A Wind Farm Gets Built Because Somebody Signed a Twenty Year Contract First
A power purchase agreement fixes the price a project will receive for its output for decades. That contract, not the technology, is what makes the financing possible.
The Cost Shape
A wind or solar project spends nearly all its money before generating anything. Once built, the fuel is free and operating costs are modest.
That produces a business whose returns depend almost entirely on two things: the cost of the capital raised to build it, and the price received per unit of output over its life.
With no fuel cost, a renewable project is essentially a financial asset that happens to produce electricity. The financing terms matter more than the engineering.
Why Merchant Risk Kills Projects
Selling into the wholesale market at whatever price prevails is called taking merchant risk. Wholesale power prices are volatile and, in markets with substantial renewable capacity, can fall to very low levels precisely when generation is highest, because everyone with the same resource is producing at once.
A lender assessing a project on merchant prices must assume conservative outcomes, which means lending less, at a higher rate, against a project that may not clear its hurdle at all.
What the Contract Does
A power purchase agreement commits a buyer to purchase output at an agreed price for a long period, commonly ten to twenty years.
| Effect | Consequence for the project |
|---|---|
| Revenue becomes predictable | Lenders will fund a high share of cost |
| Counterparty credit substitutes | Rate reflects the buyer, not the market |
| Price risk transferred | Buyer takes the market exposure instead |
The credit substitution is the crucial part. The project is no longer assessed on power prices but on whether a specific creditworthy buyer will honour a contract, which is a much easier question and prices accordingly.
Why Corporate Buyers Sign Them
Large electricity consumers, particularly technology companies with data centres, have become major buyers. Their motivations are genuine on both counts.
Fixing a long term price hedges an input cost that is otherwise volatile. And contracting for new generation supports emissions commitments in a way that buying certificates from existing plants does not, since the contract is what caused the project to be built.
Many agreements are financial rather than physical, settling the difference between the contract price and the market price without electrons moving between the parties. Economically it is the same hedge.
The Risks That Remain
Several risks sit outside the contract. Generation volume is uncertain, since a poor wind year produces less to sell. Curtailment, where the grid instructs a project to stop producing because the network cannot take the power, reduces output for reasons unrelated to demand.
There is also the counterparty question over a twenty year horizon. A buyer whose credit deteriorates turns a bankable contract into an uncertain one, and the project has no ability to replace it.
The Cannibalisation Problem
A structural issue is that renewable generation depresses the price at the moment it is most abundant. As more solar is built, the market price during sunny hours falls, which lowers the value of every solar project including new ones.
That means the price a new project can contract at declines as deployment grows, independent of construction costs. It is the main reason storage and flexible demand matter economically rather than only technically.
The Bottom Line
A renewable project is mostly upfront capital with no fuel cost, so its viability turns on the price it can lock in and the terms it can borrow at. A long term purchase agreement converts volatile market exposure into a contract with a known counterparty, which is what makes lending possible. The residual risks are volume, curtailment, counterparty credit, and the falling value of output as more identical capacity is added.