The rise of corporate power purchase agreements (CPPAs)

Benefits of CPPAs

The State’s climate action plan aims to reduce emissions by 51% by 2030 and deliver 80% renewable electricity by 2030. It includes a target of 15% of electricity demand to be delivered by CPPAs. 

Benefits for generators include:

• the fact that CPPAs offer an alternative route to market for generators who are excluded from RESS, were unsuccessful in RESS or for whom the terms and conditions are not commercially viable.

• the long-term stable income that comes with a CPPA with a financially strong counterparty – it gives the financial certainty generators need to secure debt funding to build new projects. 

Meanwhile, corporates benefit due to:

• budget certainty, particularly given volatile market prices.

• delivering additionality – without the corporate's involvement (via the CPPA), the renewable energy project would not have been built.

• guarantees of origin (GOs).

Key commercial considerations when entering into a CPPA

Factors to consider when negotiating CPPAs include:

Term
CPPAs are typically long-term contracts (about 15 years) although some short-term contracts (less than five years) have been agreed in the Irish market in the past year.

Volume
The offtakers forecast energy needs determine the size of the asset with which it can contract for some or all of the output.

Contract form
There are four forms of contract:

1. pay-as-produced
2. shaped
3. baseload
4. pay-as-consumed

Pay-as-produced contracts are the least risky for developers (as generation is not fully predictable). They are the most common form of CPPA in Ireland, where demand outstrips supply and offtakers compete with RESS. Other forms of contract need a significant premium from the offtaker as the generator is taking the volume risk.

Pricing structure
CPPAs can be fixed priced, variable or a mixture of both. Fixed pricing increases cash flow certainty for both parties, helping with budgeting, project financing and protecting margins.

It can, however, expose offtakers if there are significant wholesale market price declines as they are locked in at higher prices. Financial instruments such as collars, floors and ceilings can manage variable risk.

Accounting considerations

To account for CPPAs under IFRS, an entity considers the type of arrangement to determine if it: 

Gives rise to consolidation, associate or joint venture (JV) accounting
A corporate offtaker needs to consider if the counterparty is a special purpose vehicle (SPV) that it controls, or that it has significant influence or joint control over. This would not typically be the case.

Contains a lease
This needs careful consideration, but the CPPA is unlikely to constitute a lease if the offtaker is not buying all the output from an identified asset, or if it does not have the right to direct the use of the wind or solar farm.

Is within the scope of IFRS 9
As financial CPPAs do not involve the physical delivery of electricity, they cannot avail of the ‘own use’ exemption (held for the purpose of receiving electricity for the entity’s expected purchase, sale or usage requirements). The analysis for physical CPPAs depends on:

• Market structure – can the generator (or electricity supply company) show the physical delivery of electricity in a grid or pool market (for example, delivery to a customer's account)?
• Usage profile differences – does the corporate offtaker use all the electricity delivered across all time intervals or is some of the green electricity sold back to the grid (in other words, it’s net settled)?

If the ’own use’ exemption is not met, the CPPA would be recognised as a (embedded) derivative. It would be recorded at fair value on the balance sheet (complex, level 3 valuation) with changes in fair value (FV) recorded in the P&L unless designated in an eligible hedge relationship.

As CPPAs are often long duration contracts the potential P&L volatility can be significant, so generators and corporate offtakers often seek hedge accounting.

Tax considerations

Make sure to consider the tax impact of CPPAs across all tax heads. The main tax implications are concentrated around corporate tax, transfer pricing and VAT. 

Corporate tax 

The trading status of the parties involved in a CPPA determines the tax rate that applies to any profits arising on the transaction and also the deductibility of any related expenses. 

For corporate offtakers, the corporate tax treatment of a CPPA is influenced by the accounting policy applied and whether or not the offtaker is engaged in an active trade.

• If the accounting treatment adopted is under IFRS 9, changes in the fair value of the asset are booked to the company's P&L each year. If it is a trading entity, these changes should flow through to the tax computation and should not be adjusted for.

• If the PPA is accounted for under IFRS 16, an asset and corresponding liability should be recognised. The lease interest and depreciation should be added back, and a tax deduction taken in line with normal rules, that is, in line with lease rentals.

Transfer pricing

If the CPPA arrangement involves transactions between related parties, for example, between an intermediary offtaker and the ultimate offtaker who are members of the same group, make sure you consider transfer pricing. 

VAT

CPPAs must be reviewed carefully before they’re executed. Consider the following from a VAT perspective:

• Financial or physical: the nature of the agreement determines if a supply of power is taking place. Under a financial agreement, a physical transfer of power is typically not taking place, whereas under a physical agreement, a physical transfer of power is usually taking place.

• Tax point: review the timing of the supply to determine when the tax point starts for VAT purposes. Certain elements of an agreement, such as advance payments, can affect this.

• Agency arrangement: consider the agreement to establish if the contract gives rise to an agency agreement from a VAT perspective. Depending on the agency arrangement, this can complicate matters as it may affect who is viewed as making the supply under the agreement. 

• Cross-border aspects: consider if there is any overseas or cross-border element to the agreement. This may have reverse charge or self-accounting VAT implications. 

• Financial services: assess if a CPPA qualifies as a contract for difference (CFD) and the VAT implications if it does. 

Running a CPPA tendering process

A tendering process typically has six stages:

1. Mobilisation

2. Understanding your business requirements 

3. Tender preparation

4. Expression of interest

5. Request for proposal (RfP)

6. Final negotiations and contract close

Key success factors of a CPPA tendering process

• Understand your market, including the pipeline of projects, technologies, developers and market terms.

• Upfront your work – on your business requirements, on your procurement strategy and on your form of contract.

• Strike the right commercial balance – allocate risk to the party best suited to manage it.

• Ensure competitive tension throughout. Leave limited scope for negotiation at the preferred bidder (PB) stage.

• Note the importance of financially strong counterparties when it comes to debt funding and project valuation.