Introduction to Power Purchase Agreements

A Power Purchase Agreement (PPA) is the main contract between the public and private sectors in a power sector PPP. In countries where the power industry is primarily state-owned, it is usually between a public sector purchaser “off-taker” (often a state-owned electrical utility) and a privately held power producer. It is typically the main source of income for a PPP project. As a result, the PPA’s structure and risk distribution regime are critical to the private sector participant’s capacity to raise funds, recoup capital expenses, and make a return on equity. This overview focuses on a PPP-developed baseload thermal plant. While some aspects may be similar to all PPAs, various considerations apply to mid-range or peaking thermal plants, as well as plants that use different generating technologies (e.g., wind or solar). A number of the issues mentioned below would also need to bemodified for PPAs between private parties, such as for energy spot market sales (which are more commonly seen in jurisdictions with a more de-regulated power sector).

In addition to responsibilities related to the sale and purchase of electricity produced, the project firm is also obliged to design, build, operate, and maintain the power plant according to specified standards.

  • Sale of capacity and energy – The PPA may require the project firm to make an agreed amount of capacity at the power plant accessible to the purchaser, as well as to deliver the energy produced in line with its terms.
  • Pricing – The pricing regime in the PPA typically has two components:

1. The capacity fee (also known as “availability fee”), is paid by the off-taker in exchange for the power plant operator making generating capacity accessible to the off-taker, whether or not the off-taker actually offtakes energy from the power plant. This component is usually intended to provide a revenue floor for the project and is the primary channel through which each project proponent would recover its fixed costs (including capital investments, financing costs, and a return on equity); and;

2. An output charge – This is usually based on the volume of electricity actually delivered and is intended to cover the project company’.

The pricing mechanism is the main method for distributing income and market risk between the public and private sectors in relation to the project, and it is crucial to the private project proponent’s and lenders’ evaluation of the project’s economic viability and bankability. To ensure investment recovery, private project proponents and financiers often need a long-term PPA.

The capacity to make third-party sales may improve the project’s economic sustainability and offer some demand-side protection under the main long-term PPA. Because of the main PPA’s lengthy duration, if the market is deregulated at a later date, the power plant may participate in that market without having to unravel the primary PPA entirely. However, buyers are typically hesitant to enable third-party sales because they want to ensure that full capacity is accessible to them at all times. As a result, the PPA may contain an exclusivity period during which the purchaser must get all power generated. To guarantee that this exclusivity term does not obstruct future development/deregulation of the energy market, flexibility may need to be included into the PPA. Third-party sales will also need to be carefully addressed (both in terms of demand and physical infrastructure to supply energy to third parties).

If the project firm fails to provide electricity as promised,the PPA may impose penalties or compel it to pay liquidated damages. Liquidated delay damages, which occur when a project’s construction is not finished on time, and tariff abatements, which occur when a power plant fails to fulfil agreed-upon performance requirements during its operating phase, are two common instances. Private project proponents and lenders will be concerned about limiting the effect of liquidated damages on their ability to recoup and make a return on their capital investments. The project firm may be forced to pay liquidated damages as a consequence of interruptions beyond its control, which is a frequent source of contention.

For interruptions caused by force majeure occurrences, the project firm is usually released from its contractual duties (and from responsibility for damages). However, since it is a fundamental contractual mechanism for sharing risk between the public and private sectors, the extent of force majeure relief offered may be a significant negotiating issue. A frequent question is how much force majeure relief a project firm can get if it doesn’t get the necessary government clearances. The change in legislation regime and the force majeure regime are often connected. Depending on the technology, the extent of force majeure relief may need to be adjusted. A wind farm, for example, has distinct interruption risks than a gas-fired power station.

Testing procedures should be objective and intended to validate contractual capacity, dependability, and fuel efficiency or heat rate levels. An independent engineer’s certification of the test findings is desirable.

The PPA must address what happens if the agreement is terminated (whether at the end of the term or early due to default), including the power producer’s obligations to hand over assets to the government off-taker and what happens to the power plant’s employees if the power plant is transferred to the off-taker at the end of the term. The project’s economic feasibility and bankability will be determined by the availability and computation of an early termination payment (usually for the purchaser to acquire the power plant).

