Another bumper year for PPAs

Richard S (00:04.014)
I've started now. Yeah. Hello listeners and welcome to the Montau Weekly podcast, Bring Energy Matters in an Informal Setting. In today's pod, we return to the subject of power purchase agreements or PPAs. Europe is currently facing some fairly strong economic headwinds, high interest rates, stubbornly strong inflation, supply chain issues and falling energy prices.

How is this impacting the expansion of renewables on the continent? And especially the signing of power purchased agreements. Are costs mounting but returns dropping? So helping me, Richard Svarrasen, to discuss this and much, much more. Helping me, Richard Svarrasen, to discuss these issues and much, much more, is Luca Pedretti of Peksa Park. A warm welcome, Luca, and it's great to have you back on the pod.

Luca Pedretti (01:00.992)
Hi Richard, thanks for having me again.

Richard S (01:04.502)
First of all, let's talk about what you've seen so far this year. What are the high spots or the concerns you may have?

Luca Pedretti (01:15.684)
We came out of a very strong Q4 in terms of deals and we saw a very strong January. Already one gigawatt of PPA is signed, but there are some clouds on the sky and what we clearly see is quickly falling forward prices and this of course impacts PPA closing and that's a key discussion point.

Richard S (01:41.986)
So what's happening to prices that you've seen?

Luca Pedretti (01:45.132)
Well, definitely PPAs follow to some degree forward prices or with a lag. And there are times where things match. And what do I mean by that? So you have the sell side, you have interest rates, you have capex cost, and then you have to buy sides where you have a certain willingness to pay. And in the middle, you have a market where you have traded forwards and in the best times of the market. And we had this, for example, in Q4.

the sell and the buy side match on those fundamental principles. And right now, and this is when a time when deals really are flowing, because everyone is happy to economical buyers and seller, as well as the green buyers and sellers. And right now we're in a territory in certain markets where the market implied PPR rate is below what sellers require. And it takes them corporates that are willing to pay a certain premium to conclude the deals. And this is

in some markets a territory where we are in right now.

Richard S (02:44.83)
what kind of sector are these corporates in? Are you able to say something more generally about the areas where they are wanting to pay that premium as you mentioned?

Luca Pedretti (02:54.792)
There's a very important segmentation which we need to do in the corporate segment. When we say corporate PPAs, this is a huge universe. We have electricity intensive industries which know how to buy power for a long time. They invented the corporate PPA markets 10 years ago. Very price sensitive. We have the big tech companies, the fastest growing.

Richard S (03:02.413)
Mm.

Luca Pedretti (03:22.98)
PPA segment in the market growing 20% a year, they have very strong mandates to secure 100% green and they will buy also above market rates, implied market rates. And these are two extremes of the universe and the market is somehow moving in between those.

Richard S (03:42.89)
Mm.

Richard S (03:47.074)
And with the tech side, you know, Amazon certainly has been very active, hasn't been very prominent in signing deals, certainly at the end of last year's. But how about the smaller corporates, you know, the small to medium sized enterprises? What's happening there?

Luca Pedretti (04:03.116)
The market is expanding, so we call it the multi-buyer PPA. So we see this in certain markets being facilitated by platforms and market integrators slash utilities. And that's a key innovation for the market. And basically just expands the possible universe who can buy because you have built the trust. There's an ecosystem of lawyers, facilitators, of standard contracts where smaller corporates feel fine to add in.

and constitute together a sizable offtake so you can enable another PPA. We're seeing this in Denmark, we're seeing it happening in other markets. And this is very exciting because the next phase of the PPA market is gonna be much larger if you can facilitate smaller players, smaller buyers to enter the PPA market.

Richard S (04:54.346)
And that's being done on a multi-buyer model, you think. So they're sort of being aggregating amongst themselves and then signing deals in that way. That must add to a lot of the complexity to these deals.

