Power Purchase Agreements (PPA) 101
What is a PPA?
A power purchase agreement (PPA) means that the school district only buys the solar electricity generated by one or more solar systems installed by a third party at one or more of the school district facilities. Notice that school district does not buy any equipment. It is just a contract to supply solar electricity at a know price for the long term.
Does it make sense?
Under the terms of a solar PPA, a third party owns, operates, and maintains the solar system and sells 100% of the solar electricity generated to the school district at a locked price for a term of up to 25 years. The federal tax incentives available to businesses - the investment tax credit (ITC) and accelerated depreciation - can offset 50% or more of the installed cost of a solar system. The PPA provider can then pass a portion of the savings on to the school in the form of a lower PPA cost of electricity.
Is it cost effective?
As a result, the third-party ownership model can be a cost-effective arrangement for many public entities that are interested in pursuing solar but lack access to the necessary funding or prefer to forego ownership for other reasons. Additionally, buyout options can be negotiated into the contract for the host to purchase the system sometime after 6 years and up through the end of the PPA term at the solar system's fair market value.
Advantages of Third-Party Ownership
Ability to benefit from the Federal Investment Tax Credit (ITC).
Commercial entities can benefit from the 30% ITC. By lowering the cost of the project to the solar developer and its investors, a lower solar electricity price can be offered to the school districts.
Ability to benefit from accelerated depreciation.
Solar installations can be depreciated over a 5-year period rather than over the expected useful life, which is much longer. The impact of depreciation usually is greater losses for the investors, which then are used to offset other taxable gains. Like the ITC, the host benefits from accelerated depreciation in that it could allow for a lower price per kilowatt-hour of electricity in the PPA.
No up-front capital investments.
Although installed costs are declining, the required initial investment to install a PV system is still significant, even after rebates. The cost of a 1MWp solar system on a middle school, for example, can exceed $2,500,000. Using the third-party PPA model, it is the solar developer and investors that finance and own the system, thus eliminating the need for the school district to invest its own capital into the project.
Locked electricity prices for 20+ years.
Power purchase agreements are structured with a locked price per kilowatt-hour of electricity that is adjusted annually with a pre-determined inflation rate, also known as escalator, for the length of the contract. The kWh price is most likely competitive with the utility rates that a school is currently paying.
Operation and maintenance responsibility is handled by the system owner.
The system owner operates and maintains the solar system, removing this burden from the school district. This includes replacing the system's inverters should they fail after the standard 10-year warranty but prior to the end of the PPA term.
Buyout option provides ownership potential.
Often PPAs are structured so that the school district has the option to buy the system at various points during the life of the PPA. The first option to buy the system takes place sometime after year 6, because changing ownership before then causes significant tax penalties. The buyout price is typically calculated as the greater of fair market value of the solar system or the discounted cashflow of the remaining payments in the PPA term.
The risk of electricity production is borne by the PPA provider. The school district only is obligated to purchase what the system produces. Additionally, the PPA provider commonly guarantees a certain level of minimum production of electricity, compensating the school district for any shortfall.
Disadvantages of Third-Party Ownership
No free electricity.
Although the PPA price will ideally be less than retail utility prices, the school district does not own the solar system; therefore, it will pay for the solar electricity generated at the facility. There isn't a feeling of free electricity from the sun when the distric owns the solar system outright.
No ownership of the "clean" energy attributes produced by a PV system.
Whoever owns the system claims its environmental benefits, unless those benefits have been sold to another party such as the utility.
School districts are not familiar with PPAs
Because a PPA is a new financing tool, school districts need to allocate resources and time have to understand it. To recoup some of these transaction costs, some PPAs reimburse the school district for legal expenses incurred in negotiating the PPA. This could be a way to develop internal support for a transaction.
Large solar systems drive costs down
Placing numerous small solar systems on many school buildings is unlikely to be cost effective. Ideally, for example, a high school or maintenance facility that can host a system as large as 1 MW to anchor a system-wide PPA project could be required. In the absence of a large installation, costs will increase.
Facility access by third parties is necessary.
The developer and its subcontractors need access to the site to install the solar system and then to maintain it over time. For school districts this often must be coordinated so that students and faculty are not disrupted during the installation process.