Lesson 6 of 7

Contracts, PPAs & Price Risk

7 min read

Spot market prices — day-ahead and real-time — can swing enormously from hour to hour and season to season. Almost nobody actually wants to be fully exposed to that volatility, which is why most electricity is bought and sold through longer-term contracts that sit on top of, rather than replace, the spot market machinery covered earlier in this track.

Why hedge against the spot market at all

A generator that built an expensive power plant wants predictable revenue to justify that investment and repay financing, not a bet on where spot prices will be for the next twenty years. A large industrial consumer wants predictable costs to plan its own business, not exposure to a market that can spike tenfold during a cold snap. Contracts exist to transfer that price risk to whichever party is more willing and able to bear it, in exchange for giving up some potential upside.

The main contract types

Bilateral forward contract: A private agreement between a specific buyer and seller to trade a fixed quantity of power at a fixed price for a future period — settled financially against whatever the spot price turns out to be, without necessarily changing physical delivery arrangements at all.
Power Purchase Agreement (PPA): A long-term contract, often 10-20 years, typically between a renewable generator and a specific buyer (a utility or, increasingly, a large corporation), locking in a price for that project's entire output.
Contract for Differences (CfD): A specific financial structure, common for supporting renewable projects, where the generator sells into the spot market as normal but receives or pays the difference between the spot price and an agreed 'strike price' — smoothing revenue to the strike price regardless of what the spot market actually does.

Why PPAs became central to renewable finance

A wind or solar project has essentially no fuel cost and a large upfront capital cost — almost the opposite risk profile of a gas plant. Lenders financing that upfront cost want confidence in the project's revenue for years into the future, which is exactly what a PPA provides. This is a major reason so many corporate renewable energy announcements are specifically PPA agreements: the contract is often what makes the project financeable in the first place, not simply preferred once the plant already exists.

What this looks like from each side

A generator with a PPA is largely insulated from spot price swings — good in a market downturn, but it also means missing out if spot prices later rise well above the contracted price. A buyer with a PPA gets budget certainty but takes on the risk of having locked in a price that, in hindsight, turns out to be above where the market ends up. Neither side eliminates risk; contracts simply move it to whichever party agreed to hold it, at a price both sides accepted when the deal was signed.

Key takeaways

Long-term contracts hedge against spot market volatility, transferring price risk rather than eliminating it.
Bilateral forwards, PPAs and Contracts for Differences are the main structures, differing in duration, parties and settlement mechanics.
PPAs are central to renewable project finance because their long-term price certainty is often what makes a project bankable at all.
Every contract has two sides accepting different trade-offs — certainty is exchanged for potential upside.