Luca Pedretti (05:04.732)
Exactly. So that's the key line. So you have transaction cost versus market of the size of the market. And initially the PPA market focused on the very large deals where you have one seller, one buyer. But what we're seeing is the average size of the PPA is getting smaller and smaller and smaller. When you look at 2023, the average size was 60 gigawatt hours. It's not that much. And if you're able to go down that route,

to lower transaction costs thanks to the maturity of the market, platforms, standardized contracts, we are able to lower transaction costs. And that's exactly the game where we're in now and speaks for the maturity of the market.

Richard S (05:47.562)
That's very interesting. I mean, you also mentioned falling energy, falling forward energy prices, as I also mentioned in the intro. Surely that's also an incentive for some of these companies to come in. I mean, they must be find that lower prices means they're getting a good deal.

Luca Pedretti (06:07.296)
Yes, absolutely. I mean, the market moves in cycles and it's a very capital intensive industries. So there are times when everything comes together and there's a huge deal flow. And then there are times again where market players need to adjust. And what do I mean by that? So if there is pressure from the off-tech side on the prices, this ripples through the entire value chain on the O&M.

Richard S (06:10.926)
Mm.

Luca Pedretti (06:35.204)
on the margin you can ask from a developer. And from the sell side, they look at it like, oh, what are my options? How long can I retain my permit? When do I need to build? So it's a very fascinating interplay. But what you clearly can say, if prices go down or go up, within three months, six months latest, there is an adjustment in the market. Always the big question is who captures the biggest upside or the biggest value?

But clearly what we can say is there is ample demand for PPAs. The question is just how conducive is the environment to enable deal flow?

Richard S (07:14.174)
I mean, I think and you've highlighted the falling prices, but isn't there also the case to say that liquidity in these forward prices is also increasing or on the rise after many years where it has been declining. And that also maybe, you know, would boost some of these contracts being signed, you know, that enable these companies to hedge some of that production.

Luca Pedretti (07:36.904)
Yeah, liquidity and somehow related to that price volatility. So what we clearly saw is that due to the price surge we had before the Russian aggression against Ukraine and then during the war times, we had super high prices, but also super high price volatility and price volatility is a cost driver for PPAs. So and this is coming down now. So in the same way that...

prices might be going a bit down, we have lower costs of transaction because volatility is coming down. So this is the fascinating play of supply and demand. And just because prices are going down, it doesn't mean that the PPA market will stop. It just adjusts and it goes on. And we have very positive developments. We have new markets, we have numerous markets which hit almost one gigawatt in different price zones.

we have transaction costs coming down, and this enables to open multi-buyer PPAs, which bring in new segments, which are willing to pay a higher price. And this overall then adds again to, in my view, a rather bullish environment, also with the regulatory reforms, which have CFD and PPAs going hand in hand and...

European Union and the member states discussing measures how to support the PPA market, for example, through credit instruments. And that's a real booster for the market. If you can support credit, that's probably one of the biggest levers you have to boost the PPA market.

Richard S (09:18.734)
because you alleviate or you ease that risk or the counter party risk at a stroke. And that's obviously very good for the smaller corporates or not, you know, that could absolutely boost activity. They look good. But, you know, you mentioned the one gigawatt of deal signed in January. Where is this happening? What parts of Europe?

Luca Pedretti (09:42.084)
So overall, we have a spreading wave of PPAs, more and more markets, but clearly in the last four or five years, like 30% of the deals happened in Spain. And it has been the most active market for a long time. We believe Germany is going to topple Spain from the crown this year, just for the sheer magnitude of the size of the market. And also what we're hearing from the development side, there is real changes on the permitting, so it's getting easier.

Richard S (10:01.486)
Mm-hmm.

Luca Pedretti (10:14.292)
and projects are coming there. And you have like very interesting effects. We just had an auction in Germany for solar, was way oversubscribed. The assets that didn't make it, they will end up on the PPA market. So it's like potentially leading to a spark in additional PPAs and investments. And that's why we actually believe real action will be in Germany. Although right now,

the price environment in Germany in Q1 doesn't look too favorable for deal conclusions.

Richard S (10:49.102)
But in the longer view, then this is a country where you think there would be more activity than before.

