Treasury - how do you stop the electric shock?

The energy market has been a rollercoaster over the last few years, with dramatic shifts impacting both the economy and our personal finances. We observed electricity price dips following the aftermath of the pandemic, followed by a price surge to record highs following the energy crisis in 2021.

The consequences of the energy crisis included blackouts in some of the most developed economies for the first time. Here in the UK, we had energy suppliers collapse and businesses forced to shut. To add insult to injury, the strain on the electricity systems led to record emissions from power generation at a time when we are trying to commit to net zero by 2050.

It is no wonder then, that businesses will be exploring new ways to manage their exposure to electricity prices and to ensure that they are playing their part to reduce carbon emissions. 

The global shift towards sustainable energy practices has led to the rise of innovative solutions like Power Purchase Agreements. These instruments have emerged as key tools in the corporate strategy for renewable energy procurement and carbon footprint reduction.

Power Purchase Agreements (PPAs) are long term contracts between a renewable energy generator and a consumer. These are over-the-counter contracts, with terms tailored to suit both parties.

Physical PPAs result in the delivery of electricity at the contract price. In addition, Energy Attribute Certificates (EACs) – known as renewable energy certificates (RECs) in the US or Renewable Energy Guarantees of Origin (REGOs) in the UK - are supplied to customers to verify the amount of energy from renewable sources.

Virtual Power Purchase Agreements (VPPAs) are a more flexible variant of PPAs where there is no physical delivery of electricity. Instead, they involve the trade of EACs and financial settlements based on the market price of electricity and the agreed-upon price in the contract.

These arrangements are hugely beneficial for both parties. For a renewable energy supplier, they guarantee them a future stream of revenue, which can help secure financing and enable the supply of green energy to grow. This is all the more pertinent now that the industry has become more established and government schemes are being withdrawn.

For customers, the benefit is two-fold: they can hedge electricity prices; and they also receive EACs, which will help them meet their emission targets, an area of increasing importance, particularly for those corporates with an aggressive ESG agenda. VPPAs, in particular, enable companies, especially those without direct access to renewable energy sources, to support renewable energy projects while also benefiting from the financial aspects of energy market fluctuations. They are a critical tool for companies aiming to achieve their sustainability goals and reduce their carbon footprint.

The contracts offer huge economic benefits and are key to a greener economy. However, from an accounting perspective they can cause some significant challenges. Careful consideration needs to be given to the terms of the contract in order to determine which standard to apply.

For Physical PPAs several standards may apply depending on the circumstances. These include IFRS 10, IFRS 16, and IFRS 9. Navigating VPPAs also involves complex financial and accounting considerations.

The International Accounting Standards Board (IASB) has noted concerns on how to read the own use exemption in IFRS 9 for certain Physical PPAs.  Further, there are challenges around meeting the IFRS 9 hedge accounting requirements when hedging with VPPAs. In order to address these two areas, the IASB has added narrow scope standard amendments to their work plan, with an exposure draft due to be released in April 2024.

On a wider note, some of the key challenges companies face around PPAs include:

• Establishing the group’s risk appetite and optimal level of exposure to movements in electricity prices.
• Assessing the desired accounting outcome and incorporating this to develop a PPA strategy that will enable a successful transaction and accounting outcome.
• Determining whether transactions are ‘linked’ for accounting purposes when there is more than one contractual arrangement in place.
• Understanding and applying the own use exemption and hedge accounting criteria.
• The complexity of instruments with a variable volume and the implications of potential differences in timing of supply and demand.
• Contemplating any additional resource requirements during the financial reporting process and increased audit effort.

In summary, the accounting for these contracts are extremely complex. Circumstances change, markets evolve, and standard setters are intending to make amendments.

KPMG is a multi-disciplinary firm, and we work in collaboration with our colleagues to get you the help you need. Some of our Treasury and Accounting Advisory Services offerings include the following:

• Develop strategies and assess options that best align with risk management policies and objectives;
• Run workshops to help engage stakeholders on the impacts of entering PPAs;
• Assess the potential to achieve own use exemption or hedge accounting to mitigate Income Statement volatility;
• Draft compliant hedge documentation, where applicable;
• Provide guidance on the valuation methodology for PPAs, and also hypothetical derivatives when applying hedge accounting; and
• Assess data requirements, system capabilities, and development of models for in-house valuations.