PPA structures are evolving, and the challenge of Hybrid PPAs lies behind understanding and quantifying the benefits of flexibility, and how it’s reflected in the pricing. The risk profile of the asset is the core determinant of its fair value. And since energy storage changes the risk profile of the generation part, this would need to be reflected in the price.

To understand what’s driving the Hybrid PAP pricing, it would be better to go through how benchmark PPA prices are modelled, and the risk components driving the fair value of the energy.

What are the components driving PPA Prices?

Hybrid PAP PPAs come with a premium. To better understand how the value of the storage is influencing the PPA price, we are illustrating exactly which risk components and costs have an impact. This is why there’s no one ‘universal truth’ PPA price, but benchmark PPA prices instead which are then applied on a case-by-case basis by involved parties.

The components who drive the PPA pricing
PPA Risks Value of baseload power The first step in PPA pricing is understanding the value of the baseload energy, which is different from market to market. To infer what the future value of baseload prices would be, traded futures contracts are used as a reference, since there’s no visibility of the future spot prices to understand the value of baseload power in the wholesale markets.
Price Risk For producers, price risk is the uncertainty of not knowing the future value of the energy the asset will produce throughout the life-cycle of the asset. The uncertainty stems from the high volatility seen in the wholesale and futures markets. Market-based PPA pricing calibrates traded contracts in the futures markets to understand the future value of the baseload energy, In illiquid markets with opaque pricing visibility where term contracts (futures) have a liquid horizon of 1-3 years, price risk is likely to be larger.
Capture Risk Capture risk refers to the probability of price cannibalization in the spot markets, which could occur when renewable energy with the same profile pattern produces at the same time depressing the wholesale price (and therefore the revenues the asset will get at that point of time). In the modelling, capture risk quantifies the probability of cannibalization to occur.
Volume risk Volume risk illustrates the long-term variations between expected and actual production, as a result of the inherent weather-dependent liability of renewables.
Physical costs Balancing costs The magnitude of the imbalance cost is driven by the actual deviations between scheduled production and real production (“forecast error”), the regulatory design of the balancing market (i.e., punitive design with penalties) and whether portfolio effects may exist. The seller usually has a balancing agreement with a third party for a fee as a mitigation tool, which as the energy mix fills in with more intermittent renewables, could increase significantly
Grid Costs Grid costs refer to grid usage fees that asset owners (and every network user) need to pay to network operators to connect their assets and transfer their electrons to the grid.
Profile costs Profile costs occur when cannibalization has driven capture factors below 1, reducing the value of the energy produced. Capture risk is the probability of cannibalization to occur, and profile costs are the result of when cannibalization does materialize
Hedging costs The last cost to take into consideration is the cost of hedging, which is applicable primarily to trading houses and utilities. The cost accrues through ‘stack’n’roll hedging’ which requires back-to back deals possibly resulting in losses when the price you buy and sell is not consistent, and administrative cost fees of transactions.

Now, moving to Hybrid PPA pricing the key influencers is capture risk, deriving from the profile shape, and profile costs.

Firstly, energy storage is among the prime physical tools to mitigate capture risk, because through profile shaping the storage element can shift the power delivery to slots when the electrons are needed the most. The renewable asset can react to daily pricing patterns, resulting in an optimized delivery of the electrons, when they are needed the most.

Secondly, price cannibalization can go as far as negative pricing, while there may also be cases of curtailment where the grid operator will order plants to shut down. In terms of financial hedging, profile risk can only be transferred from one party to the other. However, through the addition of a physical hedge, the timely reaction to daily pricing patterns not only results in reduced profile costs, but such costs could become profile benefits.

Profile costs are measured with a view of historic and estimated forward capture factors. Such metrics illustrate the ratio between baseload prices (in this case the average spot price over a selected timeframe) and the capture prices (the average prices each generator will manage to realize over a period of time). Not all technologies share the same capture prices, with the main factor that influences achieved revenues being the seasonality of production. Since renewables are inherently intermittent, the narrative of the cannibalization effect is mainly intertwined with wind and solar, contrary to thermal production technologies.

As more renewables get connected to the grid, price cannibalization across Europe is set to increase, driving down capture factors. Improved capture factors influence PPA pricing either directly – through a Premium Hybrid PAP – or indirectly.

The latter applies to Baseload PPAs, where even though energy storage may not necessarily play a role in the BL hedge structure, the seller has visibility of their capture risk which is directly linked to the management of their open position, when the asset is not able to deliver the agreed volumes.