Luca Pedretti (10:58.464)
Absolutely. It's Germany toppling Spain from the crown. Those two countries probably responsible for 50% of all deal volume. But then we have in the so-called second league, we have so many markets now above one gigawatt that actually the growth is going to be quite well distributed across Europe.

Richard S (11:14.091)
Mm.

Richard S (11:19.274)
Very interesting. You mentioned some clouds and I'd just like to touch upon one. You see power prices now below what they were before Russia's aggression into Ukraine and before the war started. But solar panel and wind turbine prices are still high. Inflation is high. So you've got a rising levelized cost of electricity.

Is there a danger that you could see fewer PPA private deals signed and more going via the subsidy route?

Luca Pedretti (11:58.74)
I think it's a mixed picture. So first of all, it depends market on market, but for example, in 2023, a big driver was also falling module prices on solar. So 10 gigawatts of the 16 gigawatts signed last year were in solar and continuously falling prices and the oversupply on module really helped despite higher interest rates. So it is a mixed picture.

Richard S (12:09.377)
Mm.

Luca Pedretti (12:24.66)
and I think it will be evenly distributed depending on how will interest rates develop, how will market prices develop, what is the appetite on the demand side, but overall structurally we're bullish. So I think in the end if prices fall lower now they might delay deals, but the market will adjust again to work on lower levels. And in the same way if you have very high prices it might be very nice.

the deal flow in the first three months but then the whole value chain adapts and prices rise through the value chain. The projects become more valuable, the operators ask for more. So you have both effects in either if prices go very high quickly or very low quickly. You have a certain overshoot on both sides.

Richard S (13:15.918)
Absolutely. I mean, we've talked before as well, Luca, about hybrid PPA deals and the role of batteries. But, you know, if battery storage becomes cheaper, will that impact captured prices and bringing prices closer to the sort of base load deals again?

Luca Pedretti (13:34.848)
Absolutely. So it's hard to imagine how the energy transition will work without storage. And when you look at, for example, the UK, more than 50% of the permitted solar projects already come with some co-location of storage. Now, storage is typically one to two hours. And we already see on the horizon that you might have two to four hour batteries. So this will not bring

body cuts out the fat tails on the risk side. And this is actually what is very important is that you want to control the big risks. And this is why storage is so helpful and so important. But if we will be talking again in this podcast in three years, it will be just like 50% of all PPAs will be hybrid in some form or other.

Richard S (14:24.247)
Hehehe

Richard S (14:30.166)
I mean, it makes absolute sense as you rightly say that, but let's go more about what you've kind of forecast for this year. You've said that you see a potential of 20 gigawatts, which is more than what was signed last year. How feasible is that target? And you seem to be saying that mainly will happen in Germany. The biggest growth.

Luca Pedretti (14:56.5)
Yeah, we definitely leaned out a bit of the window and as per our discussion, the macro environment is important with prices, but fundamentally we see a bullish market for PPAs. So we would need to have 1.6 gigawatts per month. So we started with one gigawatt. We definitely going to see a certain slowdown in Q1 potentially to the price environment and then market adjusted again.

Richard S (15:22.775)
Hmm.

Luca Pedretti (15:24.972)
But the demand is so strong on the data side, on the industry side. We have new innovations on a multi-buyer and opening new segments that I would still stick to the forecast, although the likelihood has become a bit lower that we hit 20 gigawatts.

Richard S (15:38.886)
Mm-hmm.

Richard S (15:45.262)
I mean, we talked about, you know, low prices, you know, being an incentive for some people or, you know, basically a driver for some market participants, but it's also scaring some off, then you would be saying, or they need that period of adjustment to wait a bit to wait three or six months before jumping in.

Luca Pedretti (16:04.22)
Yeah, there is a certainly there's a stickiness because as an industrial buyer, of course, you might like an environment where prices are falling, but this only to a certain degree because project economics need to make sense. And at some point it breaks. And this is where it can lead them to delays of deals. And so in the end, they're all industry veterans, a deal still takes three to four months to negotiate.

And we're used to those dramas since many, many years that prices can change over the weekend and it might jeopardize the deal. But that's ingrained in the nature of doing PPAs and it's just part of the game.

