PPA Structures: Fixed Price or Market-Linked

The financing advantage of a fixed-price PPA

A fixed-price PPA isolates the project's revenue from market price fluctuations; this predictability makes it easier for lenders to offer a higher debt ratio and longer tenor.

A fixed-price structure can also help the sponsor achieve a higher valuation multiple, since future cash flow uncertainty is reduced.

The risks and opportunities of a market-linked PPA

A structure tied to market price, or fully merchant, offers higher revenue potential when electricity prices rise, but that same potential increases revenue volatility.

Lenders typically demand a lower debt ratio, shorter tenor, or additional price risk hedging mechanisms (hedge contracts) on these types of projects.

Using price hedging mechanisms

When a fully fixed-price PPA isn't available, sponsors typically manage market price risk partially through financial hedge contracts, such as a contract for difference.

These hedge structures try to synthetically approximate a fixed-price structure for the project's revenue, but they bring their own risks along with them, such as counterparty risk.

Matching PPA duration to loan tenor

A PPA duration shorter than the loan tenor creates revenue uncertainty for the remaining part of the loan; lenders typically prefer the PPA duration to cover the loan tenor, or at least the bulk of it.

The gap between PPA duration and loan tenor is treated as "tail risk," carrying the risk of transitioning to re-contracting or market sale, and it's typically offset with a more conservative debt ratio.

The importance of offtaker credit quality

As much as the PPA's price structure, the offtaker's credit quality directly affects financing terms; a contract with a government entity or an investment-grade company secures a lower cost of credit.

If the offtaker's financial position is weak, lenders typically offset that risk by demanding additional collateral, a letter of guarantee, or a reserve account.

Frequently asked questions