Scheduled outages and maintenance outages, operation and maintenance, emergencies, and account and record-keeping are common project operating problems.

The PPA shall consider the effect on tariffs and the procedure for tariff adjustment in the case of a change in applicable law. Private project proponents and financiers will be keen to guarantee that the project’s cash flows are adequately safeguarded against legislative changes (at least in the country where the project is situated). If the off-taker were a private company, the risk distribution for changes in legislation and other regulatory concerns would be quite different. In the latter scenario, the private off-taker’s capacity and hunger to absorb changes in the legislation is significantly reduced (compare to a government entity).

Understanding Commodity Derivative Contracts

A derivative contract that has a commodity as its underlying is referred to as a ‘commodity derivatives’ contract in the financial industry. According to Section 2 (ac) of The Securities Contracts (Regulation) Act, 1956, a “commodity derivative” is defined as a contract that includes the following terms:

  • For the delivery of such goods asmay be published by the Central Government in the Official Gazette or;
  • For differences, which derive their value from prices or indices of prices of such underlying products or activities, services, rights, interests, and events as the Central Government may notify in agreement with the Board, but does not include securities asdefined in sub-clauses (A) and (B).

Commodity derivative contracts are divided into four categories.They are:

  • Forward – A forward agreement is a private agreement in which the customer agrees to purchasing and the seller commits to selling a product.
  • Futures – These types of commodity derivative agreements are standardised types of forwards that are traded on exchanges like the New York Stock Exchange.
  • Options – These contracts give the holder the right to purchase or sell the underlying asset at a certain future date.

Swaps – These are contracts in which two parties swap streams of monetary flows between themselves.

Analysing the Relationship between PPAs and Commodity Derivative Contracts

A. What are virtual power purchase agreements (VPPAs)?

In recent years, as energy costs have risen and environmental consciousness has grown, both the energy sector and consumers have been more interested in corporate power purchase agreements (Corporate PPAs). As a result of this demand, numerous reports, manuals, and articles on the topic have been produced. Many of these publications claim that Virtual PPAs are contracts for difference (CDs) and financial instruments. At the same time, it’s difficult to discover an explanation of this issue, as well as a discussion of the regulatory implications of such qualifying, in them. Which may be a deciding factor in whether or not this kind of PPA can be offered and implemented.

AVirtual Power Purchase Agreement (VPPA) is a financial contract in which the buyer commits to acquire renewable energy characteristics from the developer at a ‘pre-agreed price,’ sometimes referred to as the ‘strike price.’ In contrast to a conventional power purchase agreement (PPA), in which the buyer gets the energy physically, the buyer in a VPPA does not receive the energy. Rather, the developer sells the energy on the merchant market, i.e., at the Indian Energy Exchange (IEX). If the market price of energy sold on IEX exceeds the VPPA’s pre-agreed price, the developer pays the buyer the difference. If the market price is lower than the pre-agreed price, the buyer pays the developer the difference.

A VPPA’s financial settlement will be in the form of a fixed-for-floating swap or a contract-for-differences. A pre-agreed settlement time, usually every month or quarter, will be established under the VPPA. The developer will sell energy on the wholesale market at thefloating market price at that period. The developer will compute the difference between the floating market price and the set VPPA price at a pre-determined period, as agreed between the parties. The disparities are computed at the conclusion of the settlement term. If the total is positive, the developer will make up the difference and pay the buyer. If the sum is negative, the buyer pays the difference to the developer, ensuring that the project is always paid the VPPA price.

The buyer benefits in two ways:

1. The customer gets Renewable Energy Certificates (RECs) in return for their purchase. Holding RECs equates to owning a certain quantity of green/renewable energy. As a result, obliged organisations buy these RECs to fulfil their renewable purchasing obligations (RPO).

2. Since theamount paid is a “pre-agreed” price, the transaction aids purchasers in mitigating risk associated with fluctuating energy costs. Continuing our previous example, since the market wholesale price is high, B’s power cost will be high as well. The extra money that B gets through the VPPA transaction, on the other hand, may now offset the same. It’s also true in the other direction. B would be obliged to pay A the difference if the wholesale market price is low. The reduced energy costs in general, however, will help to offset this extra expense.

