Japan Renewables Alert 56: Corporate PPAs (No.1)

Orrick, Herrington & Sutcliffe LLP

Orrick, Herrington & Sutcliffe LLP

日本語:コーポレートPPA (第1弾)

Today’s Topic

Corporate PPAs (No.1)

  1. Contract Structures for Corporate PPAs in the US
  2. Consumers to Be Eligible to Directly Purchase FIT RECs
  3. Corporate PPA Panel Discussion at Solar Energy Future Japan 2021

Corporations have dramatically increased their purchases of renewable energy recently. This worldwide trend has shifted the traditional power purchase market away from reliance upon utilities and presents a tremendous growth opportunity for renewable energy project developers—the Corporate PPA—the scheme wherein the generated renewable energy is purchased by a corporate buyer as opposed to an electricity utility.

Orrick’s US team has advised on some of the earliest Corporate PPAs since 2008 and helped to develop one of the first virtual PPAs in 2012. Considering our corporate PPA experience in the United States and our renewable experience as well as the recent trends in the Japanese energy market, we are planning to distribute a series of alert letters from time to time on corporate PPAs in order to assist smooth introduction of Corporate PPA in Japan. This Japan Renewables Alert, being the first issue of the series, will introduce some of the typical corporate PPA structures in the United States and then focus on the recent reform of the REC (renewable energy credit) market in Japan.

1. Contract Structures for Corporate PPAs in the US

In the United States, Corporate PPAs have been grouped into two categories: (1) “physical” PPAs, which provide for physical delivery of electricity, and (2) “virtual” or “synthetic” PPAs, which are based on the concept of financially settling differences between floating prices in the local electricity market and contracted prices under the PPAs based on a volume of electricity.

(1) Physical PPAs

Physical PPAs require renewable energy to be physically delivered to buyers. On-site generation, also referred to as “behind the meter” generation, is the most direct form of physical PPA, and entails the generation and the use of renewable energy on the same site. In most states, these physical PPAs qualify as “self-generation” and are generally permitted. However, while on-site generation can provide a significant portion of the energy needed for normal business uses, they cannot supply the largest loads.

Corporate buyers with larger energy needs, such as data centers, manufacturing facilities or warehouse facilities, can enter into physical PPAs with owners of offsite energy projects. Those projects typically provide much larger amounts of renewable energy (up to several hundred MWs). An offsite project delivers energy to a buyer at a particular point on the electric transmission system (often, but not always, the project’s point of interconnection), the title to the energy is transferred from seller to buyer at that point, and the energy is then transmitted by (or on behalf of) the buyer to its actual load. The seller will also transfer RECs associated with this energy to the buyer through the applicable REC tracking system for the region in which the project is located. This type of PPA most closely resembles traditional PPAs between renewable energy generators and utilities. However, unlike sales to utilities, this type of transaction – a direct retail sale by a seller that is not a regulated utility – is only permitted in a handful of states. In some cases, sellers and corporate buyers can structure a “sleeved transaction” to work around direct retail access regulations. In these transactions, sellers and buyers add a third-party entity that serves as the retail entity that will (and is authorized to) purchase power directly from the nonutility generator and sell to the corporate buyer.

(2) Virtual PPAs

When presented with the regulatory limitations inherent in physical PPAs, corporate buyers are increasingly choosing to contract through virtual PPAs. A corporate buyer might choose a virtual PPA if it has multiple distributed loads (such as a number of data centers, stores, or offices) or if direct retail access is not permitted in the state where the corporate buyer’s facilities are located. Although these PPAs do not involve the direct physical delivery from seller to buyer of energy, these PPAs enable the construction of new renewable energy facilities and the injection of additional renewable energy into the electric grid. And, if the project is located in the same energy market as the buyer’s facilities, the benefits of additional renewable energy (such as reduced emissions of GHG and other pollutants) will be felt in the same region in which the energy was generated. Importantly, virtual PPAs need an appropriate market environment that facilitates selling and purchasing of electricity. Virtual PPAs can be contracted for those projects located in regional transmission organizations (RTOs) or independent system operators (ISOs) which allow for the active trading of electricity and which have a highly liquid market for trading energy. Virtual PPAs can take several forms, all of which are intended to enable the construction of new renewable energy projects. In a “contract for differences,” (1) the buyer agrees to purchase renewable energy and RECs from a project for a fixed price, (2) the seller sells the project’s electricity (without the associated RECs) into the market (keeping the proceeds from that sale), (3) the seller transfers RECs generated by the project to the buyer, (4) the buyer purchases electricity from its local utility, and (5) the buyer and seller settle the difference between the PPA (fixed) price and the applicable real-time market (floating) price on a periodic basis based on the brown power sold. Financial settlements typically require the buyer to pay the seller the difference between the two prices if the market price is less than the fixed price, and the seller to pay the buyer the difference between the two prices if the market price is greater than the fixed price. Contracts for differences generally do not specify a fixed “notional” amount of energy that is required to be delivered by the seller to the buyer.

