Power Purchase Agreements, often abbreviated as PPAs, are long-term contracts established between an electricity generator and a buyer. Utilities have been the traditional signatories of these contracts, but they are now increasingly popular among electricity-intensive industries and corporations. The primary purpose of a PPA is to lock in a negotiated price for electricity, providing stability and predictability in a volatile energy market.
Currently, some companies within specific industries opt to sign a PPA with a supplier, while many others have not yet done so. The decision to enter into a long-term agreement with an electricity supplier is a strategic process involving a range of complex factors. Companies evaluate the costs associated with procuring energy through a PPA compared to acquiring it from the spot market, where both renewable and non-renewable sources are available. Financial considerations play a crucial role. Firms must assess the long-term financial advantages, including stable energy prices and risk mitigation against market fluctuations. Simultaneously, environmental responsibility may significantly influence their decision, as adopting PPAs can enhance a company's reputation and foster positive stakeholder relationships, especially in sectors where sustainability is a key differentiating element.
In addition to financial considerations and environmental responsibility, in industries characterized by oligopolies, where electricity expenses make up a substantial portion of their variable operating or production costs, whether to enter a PPA becomes strategic. These companies regularly encounter challenges associated with energy price volatility, which injects uncertainty into their operations and profit margins. Yet, the impact of committing to a long-term contract with their electricity supplier is more nuanced. When electricity prices rise, having a PPA can provide a competitive advantage over competitors with no long-term contract secured. This advantage arises from the stability of energy costs, enabling these companies to operate with more predictable and steady profit margins, thus bolstering their competitiveness. However, during periods of low electricity prices, companies with PPAs may experience higher energy costs than competitors without long-term contracts. This situation presents challenges as their competitors can capitalize on lower production costs, potentially affecting their market position.
We contribute with a game-theoretic analysis of the strategic interaction among firms that belong to an electricity-intensive oligopoly regarding the decision of whether to sign a long-term contract with electricity suppliers at a fair price. In this context, we analyze the equilibrium outcomes for different numbers of competing firms.
Our results show that, under certain assumptions, in an oligopoly composed of n risk-neutral or moderately risk-averse firms, no more than half of the competing firms sign a PPA in equilibrium. This outcome may seem paradoxical, as a risk-neutral agent is, in principle, indifferent between buying insurance at a fair price or not. However, the strategic interaction between rival firms makes most of them thrive in an uncertain cost environment. This result points to a possible strategic reason why some companies in electricity-intensive sectors have not signed a PPA to hedge their operational costs. Given the regulator's current willingness to implement these agreements, our results may have relevant policy implications.
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