This week the Seventh Circuit Court of Appeals issued a decision that could help clarify the allocation of risk in power purchase agreements (PPAs). In Benton County Wind Farm LLC v. Duke Energy Indiana, Inc., the court settled a PPA dispute by concluding that the contract required the utility (Duke) to pay the wind farm (Benton) for energy even when Midcontinent Independent System Operation (MISO) market prices are negative (due to oversupply of electricity generation in the area) and Duke has to pay both MISO and Benton for accepting the wind farm’s output. The key provision in the PPA required Duke to pay Benton liquidated damages if Duke failed to accept all of Benton’s electrical output (except in certain circumstances). Since MISO changed its rules in 2013 to remove wind farms constructed after 2005 from “must-run” status, Benton has been curtailed by MISO when wind overtaxes the grid, which in the case of Benton occurs about 41% of the time the wind farm could otherwise be operating. The court reasoned that because, under the PPA, Duke must pay liquidated damages caused by its failure to obtain transmission service, “[t]he risk of inadequate transmission was contemplated by the contracting parties and allocated to Duke.” The court also noted how these provisions implicate project financing for renewable energy as well as transmission development:
Potential buyers and sellers of electricity could and did foresee when negotiating this contract (and others like it) that electrical grids may be swamped by new sources of renewable power, which usually is located far from the centers of demand. They needed to allocate the risk of that development, which predictably would compel MISO to alter its rules for which sources could put power on the grid. Allocating the risk to Benton would have made it hard, perhaps impossible, to finance the project’s construction, while leaving Duke and similar utilities no incentive to expand the regional grids as wind power became available. Allocating the risk to Duke facilitates both construction of renewable-energy sources and better incentives to match the size of the transmission grid to the capacity for local generation.
While the decision, which was a reversal from the district court’s decision, applies narrowly to this contract, the reasoning could have wider ramifications for future PPA negotiations and interpretation. You can read the full decision here (PDF).