Virtual PPAs can also take the form of hedging agreements, such as a fixed for floating swap, in which the buyer pays a fixed (PPA) rate and receives a floating (market) rate for the energy produced by the project. The seller also transfers title to the RECs associated with that energy to the buyer. The swap can apply to all or a portion of the energy produced by the project or to a notional amount. In either case, the agreement provides for a fixed price arrangement that the seller can use to finance construction of its project. A virtual PPA can also be structured as a “collared” transaction, in which the buyer guarantees a floor price for the renewable energy, and the seller provides a ceiling on the energy price, so the price to the buyer and the revenue to the seller are assured of being within a defined range.

(3) Implications for the Japanese Market

Japan has already seen a number of on-site corporate PPA projects that qualify as “self-generation and self-consumption” as in the United States. With respect to off-site corporate PPAs, a corporate consumer can virtually procure on-grid renewable energy electricity by engaging an electricity retailer as a go-between to procure energy from the renewable power plants.

Scope 2 Guidance of the GHG Protocol has been regarded as the international standard on what constitutes “renewable energy” when corporate consumers procure electricity from third parties. Under Scope 2 Guidance, a corporate consumer needs to be able to track down the originating power plant for the environmental attributes of the renewable electricity it purchases. In Japan, such requirement can be met by utilizing Non-Fossil Certificates (hikaseki-shousho; “NFCs”) and the tracking system through which the attribute information of specific power plants is appropriated to buyers of NFCs. The source of electricity and the source of environmental value may not necessarily be the same if the environmental value derived from the energy can be separated as a REC; even under the current NFC system, an electricity retailer, for instance, can supply to its customers energy that is substantively renewable by procuring NFCs from power plants other than the originating power plants for the electricity it procures.

However, under the current NFC system, consumers cannot directly procure NFCs on their own; without having an electricity retailer as a go-between, it is difficult for a corporate consumer wishing to procure on-grid renewable energy from off-site renewable power plants to obtain RECs associated with a certain renewable power plant of its choice. The demand for renewable energy has diversified as some corporate consumers become more active in pursuing their renewable energy goals by requiring “additionality” (i.e., newly introducing renewable energy in the market through engagement in the construction of renewable power plants) in the electricity they consume. More and more corporates wish to achieve corporate PPAs by which they can procure renewable energy from specific power plants of their choice at a sensible price under the structure of their choice, and they are strongly demanding changes to the current system and regulations to allow for better accessibility and direct acquisition of RECs.

2. Consumers to Be Eligible to Directly Purchase FIT RECs

As described above, how RECs are treated and traded is one of the key elements for consumers in corporate PPAs. Although NFCs have been playing the role of RECs for on-grid electricity in Japan, some corporate consumers have found it difficult to utilize them for the corporate PPA structure they would like to adopt under the current scheme of NFCs, which allows purchase only by electricity retailers. In response to a strong demand, the NFC scheme is currently under the reform and the REC market in Japan are undergoing drastic change.

