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Investing in the Future with Power Purchase Agreements (Solar PPA)

Thursday, May 13, 2010

In researching the world of renewable energy production, you may have come across the term “PPA”. This is an important concept when it comes to financing new green energy projects in Hawaii, and is of particular importance to those debating the cost-effectiveness of a large solar installation. A PPA is a “power purchase agreement” and can be used to reduce the monthly cost of electricity for commercial and in some cases individual customers. But what is it? And more importantly, how can you use a PPA to make a new solar installation cost effective?

Simply put, a PPA is an agreement between a power producer and a power buyer. This agreement can be between a large utility and a major power producing facility, or between a small-scale power producer and an individual buyer.

Decades ago, PPAs started as arrangements between big utilities and major industrial customers like steel manufacturers or aluminum smelters. This was because the production of those things requires a huge amount of electricity, and so companies found it cheaper to build their own power plants than to buy electricity from the grid. Once those power plants were up and running, they made more electricity than the steel mill or smelter could use, and the excess was sold back to the utility for a profit. Over time, the profit paid for the construction of the power plant.

This is still the case in certain industrial agreements. The buyer of the power being produced is the utility company. Many large-scale power production facilities such as coal, nuclear, or solar farms are financed by outside investors and the power is sold back to the utility.

But PPAs are not limited to only large corporate entities and the utility. In smaller power purchase agreements, the same concept applies, but the power producer may be a small investment company utilizing something as compact as one or several rooftop and/or ground-mount solar installations. The buyer may be a company, a nonprofit, or even an individual power consumer.

The main way in which PPAs are used in the solar power industry today are as a financing method for large installations. The basic structure for financing a solar installation with a PPA involves the installation of a solar power system on the customer’s property (host) zero out of pocket cost to the customer. (the large nature of the installation favors the expanse of a commercial rooftop or parking lot, but there is always room for creativity when designing an installation). The customer then agrees to buy the electricity which is produced and sold at a discount rate over the span of 20 to 25 years, thereby insulating the customer from rising energy costs and paying back the initial investors who financed the installation in the first place. In short, the customer/host benefit is: zero out of pocket for investment and discount priced energy. (this is consider a hedge on the rising price of energy and smooth’s or eliminates the volatility risk in the price of energy)

In a recent real-life example, Sunetric Capital joined with the Lighthouse Outreach Church in a power purchase agreement. A solar array was installed on top of the church at Sunetric’s expense, and the electricity which is now being produced will be sold back to the church at a rate which is (and will continue to be) considerably lower than HECO. Current tax laws make this an even more attractive arrangement, because as a nonprofit, Lighthouse Outreach was unable to take advantage of the current tax incentives for installing renewable energy systems. As a for-profit company, Sunetric Capital can take advantage of those incentives and pass the savings along to the church.

A PPA is only one of many options for financing solar installations, but it has some distinct benefits that should be considered when considering a renewable energy project.

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