WattCarbon 2023 Recap and 2024 Look Ahead - Part 3
vPPAs for DERs
With the passage of the Inflation Reduction Act and improvements in the economics of renewable energy, one of the success stories of 2023 was the massive deployment of new clean energy projects. According to the Clean Energy Buyers Association, more than half of these projects in the United States were funded behind a corporate financial commitment. Increasingly, these commitments are coming in the form of a Virtual Power Purchase Agreement (vPPA). vPPAs allow renewable energy facilities to be built remotely, where land is available and a grid interconnection can be secured, and while the electricity produced by the facility does not go directly to the buyer, the environmental attributes (EACs) are retained by the buyer to be claimed against a net-zero energy goal.
vPPAs (and their onsite equivalent PPAs) also solve a vexing additionality problem with emissions mitigation strategies. Here’s why. All projects entail risk, which in turn determines the cost of providing financing for the project. To the extent that the risk of repayment is reduced or eliminated by an offtaker such as a company, the costs of deployment are reduced. Even if a project might have been able to be completed at a higher financing cost without the risk reduction, lower financing costs allow capital to be returned more quickly and redeployed into more projects. Simply put, the more that the risks of investing in decarbonization projects are reduced, the more efficiently capital can be deployed and at a much lower total cost.
Bundled vs Unbundled EACs
The WattCarbon EAC marketplace, in the form that it was deployed in 2023, offered “unbundled” EACs. That is, while we met the core criteria articulated by the Department of Energy for incrementality (all projects in our marketplace were completed in 2023), the EACs from these projects were delivered independently from the energy value. There was no direct connection between the financing of the project in the first place and the payment of the EACs. There were probably many cases in which the projects would have happened anyway! After all, there are quite a few people who want to try to eliminate their own use of fossil fuels and are willing to go to great lengths (and cost) to do so.
There’s a critique that’s made that because there are people who are willing to personally absorb the costs of decarbonizing buildings (or potentially regulations that force them to decarbonize), that the environmental attributes from these projects are automatically nullified. While the projects may be “incremental” in the eyes of the DOE, they are not “additional” in the eyes of carbon accountants. Therefore, these projects should be ineligible for any subsidy of any kind, especially one that enables a company to reach a net zero energy goal.
We consider this hardline stance to be unhelpful and short-sighted. But we also don’t make the rules and realize that a range of alternatives will be needed depending on the particular interpretation of reporting requirements. For companies that need a stronger “additionality” claim, the EAC needs to be “bundled” in with the delivery of energy. A vPPA solves this problem by requiring the offtaker (the company trying to reach net zero energy) to own the risk of the energy delivery so that a project can be financed. If the energy delivery materializes, and the environmental benefits are realized, the offtaker can claim the EACs from the project (and potentially the cash flow from underwriting the risk). If the project fails to perform as expected, the offtaker loses out on potential EACs and absorbs the financial loss. Either way, by putting its own balance sheet directly on the line, the offtaking company earns the right to claim the environmental attributes - they become bundled.
vPPAs for DERs
As we contemplate how to reduce the costs of decarbonizing buildings from current projections of $100 trillion to something closer to $10 trillion, it’s helpful to consider how the same vPPAs that are being used to underwrite the development of large scale renewable projects could also be structured to reduce the financing costs associated with the deployment of distributed energy resources. Could we, for example, fund the deployment of energy efficiency projects in schools as part of a vPPA, where the school repays the costs of the project over time out of its own bill savings? Perhaps heat pumps in apartment buildings could be financed this way, but where the risk of repayment is offset by the value of the EAC. Imagine a company that wants to make an impact in its community committing its carbon offset budget to eliminating the financing costs for its employees to decarbonize their homes. A vPPA allows the company to take on the risk portion of the financing even as employees make payments for the value of the heating and cooling produced by their new equipment to return the initial capital invested. Bundled EACs give the company a clear line of sight between their net zero commitments and actual emissions reductions from their funded projects.
To be clear, this is not a new idea. Companies like Redaptive, Carbon Lighthouse, Gridium, and many others have offered energy as a service contracts, and rooftop solar has long relied on lease structures to cushion the upfront costs for consumers. What’s different is that these projects have also delivered environmental benefits, but aside from solar RECs, the environmental benefits have largely been ignored. A vPPA structure allows a third party to underwrite the financing risks of distributed energy projects (whether in the form of generation, demand flexibility, or electrification), and obtain title to the EACs from the project to report against net zero energy goals. But instead of the price of the finance being linked to the balance sheet of the project developer or to the creditworthiness of the end customer, the corporate backstop allows the vPPA finance costs to be priced against the corporate offtaker’s balance sheet itself. This is game changing!
vPPA Economics
To better understand the powerful redistributive impact of project finance, consider the case for the average consumer. A typical heat pump installation might cost $20,000 after incentives. A well-off customer might decide to pay cash for the project, which means that the cost is simply the cost. But only 14% of Americans have more than $20,000 in savings, which means that for the other 85%, a loan will be necessary in order to pay for the installation of the equipment. Some states are now offering zero percent interest loans, but the vast majority of people will still be required to self-finance. A lucky homeowner might be able to take out a Home Equity Line of Credit (HELOC) at a 9% interest rate over 10 years. The interest charges from the HELOC would add $10,000 to the cost of the project. A non-homeowner might have to put the cost of the equipment on a credit card. With typical interest rates for credit cards, over ten years, the cost of the project would balloon to $50,000 due to interest payments. For as long as we finance decarbonization projects on the backs of consumers, our most vulnerable people will collectively pay a much higher price than needed to achieve the same environmental benefits as the most well-off.
By redistributing risks, vPPAs massively accelerate the deployment of capital into clean energy projects on terms that are fundamentally fairer to society. Because vPPAs are tied to the delivery of clean energy, the owner of the risk in the vPPA is entitled to the EACs associated with the project. The double bottom line advantage for corporate procurement of clean energy through a vPPA is not just a potential return on investment from the delivery of the energy, but also a sustainable strategy for meeting net zero energy goals.
vPPAs for DERs allow us to start rethinking the capital stack for decarbonizing buildings. Rather than putting the entirety of the financial burden on the end consumer, the vPPA allows the upfront cost and project risk to be borne by entities with access to low cost capital. Most DERs return positive cash flows within a few years, in addition to environmental benefits, making a vPPA for DER deployment one of the best net zero investments available.
Looking ahead to 2024
Beginning in early 2024, WattCarbon will be offering vPPA contracts through select deployment partners, providing companies with net zero goals the opportunity to invest in projects with financial and environmental returns, where the EACs are bundled with the delivery of clean energy from the DER. These vPPA contracts will be designed to create long-term cash flows that can be reinvested into more clean energy projects while also generating a continuous stream of EACs that can be reported against net zero goals. This will be new for us in 2024 and we will roll it out slowly as we build the financial infrastructure to scale the deployment of capital. But make no mistake, there will be no more impactful allocation of capital over the next decade than the capital going to building decarbonization projects. 2024 will be the year of the EAC, but the vPPA will be the hallmark of the decarbonization age.