Accelerating Power Purchase Agreements (PPAs)

The risks and accounting dimension of Power Purchase Agreements can be complex and delay the signing process. Depending on how the agreement is structured, the impact on financial statements may be substantial. Aspects such as the treatment of derivatives and leasing have to be considered in order to optimize PPA implementation. The own-use exemption and hedge accounting may represent attractive solutions in certain scenarios. Also, fair value measurement requires in-depth contract analysis and access to market data and robust valuation tools. It is our ambition to support organizations in their energy procurement transformation efforts. 

Derivatives, fair value, hedge accounting

If a PPA – such as a green VPPA – contains a price fixation component, this mostly implies a classification as a derivative and entails respective consequences for financial statements. The PPA is then considered a financial instrument similar to futures or options, i.e. with fluctuating future value in relation to energy market price developments. Derivatives or derivative components are to be accounted for in accordance with IFRS 9. It may be advisable to separate the contract’s specific agreements on GoOs or RECs from the power purchase transaction itself because otherwise, the contract in its entirety will have to be measured at fair value. Initially, fair value is usually equal to zero. In other cases, e.g. if fair value differs from transaction price, Day 1 Gains or Losses need to be analyzed with regard to additional risk. It is crucial for organizations to build up the necessary capacity to measure fair value and to recognize changes in P&L. In order to decrease P&L volatility over time, in rare circumstances the PPA could be designated a hedging relationship if certain restrictive conditions are fulfilled. Such hedge accounting has clear advantages through reduced P&L volatility, but it also introduces high requirements and complexity (e.g. requirement for effectiveness measurements, notes disclosure). A thorough evaluation is therefore critical. 

Accounting considerations should be discussed early in the PPA signing process in order to avoid surprises at the end.

Leasing and own-use

Another important aspect of PPA accounting is the potential classification
of a Physical PPA as a leasing contract from a developer´s perspective, which
would imply accounting according to IFRS 16. In this context, it is necessary
to differentiate pay-as-produced agreements from volume- or baseload-oriented agreements. If the transaction involves the transfer of all benefits produced, including RECs, it may be a case of leasing. Another indication of a lease contract is the transfer of control over the asset (e.g. right to shut down).
In general, lease accounting may not be ideal as it increases complexity and
implies the recognition as lease asset. To avoid these implications – for
instance in pay-as-produced contracts – the focus should be on control rights
exclusion. If only some of the lease contract conditions are fulfilled, the
financial instrument accounting options may apply. In such situations, the
applicability of own-use rules should be evaluated as a next step. The contract
is considered outside the scope of IFRS 9 (derivatives) if the contract is not net
cash settled, involves physical power procurement, and the volume specified
does not exceed actual power needs. However, it is still necessary to screen
the agreement for embedded derivatives. For most industrial companies, the
own-use option is very interesting because it reduces fair value measurement
complexity and profit and loss volatility. 

Risks, opportunities and valuation of PPAs

Understanding the risks and opportunities within PPAs is key to the decision-making process and the Fair Value measurement. It is important to analyze the underlying contract structures regarding volume and pricing and determine the relevant input parameters. The later ones can be difficult to assess and required market data might not be available on short notice. It can therefore be helpful to determine suitable market data providers considering costs and benefits and integration possibilities. At the end a robust valuation solution must be developed that serves as a basis for pre-deal analysis and post-deal valuation for IFRS reporting. Finally, a documentation of the methodology, functionalities and workflows should summarise the overall approach. 

Combined competence in sustainable energy: Deloitte and LevelTen

When embarking on the PPA route, a detailed strategy is an essential precondition to conclude a contract in a short time frame. Specialist qualification and experience enable Deloitte experts to offer valuable PPA support to energy and industrial companies, such as:

• cross-functionals workshops to understand the risks and drivers of a PPA,
• accounting support using a contract analysis tool,
• valuation and risk advisory services to develop a tool for IFRS - Fair Value Measurement,
• and audit services.

In a further step to contribute to our climate ambitions, Deloitte has started a collaboration with global renewable energy marketplace provider LevelTen Energy. LevelTen’s market platform for PPAs is based on advanced technology, including data and analytics options. For clients, it represents an attractive pathway to low-carbon energy solutions to actively source PPAs. The combination of Deloitte’s accounting expertise and efficient market access through LevelTen’s offering empower organizations to find the best way forward – towards a more sustainable future of energy. 

Download the full report „Accelerate Accounting for Power Purchase Agreements” for detailed information here.