The new market for green

February 2019 – For a long time, companies wanted one thing only: reliable power that was as cheap as possible. In the age of climate change and sustainability, however, the origin of energy is now playing an ever more important role for industrial firms and their customers alike. In Scandinavia, in particular, there is a boom in so-called power purchase agreements, whereby individual consumers sign supply contracts with green energy producers, and these look likely to take off in Germany too over the next few years. Hamburg Commercial Bank is among the pioneers in this still fledgling market.

Fancy a Becks? Or would you prefer a Franziskaner, or perhaps a Budweiser? Consumers selecting a brand from the brewing corporation Anheuser-Busch InBev are spoilt for choice. The American company has been producing beer and more for thirsty drinkers around the globe for 165 years. The Anheuser-Busch managers thought that a product as natural as beer would sell even better if it was produced as environmentally friendly as possible – and in 2017, they signed a contract with the energy provider Iderdrola. The Spaniards now supply the brewing corporation based in Mexico with 220 megawatts of power from a new wind farm.

Cutting the carbon footprint

Anheuser-Busch is more than your typical individual example. Major US companies, in particular, and most significantly tech corporations like Google, Amazon, Microsoft and Facebook, with their enormous, power-guzzling data centers, are increasingly asking for green energy in order to document their carbon footprints. Whether it’s out of pure conviction or for marketing purposes, with sustainability simply a good marketing tool among B2B customers and end consumers, European companies and their customers are also asking themselves ever more frequently where the power for their production and products actually comes from.

What’s new in all this is that instead of buying the green power “anonymously” through the market – as has been possible thus far –, a growing number of companies are making use of “Power Purchase Agreements”, or PPAs. This term covers various forms of supply and purchase agreements – from direct contracts to forwarding contracts to virtual power purchase agreements – between an energy provider and an energy consumer. According to calculations by the Hamburg Commercial Bank, in 2017 PPAs amounting to a record volume of around 1.4 gigawatts were signed for new generation capacities. Wind farm projects are predominant here. By way of comparison: In 2013 the figure was just 0.2 gigawatts. The world’s biggest PPA deal thus far was signed in Sweden: The enormous wind turbines of the onshore “Markbygden ETT” wind farm with a rated power of 650 megawatts supply green electricity for aluminum producer Norsk Hydro for a period of 19 years.

How a power purchase agreement (PPA) works (simplified version)

How a power purchase agreement (PPA) works (simplified version)

Source: Hamburg Commercial Bank

Sweden leads the way in PPAs

The Scandinavian nations and Sweden, in particular, are pioneers in the area of PPAs. At the end of December 2017, PPA volumes in Sweden amounted to 1,442 megawatts, while in Norway the figure was 702 megawatts. The UK is also turning up the turbines with PPA volumes of 884 megawatts at the end of 2017, while the Netherlands – smaller in terms of area but with plenty of wind – still reached a volume of 648 megawatts on the cutoff date. By way of comparison: According to calculations by the Hamburg Commercial Bank, PPA volumes in Germany amounted to a meager ten megawatts at the end of 2017. In 2018, at least 56 MW were added in Germany.

PPAs remain largely unfamiliar to the Germans. This has a lot to do with the national subsidies policy, and the Renewable Energy Sources Act (EEG) introduced in 2000. Yet this may well change. The spring of 2020 will see the 20th anniversary of the EEG, and the proportion of green energy sources in the country’s total energy consumption has now reached a good 40 percent. The lion’s share of this is thanks to wind power. What that also means though, is that there are ever fewer arguments for maintaining the high subsidies. Green power has de facto become competitive. Already in the past few years, the subsidies for newly created plants have been drastically reduced in order to control these additions better, but also to integrate renewables ever more effectively into the energy markets.

Green energy

Energy produced by wind farms in Germany in billions of kilowatt hours, 2013 to 2017

Country ranking by percentage of households with fibre-optic network service

Source: Bundesverband WindEnergie e.V.

Imminent end to subsidies for the original wind turbines

In around a year, even the generous subsidies for the original wind farms in Germany are to end. According to a study by the German Wind Energy Association from the year 2021, around 6,000 plants with a total output of around 4,000 megawatts will cease to receive EEG subsidies. A further 2,400 megawatts will become ineligible for subsidies by 2025. What is the future for these plants and their operating companies if they are to be profitable without any help from the state? In technological terms, many of the wind farms are still in good shape. In many solar parks too, the technical lifespan of the systems exceeds the subsidy term of 20 years.

