Part 2 – Alternative procurement and supply structures
In our previous article, we discussed some of the more traditional utility supply models. From fixed price and flexible supply models to group purchasing contracts, traditional methods are often the most common approach manufacturers take. However, alternative, sometimes more creative, procurement and supply structures have become an increasingly common choice for countless organisations, with businesses exploring more innovative ways to buy or secure energy to combat growing pressures around costs and sustainability.
These alternative procurement and supply structures can sometimes present some additional complexity when compared to traditional contracts, but they also offer a range of unique long-term benefits that manufacturers can take advantage of, including cost stability, emissions reduction and improved supply security. The key to making these models work is developing a firm understanding of them and where they may be appropriate.
- Power Purchase Agreements and Corporate Power Purchase Agreements (PPAs/CPPAs)
Power Purchase Agreements (PPAs) or Corporate PPAs (CPPAs) come in a few different shapes and sizes. Essentially, these agreements are long-term contracts directly between an energy generator (often a renewable energy generation project, such as wind, solar or bioenergy) and a corporate buyer (i.e. a manufacturer). They work by enabling the buyer to secure a direct agreement for power over an extended period, often 10 years plus, rather than buying energy directly from a licensed utility supplier.
PPAs can take a few different forms such as “private wire” or “onsite” PPAs, “sleeved” PPAs or “virtual/financial” PPAs.
These PPA models provide manufacturers with some unique benefits such as:
- Price certainty and protection from market volatility.
- Enhanced ESG credentials and renewable energy visibility.
- The ability to secure long-term energy supply aligned with net-zero strategy and goals.
However, there are also risks and considerations for manufacturers when it comes to PPAs and CPPAs such as the long duration of the contract or generator credit and counterparty risk to name a few.
In our next article, we will be discussing PPAs and CPPAs in much greater detail, so keep an eye out for our next part in the series to find out more about the benefits and considerations of PPAs and CPPAs as a procurement model.
- On-site generation and Energy as a Service (EaaS) model
Some manufacturers may have sufficient space at their site(s) and demand or suitable load profiles to opt for on-site energy generation. This can be a highly attractive option which provides access to technologies such as solar photovoltaic (PV), wind turbines, bioenergy, combined heat and power (CHP) often combined with energy storage (including commercial battery and hydrogen) or specific long duration storage technologies.
Manufacturer’s considerations mainly fall into two broad categories – on balance sheet solutions or off balance sheet solutions. Generally an on balance sheet model is where the manufacturer finances the energy generation/storage equipment and installation upfront, whereas the off balance sheet option allows for a capex free model where the generator/equipment operator finances, installs and operates the energy generation/storage equipment whilst the customer (i.e. the manufacturer) pays a wrapped-up price for the energy which they receive as a service. We have outlined some key differences between the two models further below.
- On balance sheet solution
Under this model, a manufacturer usually funds, owns and operates generation and/or storage assets and infrastructure directly. Depending on the type of generation and/or storage assets, a manufacturer may enter into a separate operation and maintenance contract with the original equipment manufacturer (OEM) or other third party operation and maintenance company and, depending on the type of arrangement, a third party may take responsibility for the asset’s performance as well as maintenance. Capital expenditure will often be on balance sheet and paid either up front or in certain stages by the manufacturer.
It’s a model that provides a clear advantage in terms of long-term cost savings, as once the initial capital is invested, the cost of generation can be significantly lower than paying grid prices and be exposed to or partly exposed to utility price volatility (for example when installing a CHP engine which produces electricity and heat, however is still dependent on natural gas, hydrogen or other fuel input and such input fuel may still be subject to price volatility). This models also gives manufacturers the opportunity to claim, dependent always on the type of generation/storage asset) associated benefits such as Renewable Energy Guarantees of Origin (REGOs) or other green or carbon certificates, which can help to strengthen ESG credentials, support sustainability and net-zero strategies, and reduce emissions related costs to the business.
However, it is a model with clear downsides as well, including high upfront costs, ongoing operation and maintenance costs as well as operational risk of equipment/systems failure. Manufacturers may not be prepared to pay a large amount of capital for certain generation/storage assets if there is no clear mid- or long-term strategy for the manufacturer to remain in the same location or where the manufacturer wishes to sell or transfer sites out of the business on which the relevant generation/storage equipment is to be located. Owning and operating on-site generation/storage equipment outright usually means having a need for internal expertise to operate, manage, maintain and optimise the generation/storage system effectively.
Then there’s the legal side. From a legal perspective, manufacturers need to be able to navigate complex planning, permitting, consenting and grid-connection requirements, supply and installation and works contracts together with the relevant warranty and guarantee provisions as well as ensuring health and safety and compliance with environmental regulations. Generally, that means this model is one that works best for larger, well-capitalised businesses who have predictable energy demand, a desire to remain at the same location for a long time, and the desire to take on long term ownership of the generation/storage equipment.
