Power Purchase AgreementPPA
A power purchase agreement is a long-term contract to buy electricity, often from a specific wind or solar project, at an agreed price or formula. It gives the generator predictable revenue and the buyer a known cost.
Wind and solar farms cost a lot up front and then produce cheap power for decades. A PPA turns that future output into a contract: the buyer locks in a price, and the developer gets revenue it can borrow against.
- Category
- Commodities, Energy and Carbon
- Reading time
- 4 min
- Also called
- PPA, Corporate PPA, Virtual PPA
- Updated
A PPA in plain words
In a physical PPA a buyer contracts for power, plus its renewable energy certificates, from a specific generator.1
The customer agrees to a set price over an agreed term, while the seller takes the risks of owning and running the plant.1
A financial (virtual) PPA has no physical delivery; it is a hedge that fixes revenue for the seller and costs for the buyer.2
How a PPA works, step by step
Pick the structure
Choose physical delivery or a financial PPA, which lets both sides hedge price volatility.3
Agree the term
Physical PPAs usually run 10 to 20 years and set all the commercial terms.1
Set the price
Fix a price or a strike; many physical contracts add a price escalator.1
Check the market rules
Third-party electricity sales are not allowed in every market.4
Settle each period
In a financial PPA the difference between strike and market price changes hands so the seller nets the strike.3
Track the risk
Above the strike the generator pays the buyer; below it the buyer pays the generator.3
Worked examples
Example 1 — Market above strike
Buyer receives $15,000A hypothetical virtual PPA has a strike of $50/MWh. This month the project sells 1,000 MWh at a market price of $65/MWh.
| Price gap | $65 − $50 = $15/MWh |
| Generator pays buyer | $15 × 1,000 = $15,000 |
| Generator's net | $65,000 − $15,000 = $50,000 |
The generator owes the buyer when market prices are above the strike.3
Example 2 — Market below strike
Buyer pays $10,000Same contract, but the market price falls to $40/MWh for 1,000 MWh.
| Price gap | $50 − $40 = $10/MWh |
| Buyer pays generator | $10 × 1,000 = $10,000 |
| Generator's net | $40,000 + $10,000 = $50,000 |
Either way the seller nets the strike price, which is the point of the settlement.3
Example 3 — Escalator cost
+$2.42/MWh by year 3A hypothetical physical PPA starts at $60/MWh with a 2% yearly escalator.
| Year 2 price | $60 × 1.02 = $61.20/MWh |
| Year 3 price | $61.20 × 1.02 = $62.42/MWh |
| Rise over 2 years | $62.42 − $60 = $2.42/MWh |
Escalators are common in physical PPAs, so model them before comparing with utility tariffs.1
Physical PPA vs financial PPA
| Aspect | Physical PPA | Financial (virtual) PPA |
|---|---|---|
| Power delivered | Yes, to the buyer | No, sold into the wholesale market |
| Price mechanism | Set price, often with escalator | Strike price settled against market |
| Where usable | Markets that allow third-party sales | Also in regulated markets |
| Main purpose | Supply plus RECs | Price hedge plus RECs |
Where PPAs are used
Corporate buyers
Lock in long-term electricity costs as a Hedging tool.
Project finance
Give developers predictable revenue to raise debt.
Price risk management
Reduce Exposure to wholesale Volatility.
Energy traders
Value the contract against forward prices like other Futures Contract-style hedges.
Advantages and disadvantages
Advantages
- Long-term price certainty for both sides.
- Helps new renewable projects get financed.
- Financial PPAs work even without physical delivery.
- Buyers can claim the associated certificates.
Disadvantages
- Long terms lock you in if prices fall.
- Financial PPAs can create large cash settlements.
- Contracts are complex and costly to negotiate.
- Counterparty risk lasts for decades.
Going deeper
Read as far as you need. Each level builds on the one before it.
The basic deal
Beginner
A buyer agrees to buy at a set price for a long term, and the seller runs the plant.1
Contract for differences
Intermediate
A financial PPA works like a swap: price differences against the strike are exchanged so the seller nets the strike.3
Ownership and incentives
Advanced
When a third party owns and operates the asset it may claim tax incentives and pass savings through as a lower price; tax rules and market access differ by country and region.4
Common mistakes
Ignoring the escalator
Comparing year-one price only.
Forgetting settlement risk
Not budgeting for payments when prices fall.
Mixing up structures
Assuming a virtual PPA delivers power.
Overlooking counterparty risk
Not checking who stands behind a 15-year contract.
Check your understanding
Test yourself before moving on. Each answer comes with an explanation.
Key points to remember
- A PPA is a long-term electricity contract.
- Physical PPAs deliver power; financial ones settle in cash.
- Settlement fixes the seller's net price at the strike.
- Escalators raise prices over time.
- Market and tax rules differ by country.
Frequently asked questions
How long is a typical PPA?
What is a virtual PPA?
Can anyone sign a physical PPA?
Further learning
- Hedging
Why buyers fix prices.
- Counterparty Risk
Risk in long contracts.
- Contract for Difference
The contract-for-difference idea.
- Volatility
Why power prices swing.
Sources
This article is written in our own words. The sources below support the specific facts, rules and figures marked with a number in the text. Links open the original publisher’s page.
- U.S. Environmental Protection Agency. Physical PPA (opens in a new tab) Checked .
- U.S. Environmental Protection Agency. Guide to Purchasing Green Power (opens in a new tab) Checked .
- U.S. Environmental Protection Agency. Financial PPA (opens in a new tab) Checked .
- U.S. Department of Energy (FEMP). Federal On-Site Electricity Contracts (opens in a new tab) Checked .
Educational content, not financial advice. Examples use hypothetical prices and simplified costs; actual fees, margin rules and regulations vary by broker, market and country. We are not affiliated with any publisher linked above. Last reviewed . Report an error or request a source credit.