Richard S (16:53.072)
You brought up the CFDs and PPAs and contracts for difference versus power purchase agreements. Can these happily coexist?

Luca Pedretti (17:03.452)
Absolutely. It's the brother and the sister of the energy transition. We always had subsidies. And when you look at historic figures, I mean, the subsidy part was historically always bigger. So it was like two thirds or even more of the capacity. Even the last years was enabled through some sort of subsidy. When you also look back where the PPA market started, it was heavily subsidized through green certificates in Sweden, in Poland.

Richard S (17:06.754)
Hmm. Hehehehe.

Luca Pedretti (17:31.604)
So what we see is that they have two different purposes. And you can steer much, in a much more granular fashion, the capacity built out through CFTs. But when you look at the design, there is a lot of carve outs for PPAs. You give the option to combine CFTs with PPAs. You give preference to PPAs in a CFT bit. So we think they will mutually coexist. And when you look at renewable investors,

They have a very structured portfolio of different revenue options. But what you can't beat the PPA market in is the flexibility. You can decide to go merchant. You can decide to do just a five year PPA instead of 10 year and lock in significantly higher revenue because this difference between those two tenors, five and 10 years in many markets is getting bigger and bigger. And this flexibility is under your control.

So you have an option to actually contract yourself, whereas on a CFD, you're bound to rules, to auctions, which you cannot control, ultimately.

Richard S (18:36.386)
Mm.

Richard S (18:39.83)
So how does this relate to the different markets and technologies? Are some more predominantly CFDs, are there PPAs?

Luca Pedretti (18:48.712)
Yeah, good point. So certain different technologies have different costs. So we clearly see that, for example, for offshore wind, it might be more difficult to do PPAs on a 10-year basis. But there, again, we have a different structuring of the market. What we see in certain markets is France or in the offshore spaces that you have super long 10 PPAs reaching 20, 25 years.

And there the commodity element in the pricing is much lower. So you have deal structures that have pricing oriented more on the CapEx side and that's another element how you can diversify. So do you take more a market view just on the next five to 10 years? Or do you take more a project view having eventually 25 year or longer view? And

depending on which view you take, you might have a different pricing regime.

Richard S (19:52.75)
I mean, we talked about hybrid, you mentioned multi-buyer PPAs, Luca. Are there any other kind of forms of PPAs that are interesting? I mean, the green procurement, green hydrogen, are these becoming more advanced as well?

Luca Pedretti (20:11.288)
What we clearly see is an important role of utilities. And so as we like to call them also market integrators. So you have players aggregating different assets to drive home certain portfolio effects. So there is the benefit of combining different profiles in different price zones. And this is something which requires

scales and system and capital. And that's something which utilities and market integrators can provide. So what we are seeing in a way is also more bigger PPAs facilitated by market integrators. So it's not just the hybrid PPAs and the multi-buyer PPAs, but it's also a very complementary role of utilities playing in the corporate PPA field.

Richard S (21:05.718)
Yeah, how are they introducing innovation into the markets?

Luca Pedretti (21:12.388)
They're trying to provide in the most generic form, I would say value enhancing services. So in the old days, we just had a seller and the buyer and one of each party was accepting the full risks or either it's baseload or pay is produced. And they're actually trying to intermediate those risks. So we're saying, okay, you have this solar profile but the client would like to have a certain fixed shape. Let us come in.

and try to provide these services. And they can do this by combining additional assets. They can do it by providing additional risk taking and trading around. And that's exactly what is needed as it helps to reduce costs and in the end getting more deals done.

Richard S (22:01.602)
So you'd say then utilities are specialists in offering tools for the management of price volatility for interbitancy and also to higher green standards. This is where they're the experts.

Luca Pedretti (22:14.204)
Exactly. This is where they can leverage their balance sheet, their trading skills, their risk management skills to the benefit of other market participants. Look, already now in every PPA, you typically have a trader or a utility involved and be it only for the balancing on the seller side or on the buyer side. So you need both parties for the market.