B. Do VPPAs have the characteristics of commodity derivative contracts?

AVPPA is a financial contract utilised by both parties to hedge risk, as we can see from the definition above. However, it is critical that we identify which group of financial instruments the VPPA belongs to. A VPPA has many of the same features as a derivative contract. A derivative contract is a financial instrument in which the contract’s value is determined by the value of an underlying asset. These underlying assets may be any kind of asset, including commodities. The phrase “commodity derivative” is defined under the Securities Contract Regulation Act of 1956 (SCRA). Furthermore, participants in a derivative contract adopt a stance. The price of the underlying asset is expected to rise (long position), while the price of a commodity is expected to fall (short position) (short position). Such features may also be seen in a VPPA. The price of energy in the merchant market affects the VPPA settlement, and the buyer takes a long position, implying that the price of energy will rise, while the developer takes a short position, implying that the price of energy would fall.

Forwards, futures, swaps, and options are the four kinds of derivative contracts. A VPPA may be classified as either a forward or swap derivative. Because, unlike forwards and swaps, futures are standardised financial products that are traded on the market, a VPPA cannot be classified as a futures derivative. Forwards and swaps, on the other hand, are customised over-the-counter (OTC) transactions that are not traded on an exchange. Because it is not a standardised contract, a VPPA may be a forward or swap contract. Rather, it is a tailored contract designed to meet the requirements and expectations of the parties; and 2) a VPPA entered into by parties is not an exchange-traded instrument. Finally, much like a VPPA, the forward or swap derivative contract has a pre-determined price.

To put it another way, a VPPA is a commodities derivative contract. Furthermore, since VPAA are bespoke and OTC transactions, they may be classified as a forward or swap derivative.

Problems arising due to the Commodity Derivative nature of VPPAs

A. Conflict in jurisdiction

The disagreement over the jurisdictional control of energy futures and forwards contracts in India is between SEBI, the financial market regulator, and the CERC, a body that has regulatory responsibilities and powers over electricity across India. In the caseMulti Commodity Exchange of India Limited & Ors. v. Central Electricity Regulatory Commission & Ors. the issue was brought before the Bombay high court. In a nutshell, both sides’ main arguments are as follows:

SEBI claimed that since it has authority over all kinds of forwards and futures transactions, it should have control over electricity forwards and futures contracts as well. Furthermore, it was claimed thatthe Electricity Act of 2003 (Electricity Act) did not even ‘slightly’ mention or deal with forward contracts and futures. It claimed that the electricity only covered “ready delivery contracts”, and that futures and forwards transactions were simply “financial contracts”, and therefore not subject to the CERC’s authority. Rather, they should be governed by a “specialised” agency established to oversee the regulation of such “purely financial transactions”.

CERC, on the other hand, claimed that the Electricity Act was established to combine the rules governing the production, transmission, distribution, “trading,” and consumption of electricity, and that as a result, it could adopt any policy to help the energy sector grow. On a combined interpretation ofSection 66 andSection 178 (2) (y) of the Electricity Act, it was argued that CERC had the authority to establish rules for the development of the energy market, including trading. Trading, it was claimed, encompasses all elements, including futures and forwards dealing with electricity.

The Bombay High Court considered all of the reasons provided and reached an “inconclusive” conclusion. It was decided that neither the SEBI nor the CERC could have full control over the electricity futures and forwards market. The court ruled as follows:

Under the FCRA, the authority cannot deal solely with electricity futures contracts. Similarly, due to the specific provisions of the FCRA, CERC cannot deal with futures contracts on its own and has no power to do so unless appropriate enactment has been made by way of statutory provision regulating futures contracts, giving powers only to one authority out of the aforementioned two authorities.

B. Conflict with regard to statutes

As previously stated, OTC products are not subject to the SCRA. OTC derivatives, on the other hand, are governed by the Reserve Bank of India’s regulatory framework (RBI).The Reserve Bank of India (Amendment) Act, 2006 introducedSection 45V of the RBI Act, 1934 (RBI Act) as follows:

Transactions in such derivatives, as may be specified by the Bank from time to time, shall be valid if at least one of the parties to the transaction is the Bank, a scheduled bank, or such other agency falling under the regulatory purview of the Bank, notwithstanding anything contained in theSecurities Contracts (Regulation) Act, 1956 or any other law for the time being in force, if at least one of the parties to the transaction is the Bank, a scheduled bank, or such.

