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Derivatives markets help hedge risk in long-term renewable power agreements

EEX is introducing 10-year base year futures in European power markets

2 March 2020

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It's not just utility companies that are replacing legacy fossil fuel generation with renewable sources. Around the world, heavy hitters such as Amazon, Microsoft, Apple and Google have arranged bespoke agreements with renewable power producers to provide clean electricity directly to their data centres and buildings.

Google, for example, made the biggest corporate power purchase agreement (PPA) in its history with the purchase of 1.6GW in renewable energy globally last year. That took the company's renewable energy portfolio to almost 5.5GW, more than the renewable energy capacity of countries such as Lithuania and Uruguay.

According to BloombergNEF, a record amount of clean energy was bought by corporations globally through PPAs in 2019, up more than 40% from the previous year's record. This came as governments in Europe scaled back subsidies that kept the renewables business growing for years. 

PPAs are long-term contracts under which a business agrees to purchase electricity directly from a renewable energy generator. Purchasers of PPAs are attracted by lower prices and the "green credentials"  from having their power supply come from 100% renewable sources. On the developer side, PPAs are necessary to finance renewable energy projects. Google, for example, said its PPAs would help towards the construction of $2 billion in energy infrastructure, including millions of solar panels and hundreds of wind turbines.

This means that PPAs are often fixed for long periods, up to 10 years or even more, to ensure revenue security for the developer.

These long-term agreements bear certain risks, however, which is where the futures market comes in. Most PPAs are financially settled, which means the price is fixed between the generator and the purchaser. However, the actual power produced is sold on the spot market, which creates price risk.

"Because of the ever-increasing trend towards long-term power purchase agreements, we see a strong demand from the market to hedge against the price and counterparty risk of the PPA agreements for the entire 2020 decade," said Steffen Riediger, director of European power derivatives at EEX.

EEX already offers cleared cash-settled futures contracts up to six years ahead in all major European power markets. Later this year it will be introducing 10-year base year futures in some of its European power markets to help members hedge a greater portion of their PPA risk.

"We will initially focus on extending the expiries in Spain, Germany and Italy to give our clients the opportunity to hedge the full 2020 decade," said Riediger, adding that the UK and Nordics may follow later.

"We are still watching developments concerning the future design of the UK power market after Brexit and potential bidding reconfigurations in the Nordic market area closely," he said. "We always strive to bring innovative products to the market, particularly to support further renewable energy investments and the market-based integration of renewables."

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