Richard S (22:38.738)
And we've also seen, I mean, over the last few months, falling geo prices. Now, guarantees of origin are an important part of PPA deals. The price quite highly though, well, over the last 12 months, but they've come down or price have slipped considerably. Is this a concern? Is this something that you're hearing from the market that people are...

waiting and seeing what's happening with the guarantees of origin prices.

Luca Pedretti (23:12.096)
Yeah, it's of course, it's one other part of your big revenue. So when you look from the seller, he has the PPA 30, 50 euro. Yes, the route to market and balancing costs can be one euro, can be five euro, depending on the market. And then you have the guarantees of origin, which fluctuates heavily. But of course those, when we had six, seven euros, people were very happy about that. And it just adds to the equation. But overall, I think it is.

Um, we need to look at the total impact on the, on the revenue stack. Uh, and you need a team to be actually managing it. So that's a key theme actually that revenue is getting more complicated. So, and a key theme, what we see in the market is that many developers are becoming IPPs and many funds are adding utility functions and basically everyone wants to have a commercial team.

because there is so much value in not just closing PPAs, but to manage them, to manage the residual volume, to manage the balancing contracts and to sell the guarantees of a origin. There's a lot of money there. It's a very important puzzle piece of the overall revenue picture.

Richard S (24:28.13)
So these companies are becoming independent power producers in a way, you know, absolutely. And you touched also upon the regulatory side. Can you just highlight some of the key factors that will drive the expansion of renewables and PPAs going forward?

Luca Pedretti (24:48.888)
So from the energy market directive, I would say the key elements are first the standardization of CFTs and the role they allow for PPAs, for example, preference for PPAs in CFT auctions, the allowing sharing capacity. So you do 50% of the project with the CFT and the rest you can do merchant or PPAs.

On the PPA side, it is definitely credit instruments. So if we have some sort of market-based credit support where market participants can buy credit insurance, that's a huge boost for the PPA market. And the third element, which is a bit fuzzy, is how is liquidity being supported, like liquidity in forward markets through design of price zones.

That's for me very unclear how regulation can help there because liquidity is very difficult to mandate. So market participants by themselves have to create liquidity.

Richard S (26:00.114)
And if you mess around with it too much, the danger is that you could drive liquidity out of it and have sort of quite unforeseen consequences.

Luca Pedretti (26:09.864)
Exactly, and we're having now live experience in the Nordic market with the change to see how this happens. And capital rules are very much important for that. And it's a very capital intensive business. And this is for me very unclear how this actually will help drive liquidity.

Richard S (26:31.638)
A final question, Luca. We're hearing from several quarters, both from individual companies, from countries that they're rolling back some of the green ambition. Companies are saying they can't afford to make these investments anymore. Countries are rolling back net zero targets. And often the argument puts...

forward is that it's become too expensive. Now, what's your view here, Luca? Has the energy transition become too costly or is it more a question of how you manage those costs?

Luca Pedretti (27:08.128)
It's the latter. So look, when I started 15 years, the joke was physically renewables don't work. So this was proven. Then the second joke was it's too expensive. Now we proven this as well. And now the third challenge or joke is it doesn't work in an integrated manner. So it doesn't work if you really go to full Monty and the market becomes predominantly organized around renewables. And that's the next frontiers. I think.

Richard S (27:09.358)
Yeah.

Luca Pedretti (27:36.564)
Last time we did the podcast, we called it the energy transition wobbles. Yes, it will be difficult, but we're at this breaking point where we have to think more in systems and in solutions and not just in single deals. And that's a healthy debate. And overall, I think let's figure it out because in the end, and this we see in the PPA market is you should allow market forces to play a big role. And.

Richard S (27:42.11)
Mm, mm, mm.

Luca Pedretti (28:06.12)
Yes, you know what, most corporates are economical buyer and in the end this is a good development. It has to work on market prices.

Richard S (28:16.214)
Luca, always a pleasure. Thank you very much for being a guest on the Monta Weekly Podcast.

Luca Pedretti (28:21.348)
Thank you, Richard.