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28 April 2022
Climate change and energy are very much in the news at the present time. Positive excitement before Christmas with the UK hosting the prestigious COP 26 conference has deteriorated into political headaches over the spiralling costs of energy and its impact on UK consumers.
But local authorities are large energy users too and will not escape the rampant energy inflation currently gripping the country. This will make their quest for a Net Zero Carbon position even more difficult as they try to make budgets balance. It may also mean that taking the source of their energy supply into their own hands is as much a financial imperative as a social and environmental one.
The majority of local authorities are, however, missing a trick when it comes to the procurement of renewable energy. In the corporate space there is a growing trend of corporate power purchase agreements. A corporate Power Purchase Agreement is a long-term contract under which a business agrees to purchase electricity directly from an energy generator. This differs from the traditional approach of simply buying electricity from licensed electricity suppliers.
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The private sector has been traditionally sensitive to the costs of running a business. Energy is an increasing part of those costs. Energy price inflation is difficult to estimate, but the trend is that energy prices are on a steep upwards trajectory.
So the private sector has developed the Power Purchase Agreement (PPA) model to seek to arrest energy price inflation. Around the world, a huge 23.7 GW of clean electricity was sourced by PPAs in 2020. The track record for this approach is therefore strong.
The majority of local authorities across the country are committed to combatting climate change and dealing with the climate emergency. The Climate Change Act 2008 sets Government level targets to reach a position of Net Zero Carbon by 2050. The Committee on Climate Change is the independent adviser to the Government under the Act. It recognises that much more renewable energy needs to be developed to meet the UK’s needs into the future – in fact four times more.
New projects depend on the viability of the business cases that underpin them. If investment is to be found, then it has to be based on a robust financial model which will deliver profits over the term of any development agreement. PPAs are also a useful way that more renewable energy projects can be encouraged to
come forward.
On the local authority side, moving to PPAs should be a natural progression. Most local authorities across the UK have now declared a climate emergency and are putting in place targets to reach the Net Zero. These targets are based on a calculation of the current carbon footprint with resultant Climate Emergency Action Plans, which set down the target sought, the route map to get there and the actual steps that a Council will take to do so. The Guardian recently claimed that one in five local authorities still had no such action plans and progress is too slow (see Sharpe Edge).
A PPA is really just a technical name for a contract to buy electricity. It is a contract between an energy generator and an energy buyer or user. It is usually a long term agreement for the sale and purchase of renewable energy whereby the generator agrees to supply and the user agrees to purchase the power on a long term basis.
This arrangement has benefits for both generator and purchaser. On the generation side, it is important for the developer of any project to be sure that it can sell the output generated, so that a financial return can be achieved. The PPA gives certainty for the generator that the power will be purchased on a long term basis.
For the user of the power the key is that the link between the electricity supplied and energy price inflation has been broken. This is because a price based on the cost of generation is negotiated (with an agreed index applied such as RPI or CPI), which will always in effect offer a discount on retail prices. The crucial factor here is that this removes exposure to energy price fluctuations, exactly like those currently being caused by the tail end of the COVID-19 pandemic and the reduction of supply of gas from Russia.
Assuming a private wire arrangement is not used (where the local authority takes control of the means of distribution and transmission of electricity), there are two different types of PPA, namely physical and synthetic. The former is the one focussed on here, which involves an end user (here the local authority) purchasing energy directly from a renewable energy generator (for example a solar or wind farm). As the amount of electricity used by the local authority and the amount generated by the generator will never match perfectly, a licensed electricity supplier has to be included in the mix. The licensed supplier will then provide top up power, over and above what the generator can generate and also sell on any excess power which is generated but not required by the Council. This balancing exercise comes at a cost but is essential to make the deal work smoothly.
No further detail is given here regarding synthetic PPAs, which are really just a financial instrument (a derivative) and under which no electricity is actually supplied. Here the instrument guarantees the price on the wholesale market for the generator (the strike price) and if the generator receives less than this price the Council would have to pay the difference, but if the generator receives more, the Council receives the excess amount as income.
The main benefit of the synthetic PPA is that as a financial instrument it does not need to be procured.
A typical PPA arrangement may look like this:
The reason that so many private sector companies have entered into physical PPAs is that the rationale for them is very strong. Key to the deals is the fact, as mentioned above, that the link to energy price inflation is broken. Price certainty over, say 20 years, will be really attractive to any energy manager in today’s market. PPAs of up to 50 years are now on offer from the latest and largest new renewable energy developments.
There are numerous other benefits to mention, including the fact that more local projects are likely to come forward in the knowledge that a corporate offtaker is available. There will be jobs and growth, greater energy security, local environmental benefits and reduced costs for the Council. Local projects themselves inject helpful income into the local economy (a recent APSE report found that £3.50 of benefit is attributed to every £1 paid locally).
Of considerable importance to local authorities, though, is the fact that such generation under the right circumstances can be netted off its carbon footprint, thereby giving it valuable progress towards the Net Zero Carbon targets. This is so, both for the Council itself (assuming it is the purchaser of the power) and the authority’s area (if new and additional generation is developed in that area).
Challenges and Barriers
A number of challenges exist for any authority deciding to move down the PPA route. The first (and arguably the most intimidating of all) is the issue of jargon. The energy space is one of the worst possible for the inclusion of jargon and technical talk that will sound no better than gobbledygook to the average officer and Member. However, if properly and clearly explained, these concepts are no more complicated that other areas of the Council’s business.
