This blog is the second of a two-part series. To read part one, The New Gold Standard, VPPAs, Risk Management, and Energy Strategy, click here.

Intermittent energy sources, like wind and solar, trade via Virtual Power Purchase Agreements (VPPAs). And until recently, companies who procured the approximately 140 GW+ of active renewable energy agreements were at the mercy of the hourly as-generated price settlements of their renewable agreements. How is that for a risk management strategy?

As we wrote in our blog last month, a VPPA can be a natural long-term hedge on power prices over the typical 10-15 year tenor of the agreement; however, it is highly volatile and creates short-term (monthly or annual) budget risk: some months, a company will receive a check for millions of dollars while other months may be a bill. These swings are notoriously difficult to forecast.

In other words, all market participants “ride the wave” of the market, which gives little optionality to corporations looking to mitigate risk.

But sophisticated energy managers have long taken advantage of the Settlement Swap Agreement (SSA), allowing corporate VPPA owners to hedge risk during the lifespan of the contract. Last month at the CEBA Summit in Seattle, Resurety led a group of 35 energy executives through a workshop focused on how to set up, execute, and manage SSAs as part of a corporate’s overall energy strategy. Here’s what we discussed.

The power of the SSA

In our blog last month, we talked about a corporate clean energy buyer, Alpha, Inc., and a trader, ABC Trading Co. In the example, Alpha, Inc. wanted to lock in budget certainty for the next three years while ABC Trading Co. wanted to gain a position in the ERCOT market. We’ve continued to use the example below.

Most corporate clean energy buyers choose to enter into an SSA because they desire one of three things:

1. Lock in a net gain - Alpha, Inc. signed at a time when VPPA prices were low, giving them an advantage to secure a net gain.
2. Budget certainty - Even if Alpha, Inc. signed a VPPA at $45/MWh, it may be worth locking in a $40/MWh SSA to provide budget certainty.  Many companies think of it as the implied cost of the REC, i.e. $5/MWh.  
3. Stop the bleeding - If Alpha, Inc. believed the value of power for their VPPA was going to continue to decline, they may decide to execute a hedge at any cost to avoid further decline in the market. 

Once price is generally agreed upon, SSA transactions can close in weeks rather than months or years, avoiding the completion delays (COD risk) of new build VPPAs.

Price transparency is key

In order to execute a transaction efficiently like the one described above between Alpha, Inc. and ABC Trading Co., Alpha Inc. needs transparency around price as well as certainty of contract terms.

Alpha, Inc. needs a marketplace to provide this price transparency. This means accessing multiple buyers without a lengthy RFP procurement process, simplifying apples to apples price comparisons, and ensuring compliance for transacting on financial (swap) agreements. It is the exact reason why Resurety built CleanTrade - the only federally compliant marketplace to buy, sell, and trade clean energy for VPPAs, PPAs, and project-specific RECs.

Finalizing the contract

Alpha, Inc. uses the underlying VPPA agreement that it signed with the developer as a starting point to create the SSA contract. The contract would typically include key terms from the underlying VPPA to ensure additional risk isn’t taken on by the SSA transaction.

After all, the point of the SSA transaction is to reduce risk. To do this effectively, it’s important to keep in mind the following elements when entering into SSA negotiations:

• SSA price - If there is a large difference in expectations between both counterparties, then a deal is unlikely to move forward. 
• VPPA sharing rights - Since the VPPA agreement dictates the underlying terms of the SSA, a hedge provider will request to see the VPPA terms and ensure they understand the risks they are taking on from the agreement.  Thus, Alpha, Inc. needs the ability to share the document. These agreements can be redacted for sensitive information like the VPPA price, credit terms, etc. Furthermore, a developer will typically allow you to share the agreement since it is in their best interest to ensure their counterparty (in this case, Alpha, Inc.) continues to pay their bills.
• Caps or limits in the underlying VPPA - Hedge providers will want to ensure there is sufficient ability to recuperate funds. Caps or limits on areas such as liability, damages, or termination increase risk for the hedge provider and can cause them to back out or reduce their SSA price to account for the risk. 
• Credit requirements - Hedge providers will seek assurance that both the SSA seller – in this case, Alpha, Inc. – and the underlying developer are in good credit standing.  
• Data rights - Hedge providers typically need real-time data access starting on Day One of the SSA agreement. These are rights most corporate clean energy buyers do not typically enforce as data on the invoice is sufficient for auditing. However, hedge providers will actively trade against their overall positions in real-time and thus need the real-time data feeds from the project. Data rights can be the item that delays agreements from being executed, as this negotiation typically requires engagement with the developer.  
• Availability damages - When a project underperforms (not an event of default), there may be damages paid out for availability – and those damages are typically a negotiation point in SSA agreements. A key consideration will be how to determine the appropriate split of damages incurred between Alpha, Inc. (seller) and ABC Trading Co. (buyer).  
• Termination damages - In the event of a project developer default, the hedge provider will want to ensure Alpha, Inc. has sufficient rights to recuperate the termination damages outlined in the underlying VPPA agreement.