Power Purchase Agreement
Also known as: PPA, Corporate PPA, Offtake agreement
A long-dated contract to buy electricity at a fixed price — the instrument that decides whether a wind farm gets built at all.
1 · SnapshotThe one idea to remember
2 · BeginnerWhat is it, really?
A power purchase agreement is a contract to buy electricity at an agreed price for a long time — often ten years or more.
It matters because of what it makes possible. A wind farm costs a great deal up front and earns nothing until it runs. A bank lending against it wants to know what the output will sell for. "Whatever the market pays" is not an answer anybody will lend against.
A signed contract with a creditworthy buyer is an answer. It turns an uncertain revenue stream into a predictable one, and that is what gets the project financed and built.
For the buyer, it is the other side of the same trade: a fixed price for a decade, which is protection if power gets dearer and an expensive commitment if it does not.
- Asset class
- Commodities (power)
- Instrument type
- Bilateral long-term offtake contract
- Traded
- Bilateral, increasingly intermediated
- Typical users
- Generators, utilities, large corporate buyers
Which risks decide the outcome
Not how risky this is, and not a rating — there is deliberately no total. It says which of five failure modes drives what happens here, in the same order on all 129 products so they can be compared. This publication's own reading; see the notice below.
- Marketdecides it
- Creditmatters
- Liquiditymatters
- Fundingbarely applies
- Operationalbarely applies
What decides it here. The power price decides it, and the shape of the generation profile decides how much of that price is actually captured. Ten years of counterparty exposure is the second question.
3 · IntermediateHow it works in practice
Two shapes, and the difference matters
- Physical: the buyer actually takes the power, with all the scheduling and balancing that implies.
- Financial (a contract for difference): both sides settle against the market price in cash, and the power is sold into the grid as normal. Most corporate deals are this shape, because most corporate buyers do not want to run a trading desk.
The risk nobody expects: shape
Wind and solar generate when the weather says so, not when demand is high. A generator selling at a fixed price is exposed to the difference between the average price and the price at the times it actually produces. When a lot of solar is on one grid, the price at midday is depressed by all of it at once.
- Volume risk: the output is not known in advance.
- Shape or capture risk: the output arrives at the hours when power is cheapest.
- Balancing risk: the difference between what was forecast and what was delivered, settled at short-term prices.
4 · AdvancedPricing & valuation
Valuation
The contract is a strip of forwards weighted by the generation profile, not a single forward at the average price:
What the symbols mean
- Va value
- hthe hedge ratio
- Ean expected value
- Fthe forward or futures price
- Kthe strike: the price written into the contract
- rthe interest rate, per year
The covariance between own output and the hourly price is the whole difficulty: it is negative for correlated renewables, which reduces the value of a fixed-price contract below what an average-price calculation suggests. Ignoring it is how a project is valued at signing and disappoints thereafter.
Credit runs both ways
A ten-year contract is a ten-year exposure to the counterparty. The generator depends on the buyer's survival to service its debt; the buyer, if prices fall, is holding an out-of-the-money commitment to a company that may not survive either. Collateral, parent guarantees and termination provisions are therefore where the negotiation actually happens.
Why this instrument is becoming a market
Standardised terms, intermediated structures and secondary transfer are turning a bespoke contract into something closer to a traded one. As that happens, the pricing questions above stop being project-finance questions and become the ordinary business of a commodities desk — which is the same path gas and freight contracts took before it.
The formulas above are standard textbook formulations, simplified for teaching. They explain the mechanism — they are not a valuation tool, and they will not reproduce a dealer’s price.
5 · Desk notesHow practitioners think about it
Now say it back
Close the page and give Power Purchase Agreement in four sentences. It takes a minute and it is the only way to find out whether reading it was enough.
- Who wants what — two parties wanted opposite things badly enough to write it down.
- What the contract obliges, and when — not the payoff; the obligation.
- Where the money comes from — name the source, or you have described a hope.
- What makes it lose — the ordinary way, not the dramatic one.