The Ministry of Economy, Trade and Industry (“METI”) has started reforming the Non-Fossil Value Trading Market (hikaseki-kachi-torihiki-shijou; “NFC Market”) and create a Renewable Energy Value Trading Market (saiene-kachi torihiki shijou; “REV Market”) in which not only electricity retailors but also electricity consumers will be able to purchase FIT Renewable Energy Certificates (“FIT RECs”) that will represent the environmental value of FIT energy sources. METI expert committees (mainly the Working Group for Systematic Review (“Working Group”) under the Electricity and Gas Strategic Policy Subcommittee) have been discussing matters related to this new REV Market, and on October 12, 2021, METI released a summary of discussions at the Working Group in a draft Sixth Interim Report (“Sixth Interim Report Draft”) that has been opened to public comments (until 5:00pm on November 11; see here; provided only in Japanese).

With worldwide recognition of decarbonization as a pressing issue, corporates increasingly demand that the electricity they use for themselves and in their supply chains come from renewables, and more and more corporates are expected to seek various ways to procure renewable electricity, including through corporate PPAs. Although the REV Market will initially focus on FIT-generated RECs for the time being, the establishment of the REV Market creates a way for consumers to obtain RECs for on-grid power that were previously only available to electricity retailors, which diversifies the ways in which consumers can purchase electricity with RECs. As the REV Market may be expanded to include RECs derived from non-FIT renewable projects in the future, its scheme and the operation will have a significant impact on the future of the renewable energy market in Japan.

(1) Previous NFC schemes

The environmental value of electricity that are generated from renewable energy sources and delivered to consumers through the power grid have been traded through the NFCs representing such value. The purchase of NFCs, however, has been limited to electricity retailers as the NFC scheme was originally established in 2018 in order to make the “non-fossil value” of non-fossil power sources visible and tradable to encourage electricity retailers with a certain volume of sales to achieve the required non-fossil power source ratio (44% or more by 2030, in principle, under the “Standards for Determinations by Electricity Utilities on the Use of Non-Fossil Energy Sources” (METI Notification No. 112 of 2016) pursuant to Article 5.1 of the Act on Promotion of Use of Non-Fossil Energy Sources and Effective Use of Fossil Energy Materials by Energy Suppliers (Act No. 72 of 2009; the “Energy Supply Act”)).

Initially, the only available NFCs were “FIT NFCs” for power sources supported under the FIT scheme, but “non-FIT NFCs” were also started in 2020 for non-fossil power sources not supported under the FIT scheme. FIT NFCs are RECs that represent the environmental value (value of being generated from renewables, value of zero emission) of power sources supported under the FIT scheme, which is funded by surcharges borne by consumers, and such environmental value of FIT power sources are regarded as belonging to consumers as a whole, rather than to individual power producers. Under such understanding, FIT NFCs are sold by the Expense Sharing Coordinating Body (a third-party organization that manages surcharges and subsidies under the FIT scheme; Green Investment Promotion Organization (GIO) is currently designated), and the proceeds from the sale of FIT NFCs are used to fund the FIT scheme so that the surcharges can be reduced at least to some extent. FIT NFCs are purchased by electricity retailors through pay-as-bid auction held four times a year. Non-FIT NFCs consist of those with “renewable energy designation” for renewable energy and “no designation” for electricity generated from nuclear power and other sources. Non-FIT NFCs are typically sold by power producers that own certified non-fossil power sources to electricity retailers through bilateral transactions or through a uniform price auction held four times a year. When the FIP scheme is introduced in April 2022, FIP-approved power producers are expected to be able to sell non-FIT NFCs as well.

NFCs are traded by recording the amount of generated electricity in the accounts of electricity retailers held under the Japan Electric Power Exchange (“JEPX”), and they do not have any attached attribute information specifying the originating power plant. Because of this, a separate tracking system is provided to trace the origin of NFCs purchased through auction, whereas when non-FIT NFCs are purchased through a bilateral agreement, the originating power plant will be identified therein.

(2) Creation of REV Market

Consumers who wish to procure renewable electricity can do so by purchasing electricity from electricity retailers that have acquired NFCs under the aforementioned NFC scheme, but they cannot acquire NFCs directly themselves. Recognizing that there is a need for consumers to be able to directly acquire RECs derived from the power plants of their choice, METI has been contemplating reforms to the NFC scheme through the Working Group and other expert meetings.

