Microsoft has figured out a way to reduce risks associated with PPAs
Corporate power purchase agreements have helped bring at least 13 gigawatts of software and wind power to the U.S. grid over the past decade — and more than 4.5 GWs during 2018 alone, thanks to a new deal revealed Monday. But the underlying risks associated with these contracts aren’t for the faint of heart. That is, of course, if you’re an insurance company.
Microsoft has figured out a way to use this to its advantage.
The software giant has co-developed a new sort of contract with insurance and risk specialists, called a volume firming agreement (VFA), that it is encouraging companies to purchase in conjunction with specially structured PPAs. Microsoft is using VFAs itself to help insulate its company from the complicated task of managing renewable electricity pricing fluctuations and operational risks related to weather-related hiccups and the intermittent nature of solar and wind power production.
"VFAs effectively remove the risk related to how future weather conditions will impact the financial value of a PPA from buyers and reallocates it to people that want that risk," writes Brian Janous, general manager of energy and sustainability for the software, in a Microsoft blog post published Tuesday.
Here’s the issue: While traditional PPAs negotiate a fixed-price over the long term for renewable electricity, the reality is that the actual market prices fluctuate hourly and daily, depending on production. There’s actually an inverse relationship. When resources are abundant, prices are cheaper; conversely, solar and wind power is more expensive at night or when weather conditions have an adverse effect on generation capacity.
Settling the differences in those prices is something many organizations aren’t equipped to handle, Janous told me when we chatted about the structure of this new sort of contract. "You can say you’re 100 percent renewable, but what you are is 200 percent renewable in some hours and zero percent in other hours. Behind the scenes, it’s a mess," Janous said.
The idea behind a VFA is to help make PPAs feel more like traditional retail energy contracts by making a third party responsible for the risk of those fluctuations. Microsoft, which has signed 11 PPAs for close to 1.2 GWs of renewable electricity, worked with several organizations including clean energy risk management and analytics company REsurety, reinsurance broker Nephila Climate and Allianz Global Corporate & Specialty’s risk transfer unit to create a new contract structure to help reduce the operational risk for corporate buyers.
Microsoft has signed three VFAs with Allianz and Nephila to cover its PPAs for wind projects in Illinois, Kansas and Texas, representing about 500 MWs of its portfolio, or almost half of its contracted renewables. "As Microsoft continues to purchase renewable energy to power our operations, we anticipate utilizing VFAs to firm the energy and match our consumption on an hourly basis," Janous wrote.
As the market for VFAs and similar products grow, we believe it will create new incentives for those who now bear these risks to procure storage resources and other assets capable of physically balancing the intermittency of renewables. Through the aggregation of risk, these insurers will be able to procure balancing resources at economies of scale that even Microsoft is unable to achieve. In that way, today’s financial firming solution is tomorrow’s physical firming solution, accelerating the adoption of storage and other resources required to eventually transition to a 100 percent carbon-free power generation system.
Incidentally, Microsoft on Monday was disclosed as the buyer behind a 15-year-long PPA covering a 90-MW wind project in Hector Township, Pennsylvania. The agreement marks the company’s third deal for the PJM Interconnection, the organization that coordinates electricity across 13 eastern and mid-Atlantic states.
Someone had to be first
To be clear, Microsoft isn’t selling the new VFAs itself. Rather, you could say it was the willing clinical trial subject for turning this concept into reality.
The software giant’s champion was Kenneth Davies, director of innovation for energy strategy & research (who engineered some of the first PPAs signed by Google), and REsurety co-founder and CEO Lee Taylor, who started working on the idea for his MBA project at the Tuck School of Business at Dartmouth College.
Here’s the problem: For decades, the risk management practices associated with the energy sector were built up around managing the cost of the various fuels, from oil to coal to natural gas. With renewables, however, those models are difficult to apply. "Fuel is free, but when it shows up isn’t controllable," Taylor said. "There isn’t the same sort of natural long-short position" that can be used to settle this market tension.
In the world of renewables, he said, the "dominant fuel risk is weather."
Boston-based REsurety, founded in 2012, spent several years building risk analytics models from a database tracking the operating performance of U.S. wind forms — companies such as Apex and Southern Co. use that information to manage project risks. The company is also building risk models related to solar installations.
"The VFA [signed by Microsoft] is the first to show off how these tools work for the buyers of power," he said.
Davies’ interest was in creating something that would help make PPAs more similar to the "block" pricing contracts that businesses traditionally sign for electricity — and that don’t require all manner of sign-off across a company’s financial and legal departments for approval. "Our goal is not to be an energy trader," he said.
That mission resulted in a twist on the PPA contract model called a "proxy generation PPA." What differentiates these agreements from typical PPAs is that they explicitly decouple the operational risks associated with renewables projects from the contract so that they can be assumed by a third party, such as an insurer. "The [commercial and industrial] buyer has little to no control over what turbines are purchased, how they are maintained or upgraded, or what terms and conditions are negotiated into warranties and services agreements, yet the C&I buyer generally bears the financial impacts and risks of those decisions," noted a white paper (PDF) co-authored by Microsoft, REsurety and law firm Orrick, Herrington & Sutcliffe. "The proxy generation PPA correctly re-allocates the operational risk of a project away from the C&I buyer and back onto the project."
Over the long term, Davies hopes this evolution in how purchasing agreements are negotiated will lead to the creation of similar contracts that are "small and simple" and will enable more smaller companies to become part of the corporate renewables procurement movement, a development that many larger buyers from Microsoft to Walmart to Google are keen to see happen.