Wind Farm Derivative Accounting and Reporting Considerations
By Matt Smith
With a lack of traditional utility power purchase agreements available to meet demand, wind project sponsors have turned to corporate power purchase agreements (PPA) and other hedging alternatives to secure predictable cash flows. Depending on the structure, these agreements can lead to derivative accounting, trigger Dodd-Frank reporting requirements, or both. The following discusses what each of these agreements represent and the associated derivative accounting and Dodd-Frank implications.
What is a PPA?
A PPA generally refers to a contract between two p arties where one party (seller) agrees to sell electricity and renewable energy credits (REC) to another party (buyer or offtaker) at a specified price. In this case, the seller is often the developer or project owner. The buyer is generally a utility or commercial and industrial (C&I) organization. With a physical PPA, the seller operates the wind farm and delivers the electricity generated from the wind farm to the buyer at the contractually specified delivery point.
Accounting Considerations: These contracts may or may not meet the definition of a derivative depending on whether the agreement includes volumetric guarantees or contains default provisions that indicate a minimum volume. If the contract meets the definition of a derivative, it may still be able to escape derivative accounting via the normal purchases and normal sales (NPNS) scope exception since the contract results in physical delivery.
Dodd-Frank Reporting Considerations: A physical PPA is not subject to Dodd-Frank reporting requirements as the contract results in physical delivery of electricity.
What is a VPPA?
A synthetic or virtual power purchase agreement (VPPA) is an alternative to a physical PPA. A VPPA is a hybrid agreement which includes a contract for differences (CFD) along with an agreement to deliver the related RECs from the project. Under a VPPA, there is no physical delivery of electricity. Rather, the agreement specifies a periodic payment to be made based on the difference between an agreed upon fixed price and a floating market price, generally at a market hub or a project node. Upon settlement, when the market price exceeds the fixed price, the seller pays an amount to the buyer equal to the difference times the agreed upon quantity. When the opposite is true and the market price is below the fixed price, the buyer pays an amount to the seller equal to the difference times the quantity.