Power Purchase Agreements: How they work and when to use them

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Power purchase agreements (PPAs) are an integral part of the commercial solar market, which consists of projects with schools, municipalities, private companies, non-profits, etc. PPAs make up 80% of sales in the annual $5B commercial solar market. However, many installers struggle with the mechanics of a PPA: when to sell it, how to price it, and what to expect after the sale is made. As such, PPAs often end up with a more complicated sales process than their cash purchase counterparts.

In this two-part series (check out part 2 here), New Resource Solutions (NRS) will explain what PPAs are, when to use them, and what to expect during the financing process. For the purposes of this series, NRS will assume that any system discussed is of sufficient size and creditworthiness to warrant a third-party project investor. In the future, NRS will provide more guidance on what determines sufficient size and creditworthiness. NRS endeavors to give its partners the tools to make selling PPAs simpler, as well as to prepare installers for the post sale work that project investors typically require before an acquisition is complete.

How PPAs Work

The primary difference between a cash purchase and a solar PPA is that an unaffiliated project investor owns and operates the system, and sells the power generated from it to the customer for a fixed and known price over 20+ years.

The customer typically receives a 5-20% savings on their cost of power in year 1, with a projected increase in savings over time due to rising utility costs. Under a solar PPA, the project investor receives all the tax benefits associated with the system, particularly the Federal Investment Tax Credit and depreciation benefits. This is important as many commercial entities are unable to use the tax benefits associated with solar, either because they don’t have enough tax liability or because they simply don’t pay taxes.

PPA Diagram

When to use PPAs

PPAs are often the answer for commercial systems due to any number of the large required capital expense, lack of technical expertise or lack of tax appetite of the customer. However, other factors may influence the decision, too. The table below outlines the key determinants for a cash purchase or a PPA:

PPA Responsibilities Table

In both a cash purchase and a PPA, the customer is the system host, just with different obligations. Under a PPA a customer has fewer responsibilities, namely paying their bills and making sure the system owner can access the site to provide required maintenance on the system. The project investor is responsible for insurance, operation and maintenance, repair coordination, and managing incentives.

Discussing PPAs as an Option with Customers

PPAs are not only for those organizations that have low or no tax liability. Some organizations prefer to finance the system and have someone else operate it. Some questions the customer can answer to help with decision making are:

  • Are you a for-profit organization?
  • Do you have enough tax liability to use tax benefits from the system?
  • Does your organization allow you to make a capital expenditure of this size?
  • Are you comfortable taking on obligations to your balance sheet?
  • Do you have a loan financing option, and does it provide you with savings/a reasonable ROI?
  • Is your organization prepared to provide financials to a project investor for credit review?

By understanding the answers to these questions, installers can better help their customers decide whether a PPA is right for them. The biggest difference between financing with a loan as compared to a PPA is that loans represent on-balance-sheet financing and the customer has to carry a long-term liability. PPA payments are treated as an expense, so the PPA never shows up on the balance sheet.

PPA Decision Tree

To simplify this process, NRS developed a decision tree to help guide installers through this often-nebulous sales process. By walking through this decision tree, installers should have no problem helping customers purchase solar in a way that most optimally fits their needs.

In the next installment, we will walk through the PPA financing process in detail.  We will focus on a step-by-step explanation of what to expect once the project investor gets involved. Contact Micah Sussman (msussman@newresourcesolutions.com) with any comments or questions related to selling and financing PPAs or commercial solar in general.