Perhaps the main problem is a lack of awareness. This might be in relation to the energy market generally, in other words how it all works; or it might be more specifically about how energy is procured by each local authority. Needless to say, Members and the Senior Management Team need to be brought on side to have any chance of moving forwards on such a deal.
The other potential barrier is inexperience of approaching a third party supplier to engage on the project. As indicated above, the deal has to have three parties involved, in order to achieve balancing and top up services. Local authorities normally procure their electricity supplier arrangements through a procurement agency such as YPO or LASER. It would be necessary to check those contractual arrangements to see if the normal energy supplier is willing and able to take on this role.
Three examples are provided of PPA activity, two on physical PPA arrangements and one on synthetic PPA arrangements, for the sake of completeness.
In November 2020, the City of London signed a PPA with Voltalia under which the Council would buy all of the electricity generated by a huge 49.9 MW solar farm to be built in Dorset. The deal was for 15 years.
This is a standard PPA arrangement. As is often the case, the developer will not build the renewable energy asset until the income from the power is secured by a PPA. By signing up to the deal, the Council has effectively facilitated the development of the solar farm.
The output of the solar farm at just under 50 MW is substantial and would power around 15,000 homes. For the Council it will provide over half of the electricity needs for its buildings including its historic Guildhall, three Wholesale Markets and the Barbican Arts Centre.
This was the first local authority PPA signed in the UK.
Bristol City Council is one of the leading authorities in the country for climate change and energy. It is seeking to take the PPA option to another level and multiply the benefits as a result.
The Bristol scheme is based on the physical PPA concept. However, it is seeking to create a dynamic system where there is not just one generator and the Council as user. Instead, it wants to develop a ‘sleeving pool’, whereby new generators can be added as time goes on and different types of generation can also be added to the system (for example solar PV and wind energy).
In each case the individual PPA will be entered between the pool and the generator, based on precedent documentation. A licensed suppler will be the pool manager, probably under its wider City Leap plans. The licensed supplier will reconcile the total generation from the pool with the Council’s energy requirements and undertake any required balancing.
As well as the standard benefits mentioned above, Bristol City Council is seeking to actively promote more renewable energy projects in its area. By knowing that the Council will purchase the power, it is much easier for projects to raise the finance necessary to make them a reality. Another key point on this proposal is that it can easily aggregate the output from a large number of small suppliers in a way that is unlikely to interest the private sector. Community schemes can also be a part of this arrangement.
This proposal is in its infancy but if it works, the benefits to local energy generation in the region will be substantial.
Devon County Council has been looking at developing a synthetic PPA, as described above. It seems to have been attracted by the fact that such a move would not affect its current energy procurement (through LASER) and would not involve the need for any procurement exercise. If successful, it is interesting to note that it will achieve the same result as Bristol City Council in promoting more local renewable energy projects, although in a completely different way.
The working of a synthetic PPA is explained above and involves the Council guaranteeing the price a generator will achieve on the wholesale electricity market. This ‘strike price’ mirrors the way the Government’s Contracts for Difference mechanism works. In that context this is to ensure the Government does not pay too much as a financial incentive; in this context it is to give the generator sufficient certainty of return to allow the project to go ahead.
The result of any synthetic PPA will very much depend on its individual terms. Obviously, the strike price will need careful consideration. The Council’s calculations reveal that it is confident that energy prices will rise and it is prepared to take the risk of a down turn. If prices do keep rising, then the Council would never be required to pay out and would return a surplus in millions of pounds. If there was a sudden collapse in energy prices, then the reverse would be true. As is always the case, financial instruments involve risk, although a downturn in energy prices is seen as unlikely.
The Council has not yet resolved to go forward with the synthetic PPA but has undertaken significant work on this and seems likely to do so.
If this facility is on offer to local developers, there seems no doubt that more projects will come forwards, again with the multiple benefits in the County’s area.
So what does a local authority need to do to move to this next level?
It will come as no surprise to know that a strategic approach is vital. Any local authority will have ongoing climate change and energy plans and this needs to dovetail with them.
A standard consultancy approach would involve asking what does the Council want to achieve? What are the outcomes sought? How will this fit within its overall plans and strategies?
Many Councils will be attracted to the cost benefits and certainty over many years, together with the potential of promoting good quality new renewable energy schemes in their areas. Such a scheme could be woven into its economic development work and significant engagement with the private sector could be achieved by canvassing views on how such a scheme might be received locally and inviting applications.
If the wider economic development angles are a step too far at this stage, then simply identifying a new renewable energy project coming forward (which would be apparent via the Town & County Planning system) and offering to enter into a PPA would be progress. This would provide all the financial and offsetting benefits outlined above.
To take advantage of this a review of current energy procurement practice in the authority would be necessary and sufficient awareness and support from senior officers and Members. It will usually be found that Energy Managers are well versed in PPA theory and practice.
For a first time foray into PPAs careful management will be required. Where a deal is on offer, due diligence will be vital on the project, the developer and its likelihood of reaching completion (assuming the asset has not yet been built). Each party has to be very clear on what is on offer and what they are signing up to. Documentation will need to be tailored to the specifics agreed. When done properly, the risks associated with PPAs are low.
Perhaps 2022 will be the year in which this practice becomes commonplace in local government?
