Italy set to replicate Spanish PPA boom

inspiratia assesses market fundamentals in the two countries, ahead of the upcoming publication of Italy’s long-awaited 8GW FER 1 renewable decree  

Italy and Spain both feature a PPA landscape dominated by utilities and traders and characterised by high electricity prices.

However, an in-depth look at the two countries reveals substantial differences, with the comparative sizes of Italy and Spain’s PPAs markets providing a notable discrepancy.

In Italy, three PPAs were signed during 2019, with the largest deal being the 300MW agreement between Danish developer European Energy and the Swiss-based utility Axpo.

As for Spain, 13 agreements – totalling nearly 3GW of capacity – were signed in the same timeframe, according to data collected by inspiratia’.

Notwithstanding this relevant gap in contracted capacity, the three PPAs signed in Italy in 2019 signalled crucial improvements, particularly compared to the country’s traditional short-term practices.

These innovations –average contract duration at above 10 years and the inclusion of the country’s first corporate PPA signed between Swiss trader DXT and steel producer Duferco – could set Italy on track for getting closer to Spain’s intense market activity over the past two years.

“We are seeing Italy catching up extremely fast on Iberia. As soon as the solar market parity concept was proved in Spain, developers have started their activities in Italy where higher energy prices compensate for lower irradiation factors,” says Dario Gallanti, partner at Our New Energy (ONE).

“We expect several hundred megawatts of projects to be fully authorized already before end of 2019,” adds Gallanti.

Attitudes towards PPAs in Italy and Spain

“The real differences we see are in terms of players having been exposed to market parity cases abroad, compared to those ones that are looking at Italy as a first experience. This is valid for all stakeholders, from investors to off-takers and financing banks,” says Gallanti.

“It is important for everyone to assess and leverage on their competitive hedges as well as on the experiences from abroad to best succeed in the Italian market.  At ONE we feel privileged in paving the way in this sense, in particular when it comes to using the PPA as a leverage tool with financial institutions on the Italian market,” he adds.

Furthermore, to properly assess the value of a PPA, it is useful to understand future price indications – particularly in a country such as Italy where future markets are restricted to a two- to three-year time horizon – as well as the evolution of renewable players’ attitudes.

“Even though forward markets currently show limited liquidity on long term products, we will see this changing as soon as the first large deals are getting signed, this giving more transparency to the entire sector. Nevertheless, we are already witnessing offtakers willing to commit up to 20 years ahead, under similar structures to the ones discussed in Iberia,” notes Gallanti.

Synthetic PPAs

Because of these trends, price stability and long-term forecasting could be enhanced, thereby laying the grounds for the adoption of financial – also known as synthetic – PPAs in Italy.

The latter are hedging contracts whereby a buyer and a seller settle the difference between the agreed energy price and the spot price, while respectively continuing to purchase and sell electricity via separate agreements with one or more utilities.

These types of agreements require, aside from the willingness of developers, offtakers and lenders to take on an increased and diversified set of risks – such as development or bidding risk – also strong market liquidity to be successfully carried out.

Synthetic PPAs are already taking off in Spain with the recent signing of the Statkraft-Audax (both utilities) financial PPA in early July 2019.

The contract in question is a milestone because it could leverage its long-term fixed price as a bellwether for the development of SME-tailored pricing schemes via Audax offering personalised product to Spanish enterprises.

Moreover, the deal between Statkraft and Audax is relevant because it is a model that could be replicated in Italy.

The above seems particularly true given the predominance of SMEs and the presence of few energy-intensive industries in both the Italian and Spanish.

In Spain, the SMEs market developed when a group of energy-intensive industries – represented by Fortia – successfully signed a 10-year baseload PPA with Norwegian utility Statkraft in January 2019.

Electricity price peculiarities

Another aspect to consider when analysing PPAs in Italy and Spain is the electricity price in each country.

Indeed, while it is true that both countries present higher electricity prices compared to the rest of Europe, important price differences remain in the two markets.

Italy and Spain’s electricity prices 2014-2019

Sources: Red Eléctrica de España, Gestore Mercati Energetici

These peculiarities, in turn, are relevant for the determination of any PPA price – especially for hedging tools such as financial PPAs.

A major disparity between Italy and Spain is the Italy’s less developed futures market, which is fragmented in six regional districts with variations that could reach double digits per MWh.

Furthermore, Italy and Spain have different dates for the phasing out of conventional sources. Italy, for instance, pledged to shut down its coal fleet by 2025, while the Spanish government has not yet reached a clear position on the matter.

These disparities are important because a different amount of pressure on prices will exist, given the different composition of the countries’ future energy mixes.

In addition to the above, price fluctuation mitigants are also different, such as Italy’s high reliance on gas power plants, which is set to continue at least in the next decade.

This brief overview of Italy and Spain’s peculiarities highlights the importance of electricity price forecasting for PPAs.

Nevertheless, analysing trends and variations in electricity prices is also important for merchant projects or combination of the the latter with PPAs.

In fact, the limited sensitivity of declining LCOEs for renewables to future price expectations, compared to what happens for conventional sources, do not exempt players eyeing merchant projects to pay attention to electricity prices’ evolutions.

The above seems particularly true at a time when these types of schemes are starting to spread in the Spanish renewables market.

A proof of this increasing activity is the financial close reached in early May 2019 by the 300MW subsidy-free Talasol solar park which will be built by Israeli developer Ellomay Capital and which is also supported by a financial PPA covering 80% of the total project’s output.

A buyers’ market

Financial PPAs, fully merchant projects or a combination of the two with the ability to successfully compete with wholesale price are evolving in Spain and could soon take off in Italy.

The main drivers of these activities are their ability to act as viable tools to mitigate regulatory risk and, mainly for PPAs, to reduce exposure to long-term price volatility.

Regulatory uncertainties – which temporarily damaged investor confidence – spurred from the abrupt tariff cuts carried out by the Italian and Spanish government since the early 2010s.

Now, as renewable players look to make the most of declining LCOEs for renewables in the two countries, it seems natural that their preferences fall on subsidy-free projects shielded from change-in-law risk.

However, this is not the whole picture. Indeed, merchant projects are also being favoured by the fact that they provide higher returns compared to schemes incentivised by public support.

A downside of this recent evolution, however, lies in the fact that only large and highly structured entities can deal effectively with merchant risk and thereby dominate the market.

This is the main reason why Spain is currently witnessing a market strongly skewed towards buyers with limited diversification and, ultimately, a hindered competition.

Unfortunately, the same feature is present in Italy, albeit for different reasons.

Here, prolonged frozen auctions and a flawed permitting process carried out by local authorities, often not aligned with the government’s intentions, halted project developments.

This led large players equipped with a substantial amount of capital to invest in operative projects – given also the scarcity of new quality projects – with the aim of reaching portfolios’ consolidations.

The role of auctions in a merchant world

Auctions could be utilised to support a more competitive renewables market, by attracting more players such as aggregation of SMEs or consortia of energy-intensive buyers.

Indeed, unlike Spain which currently lacks any forthcoming auction, Italy has 4.8GW of capacity to be auctioned between 2019-2021 following the recent positive evaluation by the EU Commission regarding the non-violation of the European competition rules.

Moreover, as far as corporate energy procurement is concerned, auction prices could represent a good indication for valuing large PPA-backed projects – provided, however, that a substantial capacity will be successfully auctioned in the coming years.