What the hell’s a Volume Firming Agreement?

Power purchase agreements have increased in popularity over recent years, with big corporations accounting for over 14GW of renewable energy deals agreed in the US between 2013 and 2018. Tech giants including Google, Amazon and Microsoft have been happy to sign them because they make business sense. We know that by now.

However, these PPAs are still seen as too risky by many small- and medium-sized companies. The intermittent nature of wind and solar supply and the financial impact of these agreements are just too much for smaller companies.

This is why we’re intrigued by a new solution proposed by a group led by Microsoft.

Microsoft has teamed up with risk management company Resurety, weather risk insurance firm Nephila Climate and the alternative risk transfer unit of Allianz, to create a new contract called Volume Firming Agreement (VFA).

This new mechanism can be used to mitigate price risk to the buyer, and Microsoft, which has a portfolio of 1.2GW of renewables PPAs worldwide, said it anticipated ‘utilizing VFAs to firm the energy and match our consumption on an hourly basis.’ In fact, the tech giant has already signed three of these contracts, in partnership with Allianz and Nephila, at wind farms in Texas, Illinois and Kansas totalling 500MW.

This is how this new structure works.

The first thing to say is VFAs don’t replace traditional power purchase agreements but can be used in conjunction with them, to mitigate price fluctuations for buyers. Traditional PPAs establish a fixed-price over the long term for renewable energy, but the reality is that actual market prices fluctuate hourly, depending on production.

For example, when winds blow strongly and electricity is abundant, the market price of wind energy will fall – and so will the price that the buyer receives from the grid for its power. This means the buyer will be obliged to ‘top up’ this deficit.

Of course, the same works in reverse – in times of low resource, market prices are high and the IPP, which now commands a high price for its power, will share these profits with the buyer. However, this uncertainty is a deterrent to smaller companies.

This is where the VFA comes in. The idea revolves around taking risk from buyers and reallocating it to businesses that want the risk – namely, insurers. The growing interest in using hedging products in the wind sector shows that there’s demand.

The idea is that, as the market for VFAs and similar products grows, insurance firms would be encouraged to invest in storage and other solutions capable of balancing renewables supply and demand. This would support the rollout of storage systems and improve the stability of renewable energy. We have all heard the accusations of unreliability that are levelled at renewables – so this is an important step.

The VFA could make a big difference to small- and medium-sized businesses, which are considering signing a PPA but struggle with the inherent risks. Large companies and conglomerates have the financial heft and experience to deal fluctuating prices, but these are often bigger risks for smaller companies, where the people signing the PPA may not be energy experts or have even signed a PPA before.

Of course, that raises another question. If the people in charge of signing the energy deals at these small- and medium-sized businesses aren’t experienced with PPAs, then how will they react if they’re forced to understand a VFA as well? It could be a useful solution, but one that further confuses those that that it seeks to help.

So in theory, it’s a yes from us. Helping small businesses to understand the process of signing PPAs, and mitigate their risks, will be crucial if PPAs are to move beyond their current status as deals that are predominantly signed by multinationals. A VFA could be a first step to provide the security they need to sign on the dotted line – but it’s up to the industry to explain what one actually is first.