How to choose the right renewables project model
5 minute read
Senior Vice President, Supply Chain Consulting
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In the wake of the Inflation Reduction Act (IRA), the renewables market in the US is looking extremely robust. With the increased certainty and support the IRA offers, the outlook for wind, solar and other low-carbon solutions is extremely positive, and a number of new projects have already been announced.
Utilities wanting to procure renewable supply must find the right balance across multiple dimensions at the portfolio or project level. These including market pricing, regulations, commercial risk, supply chain issues, ownership structures and total cost of ownership, all of which affect the viability of a project.
A further key element is the model for development, ownership and operation of the renewable assets that will supply the utility. Over time, three key models have evolved to deliver renewables projects:
- Power purchase agreement (PPA)
- Build-Operate-Transfer Agreement (BTA)
Selecting the best approach for projects from these three options is a key factor in any utility’s approach to their renewable energy sourcing. With the market constantly changing, it is important for utilities to evaluate all options before making a decision. In this article we’ll explain the three models and explore the key advantages and disadvantages of each.
Power purchase agreement
As the name suggests, a power purchase agreement (PPA) is an agreement to purchase the output from the owner of a project, who owns and maintains the asset throughout its lifetime. Typically, PPA contracts will last for 15-25 years. The site will already have been identified and permissions and rights will be in place for access, construction, connection to the grid and operation.
For utilities, the appeal of PPAs is that most of the risks involved in construction and operation remain with the asset owner. What’s more, no construction or operational experience in the project type is required, so utilities can add to their supply portfolio relatively quickly and at lower risk.
The key disadvantage is that the utility has no direct control over the overall design or materials used, or the day-to-day operation of the plant. Contract terms must therefore carefully define performance and remedies to avoid issues or disagreements. In addition to cost and operational considerations, the pre-qualification process should include an assessment of the financial viability of the owner over the whole life of the asset. Finally, the end-of-life disposition for the asset should be clearly defined.
Because the burden of risk and responsibility for development, construction and operation lies with the owner, the cost to the utility of a PPA will tend to be higher. What’s more, while there are plenty of qualified developers and independent power producers (IPPs) capable of building and operating an asset, exploding demand in the sector is resulting in even higher prices in the short term.
Build-operate-transfer agreement (BTA)
A build-operate-transfer agreement (BTA) is an approach whereby a developer builds and operates an asset for a defined period, after which ownership is transferred to the utility. Transfer of the asset can take place at any time from commercial operation date (COD) onwards. Agreements typically include between one and five years of operation so that the owner can train their own staff before taking full control of the asset.
Utilities are increasingly conscious that renewable generation is set to become a significant part of their overall portfolio. To some extent this is likely to involve building on existing infrastructure and expertise rather than starting completely from scratch. A BTA can therefore make sense as a way to acquire the expertise to operate and manage renewables projects.
Where timelines allow, a BTA creates a closer partnership between a developer and a utility than a PPA. The utility is able to acquire valuable knowledge and experience of developing and operating the type of project. At the same time, it allows the utility to build cost-effectively without requiring a large internal workforce. A BTA also enables a higher level of control over aspects such as design standards and operational goals, and can incorporate detailed performance measurements and incentives.
For developers, BTAs create the need to recoup investment over a shorter contractual lifespan than for PPAs. As a result, upfront prices for BTAs tend to be high. To make a BTA effective, utilities need to build transparency into contact structures to both manage costs and ensure transfer of knowledge. The transfer timeline must be aligned with the lifespan of the asset and operational goals, and internal resources must align carefully with the developer-operator to ensure a smooth transfer as the contract term is completed.
Self-build is where a utility hires a contractor – typically an engineering, procurement and construction (EPC) firm – to build the project to the utility’s specifications. This requires internal capability and capacity to specify, procure equipment and contractors, provide project oversite and operate the asset (either using internal staff or by hiring a third party).
For utilities, the goal with a self-build model is to manage costs and develop internal expertise for building and operating renewable assets. Self-build offers a high level of control over project specifications and timelines. At the same time, alignment with a wider project portfolio can create economies of scale in equipment procurement, as well as allowing some flexibility in resourcing. For greater efficiency, a portfolio-level operations and maintenance strategy can be adopted.
The key disadvantage of self-build for utilities is that the burden of risk lies with them both as developer and operator.
Making the right choice
The right choice of model for any given project is ultimately a function of cost, risk and expertise thresholds.
Utilities first need to decide whether they want to own their own asset. They then need to consider whether they currently have the right resources and expertise to build and maintain an asset, or if not whether these elements can be acquired within the relevant timescales. Values need to be assigned to each of these factors in order to make an informed decision as to whether they offset the costs involved in each case. In this way the right decision can be made in terms of managing both risk and cost.
Assessing these factors objectively is complex; Wood Mackenzie can leverage a vast array of data and expertise to support you in making the right decision. We are procurement experts and can help structure bid events, through our own sourcing intelligence or your own bid tools, to ensure the necessary level of transparency in bid responses regarding pricing structure.
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