As C&I consumers in India seek to procure more renewable power, they are keen to consider alternative procurement models particularly because of the various challenges faced by traditional rooftop solar and open access routes. A new route, virtual power purchase agreements (VPPAs), immensely popular internationally, is gaining more attention in the process. In the USA, VPPA volumes were estimated at 6.4 GW in 2018 and 3.8 GW in H1 2019. The model has become the favoured choice of consumers in the USA, UK, Australia and elsewhere. It is preferred over conventional PPAs and other procurement routes because of its simplicity and scalability.
- VPPAs are hybrid financial transactions providing effective price hedge to both project developers and consumers subject to efficient exchange-based trading of power;
- VPPAs have huge growth potential in India as physical delivery-based open access route faces severe implementation barriers in many states;
- Many large consumers are keen to tap the VPPA model in India but progress still seems some way off because of various regulatory glitches;
A VPPA is a hybrid transaction, somewhat akin to a Contract for Difference (CFD), whereby a consumer agrees to notionally purchase power from a project developer for a fixed cost (strike price, X) and period. But both parties trade physical power on the exchange at prevailing market prices (M) and settle the difference between strike price and market price periodically between themselves, effectively providing them a complete price hedge. ‘Green’ attributes attached with renewable power, or RECs, are simultaneously transferred by the developer to the consumer.
Source: BRIDGE TO INDIA
Note: This chart shows only financial flows between different counter-parties.
The VPPA model is best used when a renewable power plant is not able to supply physical power directly to the consumer because of sub-optimal location (lack of suitable land in proximity or high cost, low resource) and/ or transmission constraints and/ or high grid charges. There is no need for the two parties to be connected to the same utility or regional transmission network. On the flip side, VPPAs require an efficient exchange-based market with market price parity between the points of power generation and consumption. Any deviation in prices at the two points reduces effectiveness of the hedge. Similarly, VPPAs work only when there is negligible curtailment risk.
In India, VPPAs can help consumers overcome lack of inter-state scheduling of power, infrastructure constraints as well as policy risk associated with open access. The model could be huge success in states like Haryana, Punjab, West Bengal, amongst others, where such challenges have prevented growth of open access renewable market so far. But there are a few regulatory and market challenges in the way. First, there is no clarity over regulatory jurisdiction over VPPAs. Since VPPAs are structured as bilateral contracts i.e., not traded on any platform, there should be no approval required from any regulatory agency for such transactions. But both CERC and SEBI, the financial market regulator, claim jurisdiction over all power derivative contracts. Subsequent to a legal case, the two agencies have agreed that SEBI would regulate financially traded contracts, while CERC would oversee physically settled contracts. However, VPPAs combine elements of both financial and physical settlement and hence, ambiguity in this matter still persists.
The second major regulatory issue with VPPAs relates to bilateral transfer of ‘green’ attributes or RECs from project developer to consumer, which is currently not allowed in India. Moreover, the project developer needs to sell power on the ‘brown’ exchange to retain ‘green’ attributes for transfer to the consumer. But selling renewable power on the ‘brown’ exchange is not viable due to onerous forecasting & scheduling provisions. High (and volatile) short-term open access charges are also a barrier.
We understand that as open access market is facing severe implementation challenges in many states, some international IT and manufacturing companies are actively exploring feasibility of the VPPA model in India. But progress still seems some way off.