Power Purchase Agreements vs Wholesale Spot Market

By Paola Moreno

The energy reform in Mexico introduced Power Purchase Agreements (PPAs) as one of the primary ways to trade energy.

Both parties benefit from PPAs. Developers reduce risk in projects through stable cash flow from the PPA, while consumers, usually large industries, benefit from 1) locking in power prices at a discounted rate, 2) protection from price fluctuations and volatile operating costs, and 3) showing government regulators that they have a long-term commitment to renewable energy and/or are in compliance with renewable energy policies.

Renewable energy projects can also realize significant value by using PPAs. Projects can achieve a lower cost of capital through the use of PPAs. In fact, many projects would not receive financing without having PPAs secured. The trade-off is between locking in cash flow, versus the option to capture higher prices in the future.

Renewable power plants have an advantage when entering into long-term PPAs since the costs of renewable power, once up and running, are fairly constant. In addition, renewable project managers can better forecast generation since weather models have improved over time. In contrast, this is not an appropriate tool for fossil fuel plants because they depend on oil-linked price inputs which are inherently volatile. Fossil fuel generation is also susceptible to political and economic factors which impact input costs.

How is the “Spot Market” Clearing Price Set?

Market participants can buy energy through via the wholesale market at spot price. Prices are calculated in real time and what’s known as “day ahead” prices. The Mexican system operator, National Center for Energy Control (CENACE) takes bids from producers and then dispatches the least expensive plants first. This proceeds on to the higher-cost dispatch until the domestic power demand is met. The kWh price paid is fixed at the value of the last kWh dispatched. Prices fluctuate depending on several factors such as supply, demand, oil prices, maintenance, plant state, among others.

This pricing mechanism is advantageous for consumers because it forces power producers to constantly focus on lowering operating costs. As producers lower operating expenses, they can bid lower prices, and thus have more of their bids accepted. This is positive for large consumers of energy including manufacturers and companies with a large real estate footprint.

Which Is the Better Option in Mexico?

We expect PPAs to continue to be a “win-win” for market participants in Mexico. They allow for lower costs of capital (for both consumers and developers) and higher asset values on the open market. These agreements also demonstrate to regulators a commitment to renewable energy and compliance with new regulations. PPAs are not without risks, but scrutiny of various contract terms, and transparent negotiations, can make PPAs a viable option.

PPAs act as a new type of subsidy for participants. Consumers can purchase power for a lower price than from the grid, and developers receive lower-cost funding. For consumers this can be a daunting task, especially as a 15- or 20-year agreement would typically be the longest commitment that the company has entered into. Please contact us to learn more about our solutions to lower operating costs through the use of PPAs, while mitigating execution and performance risks.

Our Services Related to Power Purchase Agreements:

  • Perform financial analysis to assess the long-term market risk of a PPA, by modeling multiple forward-looking cases for each PPA opportunity
  • Provide valuable insights into current and future regulatory risks during project selection and contracting
  • Offer expert perspectives on the contractual terms that have the potential to impact the PPA
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