Bitesize PPAs – Synthetic Power Purchase Agreements

What are synthetic PPAs and how do they work?

Whilst a ‘synthetic PPA’ might sound like it could be a complicated contractual arrangement, there is nothing too scary about them. Synthetic PPAs have been utilised by large corporates for a number of years now as they are an effective means of both saving on energy costs for relatively high amounts of electricity as well as obtaining renewable energy certificates such as REGOs.

In essence, synthetic PPAs are contractual arrangements that provide for the use of a financial instrument or derivative between a renewable energy generator and an offtaker (or consumer). Often, this derivative will take the form of a contract for difference (“CfD”) for a certain, long-term period. The CfD between the generator and offtaker operates alongside both:

• an offtaker’s supply agreement with a licensed supplier to receive electricity; and
• a PPA between a generator and a licensed supplier.

The CfD is designed to provide both a generator and offtaker with price certainty by guarding against fluctuations in wholesale electricity prices. The CfD does this by establishing a “strike price” that allows a generator to receive a certain fixed net payment for the electricity it produces and an offtaker to pay a certain fixed net payment for the energy it consumes.

A strike price is a fixed price per megawatt hour that is agreed between the generator and offtaker that is compared against a wholesale market energy reference price. In simplistic terms, where the wholesale market energy reference price rises above the strike price, the generator will pay the offtaker the difference. Where the wholesale market energy reference price falls below the strike price, the offtaker pays the difference against the strike price to the generator, thus ensuring the price certainty of the strike price.

The diagram below provides a simple illustration of the contractual arrangements involved:

As well as providing for price certainty, synthetic PPAs are negotiated for the transfer of renewable energy certificates such as Renewable Energy Guarantees of Origin (REGOs) to the offtaker.

Why should local authorities consider the use of synthetic PPAs?

Further to price certainty/cost stability and REGOs, the following are additional benefits that local authorities should consider when determining to enter into a synthetic PPA:

• Procurement – a CfD as a financial instrument does not fall within a contract that is subject to the procurement rules resulting in a less burdensome process for local authorities.
• Sustainability goals – many local authorities have committed to carbon neutrality by 2030. Synthetic PPAs provide a means of stimulation of renewable energy projects that will assist in the reduction of greenhouse gas emissions.
• No operational change – a synthetic PPA does not require any physical alteration to any connection to receive electricity as might be required under a private wire arrangement with a renewable energy generator.

Legal considerations

Unlike private wire PPAs (please see here for more information and legal consideration of private wire PPAs), there is no direct connection to a renewable energy generator in a synthetic PPA arrangement. As such, there are, on the whole, fewer legal considerations concerning the agreement of a synthetic PPA as electricity is supplied to an offtaker by a licensed supplier through the national grid.

That being said, as a contract for difference is an ‘Over the Counter’ (OTC) derivative, it will need to be considered for compliance with relevant financial regulation and reporting obligations.

Further to this, local authorities will need to ensure that any arrangement complies with subsidy control regime under the Subsidy Control Act 2022.

Steve Gummer is a partner and Tom Knox is an Associate at Sharpe Pritchard LLP.

This video is for general awareness only and does not constitute legal or professional advice. The law may have changed since this page was first published. If you would like further advice and assistance in relation to any issue raised in this article, please contact us by telephone or email enquiries@sharpepritchard.co.u