- Off balance sheet solution
In contrast to on balance sheet solutions, off balance sheet models enable a manufacturer to use a third party, often a specialist energy services company (ESCO) to finance, own and operate the energy generation/storage equipment and infrastructure. The manufacturer usually makes available their land on which the energy generation/storage equipment is located and essentially buys the energy produced by the generation equipment “as a service”, meaning that instead of paying for the energy generation/storage equipment itself, they instead pay a price, which can be regular fixed fee (i.e. monthly), usage fee, combination of the two etc., for the energy output under a long-term supply arrangement. This removes upfront capital requirements of an on balance sheet model whilst simultaneously helping to improve cash flow and shift operational and performance risks onto the ESCO.
It's often an attractive option for manufacturers who may have limited capital or do not want to take on the risks of ownership. But there are trade-offs. Contract structures can often be complex with long-term obligations that can reduce flexibility, and the pricing can sometimes be less favourable over the lifetime of the agreement compared to owning generation assets outright. It is also essential to carry out careful legal due diligence to ensure clarity on performance guarantees and triggers to entitlement to financial compensation for not achieving key performance indicators (KPIs) for performance, asset availability, or other KPIs such as maintenance standards as well as to determine liability for asset downtime and types of financial losses of the manufacturer.
Manufacturers need to clearly understand their obligations in relation to such arrangements. For example, it is not uncommon that an ESCO will require a manufacturer to provide its own fuel input (i.e. natural gas for CHPs) and this will keep manufacturers exposed to market price volatility for input fuel. Manufacturers should also look out for exclusive offtake provisions and liabilities which may come with such provisions, as well as termination consequences as ESCO’s will require to be kept financially whole should the energy services provision be terminated for any reason.
Both approaches outlined above (or further developed hybrid solutions of such approaches) can deliver real value to manufacturers, but they each involve very different considerations, including the manufacturer’s appetite for taking certain risks. For those weighing up these options, it’s essential to assess all angles including not only cost implications but also energy regulation matters relating to the generation, distribution, storage and supply of energy (including dealing with any excess energy or any back up and top up energy which may be required from a licensed supplier from the licenced grid networks).
- Aggregation, demand side response (DSR), demand flexibility service (DFS) and other balancing/ capacity market service contracts
Many manufacturers are now beginning to opt in for participation in flexibility markets through aggregation and demand side response (DSR), demand flexibility services (DFS), or other types of flexibility, balancing or capacity market services arrangements. These approaches allow businesses to adjust their energy use to support grid stability and grid balancing, as well as creating additional revenue streams for the business by either using their existing assets such as back up energy assets to generate and export to the wider grid or to reduce their own energy requirements on site and potentially reducing their own costs in the process.
Through aggregation, multiple businesses pool their flexible capacity, such as having the ability to pause production or draw power from on-site storage/generation, so that an aggregator can trade it as a single block in the market. This makes flexibility accessible even for manufacturers who might not be able to meet capacity thresholds on their own.
DSR or DFS contracts act as a way to formalise this arrangement. These contracts involve manufacturers agreeing to reduce or shift consumption (load shifting) at times of peak demand or system stress, and in return, they receive a payment or reduced network charges. It’s a financially attractive solution, but these agreements do come with obligations. For example, under-delivery can result in penalties, so businesses need to carefully assess which processes can realistically provide flexibility without disrupting their production schedules.
Organisations also need to think about the significant legal considerations. Aggregator agreements need to clearly set out risk allocation, revenue sharing, and termination rights. Also, flexibility contracts need clarity around performance metrics, availability windows, and compensation mechanisms. Then there are further issues around competition law and operational alignment, which are vital for manufacturers to address before committing to a particular service.
However, for those who are able to participate, aggregation, DSR, DFS or other flexibility or capacity market services can provide not only an extra revenue stream, but also a way to demonstrate resilience and can contribute to the UK’s low-carbon transition and businesses own sustainability strategy and goals.
Making the right choice
As with any strategic decision, choosing whether an alternative energy procurement model is right for your business needs careful consideration. After all, these are models that can unlock significant value for you as a manufacturer, but it pays to make sure you plan carefully and negotiate effectively. Whatever route you take, you should spend the time on financial and legal due diligence to make an informed choice for the business.
As the energy landscape continues to evolve, the models we’ve discussed in this article are likely to continue growing in prominence but also evolving. With the right advice, you can take advantage of the opportunities they present (short term or long term), whilst also ensuring you are protected against potential risks. If your business is looking to explore new energy procurement models, our Energy, Infrastructure & Projects team can help navigate you through various options. Our specialist team can help you assess your options and begin to future-proof your procurement strategy. Don’t hesitate to get in touch with us to find out how we can help you, even if you use us just as a sounding board.