Connecting the Earth to the moon

Civil engineers and craftsmen have already laid around 375,000 kilometres of fibre-optic networks for Deutsche Glasfaser.

It’s precisely here that the power purchase agreements come into play, as the bilateral contract gives the recipient the certainty of consistently receiving green power of certified origin. At the same time, environmentally minded industrial companies or IT providers with high energy requirements can secure energy prices at current levels for the long term. In the long term, prices on the wholesale market for electricity are likely to rise - one reason for this is likely to be the more expensive emission allowances in Europe. Thanks to a PPA, the green energy producers also have long-term planning certainty. “PPAs will undoubtedly become established in Germany”, says a confident Lars Quandel, who heads the Energy & Infrastructure division at Hamburg Commercial Bank.

From what Quandel says though, PPAs are not yet worthwhile for many new plants in Germany. For this to change, yields from tendering need to reduce from their current level of six to seven cents per kilowatt hour to the wholesale level of three to four cents per kilowatt hour. However, Quandel believes it will be no more than ten years before there is a major breakthrough of power purchase agreements among new plants: “The way has been paved. PPAs are an area that everyone is now exploring and indeed must explore.”

The crucial factor for success for the breakthrough of PPAs in Europe is the answer to the question: “Can a renewable energy project be profitable even without state support?” “Alongside achieving further efficiency gains in plant technology and in the operation of a wind or solar park, the development of energy prices is particularly crucial here”, says Quandel.

“The way has been paved. PPAs are an area that everyone is now exploring and indeed must explore.”

Lars Quandel, Head of Energy & Infrastructure Hamburg Commercial Bank

While operators of German solar and wind parks are only edging towards the entirely free market economy gradually, many other countries are way out in front here. In Scandinavia, the Netherlands, the UK, and increasingly also in southern European countries such as Portugal, the result is evident: a significantly higher number of PPAs. Particularly if, unlike in Germany, no state subsidy programs exist, a PPA is a useful tool for limiting the market price risks of a renewable energy project”, says Michael Kohn, Head of Project Finance at BayWa r.e renewable energy GmbH, based in Munich. “Our business relationship with Hamburg Commercial Bank goes back many years. We value the competence in international project financing but also, most significantly, the expertise of our financing partners in the area of renewable energies”, stresses Ralf Ketteler, Head of International Project Finance at Bremer Windparkspezialisten wpd europe GmbH.

On the up

Investments in new wind farms in Germany and development of output in megawatts since 2008

Investments in new wind farms in Germany and development of output in megawatts since 2008

Source: Bundesverband WindEnergie e.V.

As simple as PPA agreements may seem at first glance – a green energy producer signs a contract with a direct recipient –, they are, in fact, quite complicated in practice. Alongside the most common case, the “physical PPA”, whereby the energy is supplied directly from the producer to the recipient and the contract term generally corresponds to the project duration, there is also the option of “synthetic PPAs” in two versions. Here, the power is either supplied to the network, withdrawn at another point and processed via an intermediary, or alternatively, there is no supply of energy between the contracting parties. Rather, the green power is marketed or purchased on the wholesale market similarly to a derivative. It is all terribly complex and convoluted, especially since in both synthetic forms the contract term rarely corresponds to the period of financing.

This means a great deal of expertise is required on the part of the financing partners, who have to successfully balance out the stability of the cash flow, the debt ratio and the credit term of a PPA. In addition to the volume and price risk, direct PPA deals also entail the performance risk of the energy producer and the credit risk of the individual buyer. Assessing all this correctly and putting a price on it requires specialist knowledge. The experts at Hamburg Commercial Bank have already been dealing with the sometimes peculiar rules of play in this business and the correspondingly specific financing requirements for many years. “In power purchase agreements, we not only act as project financer, but also utilize our established market contacts to help operators of a wind farm or solar park with finding investors and, most importantly, direct buyers for their green energy”, explains Lars Quandel. This approach is well received by clients in Scandinavia or southern Europe – and soon in Germany too.

PPAs come in many forms

At 100 Mbit per second, the fibre-optic networks are far from their potential maximum performance. One of their chief benefits is scalability: there is virtually no technical limitation on their potential speed and number of connections. It is possible to increase capacity at any time. “This feature is one of the most important factors for the success of a long-term infrastructure for the country’s digitalisation. And it’s also what makes the asset class so interesting for institutional investors such as banks, insurance companies, and pension funds”, says HSH Nordbank expert Leiwesmeier. Jens Müller from Deutsche Glasfaser is certain: “The potential for fibre-optic networks is very high. There will definitely not be a lack of demand for the expansion”.