compliance with local regulatory regimes. In other jurisdictions, you might have a voluntary market where environmental attributes can be used to generate credits that can help buyers meet their net zero or other ESG commitments. In terms of the Alberta market, there's some really great opportunities for private PPAs. The Alberta market is deregulated, which allows for open competition to generate power, which can then be sold to multiple different buyers. This allows buyers to enter into agreements with renewable electricity generators in Alberta to secure the environmental attributes. And in the case of a physical PPA, the renewable energy, the renewable energy to power their operations as well. This is contrasted with other jurisdictions where you have one single provincial buyer of power that may not have opportunities for private PPAs, the same way that Alberta does. Now to hear a little bit more about some of the financing concerns and issues that come up with private PPAs, I'll pass it off to Scott.

Scott Kraag (04:52): Thanks very much, Taylor, and thanks, Chris. When it comes to the PPA market, lenders are concerned about price certainty. And as Taylor mentioned, the deregulated market in Alberta doesn't allow for power price certainty. And in fact, it is a variable price that no one can predict with the type of certainty that banks require. And for that reason, banks categorize projects that feed into the Alberta Power Pool as what we call “merchant power projects”. Merchant power projects are generally seen as unfinanceable without some type of enhancement, whether that enhancement come from a corporate guarantee, from the parent, possibly a increased equity commitment so that the leverage isn't as high as the banks would maybe give for a utility scale PPA. They'll look to other alternatives. These PPAs give the lenders certainty around that power purchase price so they can run their debt service coverage ratios according to a minimum power price. Most of the PPAs that we've seen in this market are effectively contracts for differences. The counterparty to the PPA is willing to compensate for the loss of power price below a certain threshold that the lenders or equity require. And for that reason you'll find that banks are willing to do merchant deals when enhanced by a corporate PPA or, you know, a private PPA that involves either virtual rec type of attributes or, as Chris mentioned, for those that can be co-located with a data centre or an electricity user, perhaps in the Alberta oil and gas market that we can see a direct ability to finance those projects. One of the other things that the banks are going to look at with these PPAs is, what happens if the PPA is terminated? Is there a pass-through of a forward-looking IRR type of repayment or forward payment by way of a termination payment? We're not seeing the market have those in every case. In some cases, we're seeing PPAs supported by strong parent guarantees that guarantee the full performance of a contract without a termination payment. But that is something that the lending market will be looking for. Thanks, Chris. Thanks, Taylor.

Chris Christopher (08:07): That's great. Now what's next? I think we expect to see activity in this area to continue to grow as companies and government need to set ambitious reduction targets alongside the rising price of carbon. Companies will increasingly look for opportunities to reduce and offset their own emissions, including through virtual PPAs. As this trend continues, companies will want to ensure that these PPAs are structured and negotiated to ensure that they support the buyer dollar and the lender’s commercial objectives, regulatory requirements and corporate ESG commitments. Thanks for watching. For more on our infrastructure, energy and ESG work, head to www.torys.com.