Designing Renewable Power Purchase Agreements

The paper presented in this Decarbonization Seminar / Joint ZEW–MISES Seminar studies a long-term power purchase agreement (PPA) between a firm and a new renewable energy generator. The firm must dynamically satisfy uncertain electricity demand beyond its existing energy sources, while wholesale electricity prices evolve stochastically over time. Upon signing a PPA, a new renewable facility becomes operational, and the firm owns its output for the contract duration. The new facility’s capacity is determined based on PPA terms. The firm dynamically chooses when to initiate the PPA and how much to pay to maximize its expected total discounted benefit. The authors show that the firm’s optimal timing follows a (time-dependent) threshold policy. The results offer key insights for policymakers and renewable energy developers. The authors find that, contrary to common wisdom, reducing investment costs for renewable technologies can lead to smaller renewable capacity, output, and emissions savings when projects are developed under PPAs. This finding calls for caution in applying investment tax credits in such contexts. The authors also show that total renewable energy generation and emissions savings may decrease with higher site productivity. Therefore, restricting renewable facility development to most productive sites might be counterproductive under PPAs. The authors establish the robustness of findings across a broad range of practical scenarios.