An Equilibrium Analysis of Power Purchase Agreements
Electricity market participants in the US use Power Purchase Agreements (PPAs) to sell and purchase electricity generated from renewable sources at a fixed price over long periods. These contracts are an essential means of financing renewable projects for the developers. This paper investigates the link between wholesale market risk and the equilibrium prices of these contracts. We first present a stylized model of PPA equilibrium to fix intuition on the relationship between PPA prices, wholesale prices, and market volatility. We then test the model predictions using data on all utility-scale wind projects. Results suggest that the mean retail and wholesale electricity prices have a positive association with PPA prices whereas wholesale price volatility is negatively associated with the equilibrium price. This finding is likely due to higher participation amongst risk-averse developers in the PPA market to avoid risk in the wholesale market. These findings highlight the role of government policy in reducing barriers to entry and regulations on contract length thereby affecting the participation of developers in the market.