Physical vs virtual PPA: what’s the difference?

A corporate power purchase agreement (PPA) is a long-term contract between an electricity generator and a corporate buyer that wants certainty over where its electricity comes from, what it costs, or what it can claim about it. The generator does not have to be renewable. Wind and solar projects are the familiar examples, but the same concept applies to other energy projects as well.

Our last blog covered the basics of how a PPA works. The next question for any buyer is which of the two main structures to use, physical or virtual, and whether it needs to choose at all.

The simplest way to understand the distinction is to look at what the buyer receives.

With a physical PPA, the buyer contracts to take the electricity the project generates, along with the energy attribute certificates (EACs) that verify it came from a renewable source. The power reaches the buyer through the grid, and the buyer’s supply is tied to that project’s output.

With a virtual PPA, the buyer keeps its usual retail or grid supply. The PPA is a purely financial agreement with the project, and no electricity changes hands under it. The buyer receives two things: the environmental attributes and a hedge against wholesale price movements.

Both structures let a project lock in long-term, predictable revenue, which makes it bankable and financeable. The key difference is that a physical PPA includes the supply of electricity, while a virtual PPA is a financial agreement that runs alongside the buyer’s existing supply.

Physical PPAs

Under a physical PPA, the buyer usually agrees to pay a fixed price for the electricity the project produces. That gives the buyer greater certainty over energy costs and gives the developer a predictable source of long-term revenue.

Because wind and solar generation varies with the weather, someone has to manage the gap between what the project produces and what the buyer consumes at any given moment. A utility, supplier, or specialist third party often handles this process, known as balancing, but the buyer is responsible for it and pays for it.

A sleeved PPA is one way of making balancing simpler for the buyer. A utility or energy supplier acts as an intermediary between the project and the buyer. It manages any shortfall or excess generation and provides the buyer with a consistent electricity supply, usually in return for an additional fee.

Physical PPAs are the dominant structure outside the US and the primary option in many APAC markets, largely because a virtual PPA depends on a type of wholesale market that many of those markets do not have.

Virtual PPAs

With a virtual PPA, or VPPA, the buyer continues to buy electricity from its existing supplier or local grid and enters a separate financial agreement with the project.

Most VPPAs operate as a two-way contract for difference. If the wholesale market price falls below the agreed PPA price, the buyer pays the seller the difference. If the market price rises above the PPA price, the seller pays the buyer the difference.

The project gets predictable revenue from this arrangement. The buyer gets a hedge, and for many buyers that hedge is the main reason to choose a virtual PPA. A buyer whose supply contract tracks wholesale prices is exposed every time the market moves. With a VPPA in place, a rise in wholesale prices pushes up the buyer’s supply bill and triggers a payment from the seller at the same time. The two largely offset each other, which gives the buyer a more predictable cost of electricity without any change to its supply arrangements.

VPPAs are operationally simpler because the buyer takes on no physical delivery or balancing responsibilities. The financial outcome still depends on wholesale prices, and on how closely the market where the project settles tracks the market where the buyer uses energy.

VPPAs are widely used in the US and are also called financial or synthetic PPAs.

How a buyer chooses between them

Four factors drive the choice. They run in order of how binding each one is: the first can remove the choice altogether, and the last shapes it at the margins.

1. Regulation and market design. A virtual PPA needs two things: a liberalized wholesale electricity market, and a transparent reference price for the contract for difference to settle against. Where either is missing, a VPPA cannot work, and in some markets regulation rules out financial PPAs altogether. In those markets, a physical PPA, sleeved or direct, is the only route. This is why physical dominates outside the US and across much of APAC, while virtual is common where those conditions exist, the US being the clearest example.

2. Operational appetite. A physical PPA brings balancing responsibility. Even with a sleeving arrangement, the buyer pays someone to manage the gap between generation and consumption and still has to oversee that arrangement. A virtual PPA avoids this entirely: the buyer’s existing supply continues as before, and the contract settles financially. Buyers with a small energy team, or no wish to build one, often prefer virtual where the market allows.

3. Procurement objective. What is the buyer trying to buy? A physical PPA delivers supply of power with a green claim attached. A virtual PPA delivers a price hedge and an environmental attribute claim, both of which can be layered on top of whatever physical supply the buyer already has. A buyer that wants to secure or replace its supply will go physical. A buyer that is content with its supply and wants certainty over price or attributes can get that from a virtual PPA.

4. Basis exposure. The last driver is where the buyer’s load is relative to where the project settles. If the project settles against a price in one region and the buyer consumes in another, the hedge will track the buyer’s costs less closely. This moves into the territory of risk, which deserves a follow-up post of its own.

The two can work together

The choice is also rarely all or nothing. A buyer that already takes physical supply, whether under a physical PPA or a standard supply contract, can add a virtual PPA on top. The two contracts have different purposes, so they do not compete. The physical arrangement keeps the power flowing. The virtual PPA adds a hedge if the physical supply tariff is not fixed, secures environmental attributes to cover more of the buyer’s consumption, or both.

Why environmental attributes matter

Every verified megawatt-hour (MWh) of renewable electricity generated creates a certificate recording its renewable origin. These certificates are energy attribute certificates, or EACs.

Once a buyer uses a certificate to support a renewable energy claim, the registry retires it so no one can use it again. That prevents the same attribute from being counted twice.

In a physical PPA, the attributes generally come with the electricity. In a virtual PPA, they are the primary environmental deliverable.

Increasingly, buyers are also looking beyond the attributes themselves to additionality: whether their long-term commitment helps bring new renewable capacity online. That question applies whichever structure they choose.