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Physical vs Virtual PPA – How Each One Works

By Off Grid DataGrid and Policy7 min read · Updated

Physical vs Virtual PPA – How Each One Works - 3D Cutaway Animation

Two companies sign contracts with the same wind farm on the same day. One will actually take the power. The other will never receive a single electron from that project, yet both can say they're backing new renewable energy. The difference is whether they signed a physical PPA or a virtual PPA, and it matters a lot for cost, risk and accounting. How does each type of power purchase agreement actually work, and which one fits which buyer?

In a physical PPA, the buyer takes delivery of a project's electricity at a point on the grid and uses or resells it, while in a virtual PPA the buyer never receives the power and instead settles the difference between a fixed contract price and the market price. Both usually transfer the project's renewable energy certificates (RECs) to the buyer, and both typically run 10 to 20 years.

A physical PPA needs a competitive market or a utility willing to sleeve the deal, while a virtual PPA works almost anywhere. The trade-off is that a virtual PPA exposes the buyer to market price swings, especially when wholesale prices at the project drop very low.

How Does a Physical PPA Work?

A physical PPA works like a long-term purchase of actual electricity. The project delivers power to an agreed point on the grid, and the buyer, or a retail supplier acting for it, takes title to that power and pays the contract price.

The US Environmental Protection Agency describes physical PPAs as long-term contracts, typically 10 to 20 years, for both electricity and RECs from a specific generator. It also notes they're mostly limited to competitive markets and large, investment-grade buyers.

The buyer has to deal with the logistics. It needs a way to move the power from the delivery point to its facility, usually through a retail supplier or by registering in the wholesale market. It also has to balance the gap between when the project produces and when the buyer uses power.

How Does a Virtual PPA Work?

A virtual PPA works as a financial contract layered on top of normal operations. The project sells its power into the wholesale market at whatever price it gets. The buyer keeps buying electricity from its utility. Then the two settle up on the difference between a fixed "strike price" and the market price.

Analysts at RMI describe it as the buyer swapping a fixed price for the market price while receiving the RECs. Finance people call this a contract for differences. If the market price is below the strike price, the buyer pays the project the difference. If the market price is above the strike, the project pays the buyer.

Nothing about the buyer's actual electric bill changes. The virtual PPA is a hedge that sits beside it.

Virtual PPA Settlement Math, Step by Step

Virtual PPA settlement comes down to one formula: (strike price minus market price) times the MWh produced. Try it with a $40/MWh strike price and 10,000 MWh of monthly output (made-up numbers):

MonthMarket priceDifferenceSettlement
Month A$30/MWh$40 − $30 = $10Buyer pays $100,000
Month B$55/MWh$40 − $55 = −$15Project pays buyer $150,000
Month C$40/MWh$0No payment

Now add the buyer's utility bill. In Month B, wholesale prices are high, so the buyer's power costs may be high too, but the $150,000 settlement offsets some of that. In Month A, the buyer pays the project, but its regular power costs are probably lower. Over time, the combination behaves roughly like a fixed price, which is the whole point.

The catch is the word "roughly." The project's market price and the buyer's utility price aren't the same number. They can move apart, which is the biggest risk in these deals.

What Does a Virtual PPA Look Like Over a Full Year?

Over a full year, the settlements add up to a net payment one way or the other, and that's the number finance teams watch. Scale the example up to a year with assumed figures:

If market prices average $45 instead, the project pays the buyer the same amount. A buyer signing for 15 years should model a range of price paths, not one forecast, and set aside budget for years when the settlement runs against it.

Who Keeps the RECs?

In both physical and virtual PPAs, the buyer usually keeps the renewable energy certificates, and that's what lets it claim the clean energy. One REC represents one MWh of renewable generation. In the example above, the buyer would receive about 306,600 RECs a year.

Buyers need to retire those RECs on their own behalf to make a credible claim. If they sell them instead, they give up the right to say they used that renewable power. That rule trips up first-time buyers more than you'd expect.

Physical vs Virtual PPA Side by Side

Physical and virtual PPAs share a goal but differ in nearly every mechanical detail:

Why Do Buyers Choose a Virtual PPA?

Buyers choose a virtual PPA mainly for flexibility. A company with offices and facilities in many states, including regulated utility territories, can support one large project in a windy or sunny region without changing any of its local power supply.

Virtual PPAs also let buyers pick the best projects instead of the closest ones. A data center in a state with weak renewable resources can contract with a high-output wind farm hundreds of miles away. And because the contract is financial, several buyers can share one project by each signing for a slice of its output.

What Are the Risks of a Virtual PPA?

Physical vs Virtual PPA – How Each One Works - 3D Animation

The main risks of a virtual PPA are basis risk, shape risk and low or negative prices. Each one can make the hedge behave differently than the buyer expects.

Basis Risk

Basis risk is the gap between the market price at the project and the price where the buyer actually buys power. If the project sits behind a transmission bottleneck, its local price can be much lower than prices elsewhere. The buyer then pays large settlements while its own power costs stay high.

Negative Prices

In areas with lots of wind or solar, wholesale prices sometimes go negative. In a simple virtual PPA, the buyer then pays the strike price plus the size of the negative price. With a $40 strike and a −$10 market price, the buyer pays $40 − (−$10) = $50 per MWh. Many contracts now include clauses that limit settlement during negative price hours, so read that section carefully.

Shape Risk

Solar settles only during daylight, wind when it blows. If prices are lowest exactly when the project produces most, the buyer pays settlements in many hours and rarely receives them.

Does a Virtual PPA Keep the Lights On?

No. A virtual PPA has no effect on the physical power a facility receives. If the local grid goes down, the virtual PPA does nothing to keep the facility running. Reliability still depends on the utility connection and on-site backup equipment.

That's why many large users pair renewable contracts with on-site generators or batteries. If you go that route, expect regulatory work beyond the energy contract, starting with an air permit for generators in most states.

Physical vs Virtual PPA: Let Your Market and Your Load Decide

A physical PPA fits a large buyer in a competitive market that wants actual delivered power and can handle scheduling. A virtual PPA fits a buyer that wants to support a specific project, operates in regulated territories or across many states, and is comfortable managing a financial hedge.

Either way, the fine print decides the outcome. Before signing a virtual PPA, ask for historical prices at the project's node and at your own load zone, and look at how far apart they ran in the worst months. That one comparison tells you more about basis risk than any sales deck. Then run the settlement under low, high and negative price cases, and have accounting and legal advisors review the contract, since this article is not legal, accounting or investment advice.

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