As a result, according to the RBI Act, an OTC derivative may only be legal if at least one of the parties is the RBI, a scheduled bank, or any other RBI-controlled entity. Parties that enter into a VPPA, on the other hand, are not regulated by the bank and therefore are not subject to the RBI Act’s regulations.

However, the proposedCERC (Power Market) Regulations, 2020 sought to enable buyers and sellers to enter into energy OTC forward contracts. This can be seen in Regulation 43 of the proposed Regulations, which states that participants in the OTC platform may be both energy producing businesses and open access customers. However, there are several stumbling obstacles in the path of VPPAs. On reading Regulation 7, which states that the only way to fulfil contracts made in the OTC market is to physically deliver energy. As a result, the proposed Regulations clearly prohibit the VPPA from falling within CERC’s authority. The only conceivable option is for the CERC to include RECs within the definition of “physical delivery of electricity” or for Regulation 7 to be amended to include “physical delivery of products” instead of simply electricity. If VPPAs can’t be classified in that manner, they won’t be allowed on the OTC market.

Although the CERC must provide clarification on whether or not VPPAs are deemed “physical delivery of energy”, it is safe to assume that VPPAs are contracts that may and should be traded on the OTC market. There are two reasons for this: To begin with, one of the reasons for establishing the OTC platform is to satisfy the “increasing need for purchase of renewable electricity to meet renewable purchasing obligations by the obliged companies”, according to the draught rules’ explanatory memorandum. VPPAs are one of the most important tools for meeting this criterion. Because there is no need to supply solely to the buyer under a VPPA, it enables organisations with dispersed loads or limited access to renewable energy to acquire renewable energy characteristics and fulfil their renewable purchasing requirements. Second, even if the energy is not physically supplied to the buyer, it is delivered into a grid, and all of the RECs “associated” with that electricity are in the buyer’s name. As a result, the buyer receives proper credit for his “purchase.” This differs from a strictly “financial transaction,” in which the purchaser loses all connection to the energy once he or she exchanges it with another individual.

Conclusion and Suggestions

The primary aim with this research is to explore and resolve certain conflicts that may potentially arise with regards to the commodity derivative nature of virtual power purchase agreements in India. The author is of the opinion that the jurisdiction of matters related to VPPAs should rest with the CERC. Reasons: First, the SEBI is in charge of regulating the instruments that may be exchanged on an exchange by anybody looking to earn a ‘profit’. Futures need SEBI authority since they are standardised and tradeable, both of which require SEBI oversight. Because VPPAs are not traded as futures, the SEBI’s monitoring as a market regulator is not needed. And OTC derivatives are not SEBI-regulated. In reality, Section 18A of the SCRA does not regulate OTC derivatives like futures and Swaps. This proves that VPPAs are not within SEBI’s jurisdiction. Finally, VPPAs are more of a ‘physically deliverable contract’ than a ‘purely financial contract’, thus favouring CERC. Financial contracts like ‘futures’ are all about price discovery and profit. No product is provided in such endeavours. Although no ‘physical’ energy is delivered in VPPA, it is delivered in the form of RECs. So, the product and the financial instrument are linked.

When it comes to the legislative authority governing VPPAs, there appears to be a need for clarification. However, the present draft of the law permits OTC VPPAs. This interpretation aligns with the goals of establishing an OTC platform and the VPPA’s semi-financial and semi-delivery character.


This blog is a part of ‘Scrivener- Blog-writing Competition’ held in collaboration with Khaitan & Co., Delhi.

About the Author 

Mr. Rishav Ray is a third-year law student at the School of Law, Christ University, Bengaluru. He is also the winner of Scrivener in the “PPA: Whether a New Age Commodity Derivative Contract?” category.

Editorial Team 

Managing Editor: Naman Anand 

Editors-in-Chief: Jhalak Srivastav and Akanksha Goel 

Junior Editor: Tisa Padhy

Preferred Method of Citation  

Rishav Ray, “PPA: Whether a New Age Commodity Derivative Contract?” (IJPIEL, 30 March 2022) 


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