POWER September 2020 - 20

LEGAL & REGULATORY
Fixed-Volume
Hedges Help Bring
Revenue Certainty
John Leonti and Xuan Li
W
ith a lack of attractive solar power purchase agreements
(PPAs) available in the market, project owners
have been seeking alternative arrangements
to secure long-term revenue certainty. One alternative is a
fixed-volume hedge, which is available in deregulated power
markets.
Under a physically settled fixed-volume hedge, the project
company purchases a fixed volume of power at the " hub " for
the then-prevailing market price, and delivers the power to the
hedge provider for a fixed price. The price for the power and
volume of power, or shape, to be delivered is agreed upon at
execution of the transaction. The actual power the project generates
and delivers to its node is sold separately at the thenprevailing
nodal price. The project company uses the revenue
it receives from the nodal sales to purchase the " hub " power
delivered to the hedge provider.
Price and Risk Factors
Fixed-volume hedges also may be settled based on notional
amounts of fixed and floating amounts. For the fixed amount,
the fixed price is multiplied by the notional amount of power
for the applicable hours. The floating amount is determined
by multiplying the hub price and the notional amount for the
applicable hours. If the fixed amount exceeds the floating
amount, the hedge provider pays the project company an
amount equal to the excess. When the floating amount exceeds
the fixed amount, the project company pays the excess
to the hedge provider.
With these transactions settled at the hub based on a
fixed price and shape, the project company is exposed to
price basis risk and volumetric, or shape, risk. Price basis
risk arises when there is a mismatch between the nodal
price the project company received and the hub price it paid.
Shape risk occurs if the project is not producing power in a
manner that matches the agreed-upon shape.
Some transactions rely on tracking accounts, ostensibly
a working capital facility, to mitigate or defer risk. If the
project company's realized revenues (not just those related
to the hedged volumes) in a given settlement period
(usually monthly) are less than the project company had to
pay out in that month, the hedge provider will advance the
project company the shortfall, up to a cap. If the realized
revenues exceed the amount the project company had to
pay out, the excess is applied to reduce the tracking account
balance, including interest. At the end of the term,
the project company either pays any outstanding tracking
account balance in a lump sum, or during an agreed-upon
term (typically not more than 36 months). If the transaction
does not have a tracking account, tax equity investors may
seek price basis and shape risk mitigation in the tax equity
transaction.
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Collateral Package
The collateral package for hedges usually includes letters of
credit, cash, or a credit-worthy parent guarantee during the
construction period. Upon achievement of commercial operations,
solar project companies often grant the hedge provider
a first priority lien on the project assets, and a pledge of the
membership interests in the project company and the sponsor's
ownership in the tax equity partnership (a " Class B "
membership interest).
First-lien solar transactions raise financing issues for the tax
equity investors and back-leverage lenders. To monetize the investment
tax credit (ITC) and avoid recapture of the ITC, among
other things, the original tax owner must place the project in
service for federal tax purposes and remain the owner for at
least five years. If the hedge provider foreclosed on the project
assets or project company membership interests prior to the
end of the 5-year recapture period, all or a portion of the ITC
would be recaptured.
One solution to avoid recapture has been to have the hedge
provider and tax equity investor execute a forbearance agreement.
The hedge provider can then foreclose on the Class B
membership interests, but not the project assets or membership
interests unless specified events occur during the recapture
period. With the forbearance, tax equity investors guard
against recapture, and the hedge provider may still gain operational
control of the asset by foreclosing on the Class B membership
interests.
Back-leverage lenders have a further concern because their
main collateral is the equity above the Class B member. The
lenders do not want the hedge provider to foreclose and eliminate
their collateral and source of repayment, and will seek
cure rights to avoid foreclosures.
Sponsors may choose to forgo the lien collateral package
and leave the construction period collateral in place for the
transaction's term, but this also has financing challenges.
For instance, the hedge provider may require credit downgrade
protection with the right to terminate the transaction
if, for example, the guarantor is not replaced. Tax equity
investors will require additional structural protections to
mitigate the risk of termination.
It's likely the use of the fixed-volume hedge will grow as the
amount of attractive PPAs remains low, and corporate credits
are an unknown in the ongoing pandemic. The hedge market
will continue to evolve beyond the fixed-volume transaction.
Parties are employing other novel products using puts, calls,
swaps, and collars to mitigate price and/or volume risk, as well
as mixing asset classes such as solar and battery storage, and
solar and wind. ■
-John Leonti is a partner at Troutman Pepper and
leader of the firm's Capital Projects and Infrastructure Practice.
Xuan Li is an associate with the firm's Capital Projects
and Infrastructure Practice.
www.powermag.com
POWER | September 2020
http://www.powermag.com
POWER September 2020

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