So far, METI has decided to divide the NFC Market into two markets—a REV Market, in which both electricity retailers and consumers can purchase FIT RECs, and a “Market for Achieving Energy Supply Act Obligation” (“ESA Market”), in which, as before, only electricity retailers are eligible to purchase non-FIT NFCs usable to satisfy obligations under the Energy Supply Act (pp. 9 and 10 of the Working Group’s Fifth Interim Report dated August 26, 2021 (see here; provided only in Japanese)). The first auction for the ESA Market was held on August 26 and 27, 2021.

The REV Market will also allow corporates other than electricity retailers to participate upon satisfaction of certain conditions. Members of the Working Group have argued against overly narrow eligibility criteria, and the Sixth Interim Report Draft states that JEPX should consider setting additional criteria for consumer participation, such as having a domestic legal personality, while keeping minimum JEPX trading qualifications such as having net assets of 10-million yen or more in principle (p. 10 of the Sixth Interim Report Draft). Subject to certain rules, brokers will be allowed to participate in the REV Market and transfer FIT RECs procured in the market to corporate consumers (pp. 11 to 14). Further, the REV Market will conduct pay-as-bid auctions as in the previous FIT NFC market (p. 5) and the minimum FIT REC price will be set at 0.3 yen/kWh tentatively for initial auction (p. 8).

Attribute information of power plants will continue to be attached separately from FIT RECs through the separate tracking system. Until now, the transfer of attribute information of a FIT power plant to a FIT NFC purchaser required the consent of the FIT power producer, but METI plans to eliminate such requirement so that the attribute information can be given to FIT REC purchasers without power producer consent. The consent of FIT power producers is, however, expected to be required in the case that a FIT REC purchaser discloses the acquired attribute information to the public; JEPX rules are expected to incorporate such rules so that JEPX can suspend transactions or take other appropriate action in the event of violations.

Corporates that have obtained FIT RECs are expected to use them for their reporting of GHG emission as required by the Act on Promotion of Global Warming Countermeasures (Act No. 117 of 1998) or to comply with the requirements under the Scope 2 Guidance of the GHG Protocol (p. 16 of the Sixth Interim Report Draft). The first REV Market auction is scheduled to take place from November 19-26, 2021.

(3) Future outlook

METI has indicated that it aims to create a system that is friendly to consumers including corporates pursuing corporate PPAs. Regarding the REV Market, as the government intends to “study and promptly reach a conclusion on how to make it possible to trade not only RECs of FIT energy but also RECs of non-FIT renewable energy in the market” by FY2022 (April 2022 to March 2023), according to the FY2021 Regulatory Reform Implementation Plan (see here; provided only in Japanese) that was approved by the Cabinet on June 18, 2021 (p. 54), it is possible that the government may consider allowing REC transactions between power producers and consumers for non-FIT projects (including FIP projects). Further, METI is also reviewing and soliciting public comments (see here; provided only in Japanese; until October 27) for amendments to the Enforcement Order for the Electricity Business Act and Self-Wheeling Guidelines that will relax self-wheeling requirements and facilitate the procurement of renewable electricity (non-FIT and non-FIP) from off-site.

In addition to amendments related to the FIT scheme, the government is also proceeding with the development and reform of measures for renewable energy projects that do not fall under the FIT scheme, and it is becoming increasingly important to keep a close watch on post-FIT measures for renewable energy and to voice opinions as necessary.

3. Corporate PPA Panel Discussions at Solar Energy Future Japan 2021

Minako Wakabayashi, partner in Orrick’s Tokyo office, moderated the panel discussion on Corporate PPAs at the conference of Solar Energy Future Japan 2021, held on the 12th and 13th of October 2021.

The panel discussion was on the theme “Possibilities and Difficulties of Corporate PPA in Japan” featuring panelists from Amazon Web Services Japan, Minna Denryoku (Updater, Inc.), Orix Corporation and Jinko Solar Japan. The lively and productive discussion focused on topics such as activities related to corporate PPAs, challenges facing players in introducing corporate PPAs in Japan and potential solutions from the Japanese government. The panel discussion attracted a large audience, indicating strong interest in the market toward corporate PPAs.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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