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2.2 Determining whether a power purchase agreement (PPA) is or contains a lease
Publication date: 31 Mar 2023
us Utilities guide
An agreement is or contains a lease if it conveys the right to use an identified asset for a period of time in exchange for consideration. Power purchase agreements that are dependent on an identified power plant may contain a lease. In contrast, contracts for which a specific power facility is not identified (e.g., market-based purchases and sales) are generally outside the scope of the lease guidance (see UP 2.2.1).
When evaluating whether a power purchase agreement is or contains a lease of a power plant, reporting entities should consider the following:
- Is the arrangement explicitly scoped out of ASC 842?
- Is there an identified asset (the plant can be explicitly or implicitly specified)?
- Does the purchaser have the right to control the use of the identified asset?
The following sections discuss each of these considerations for a typical power purchase arrangement.
2.2.1 PPAs: Is the arrangement explicitly scoped out of ASC 842?
ASC 842-10-15-1 includes the following list of arrangements excluded from the scope of the leases guidance:
- Leases of intangible assets subject to ASC 350, Intangibles—Goodwill and Other
- Leases to explore for or use minerals, oil, natural gas, and similar nonregenerative resources subject to the guidance contained in ASC 930, Extractive Activities—Mining and ASC 932, Extractive Activities—Oil and Gas
- Leases of biological assets
- Leases of inventory
- Leases of assets under construction
LG 2.2 includes further discussion of scope exceptions; however, we would generally not expect a power purchase agreement (PPA) to qualify for any of the scope exceptions.
Question UP 2-1
Can an undivided interest in a plant be the subject of a lease?
Can an undivided interest in a plant be the subject of a lease?
PwC response
Yes. An owner of an undivided interest in a plant (a joint plant arrangement) may enter into a power purchase arrangement to sell the output from its undivided interest or may otherwise enter into a legal-form lease of its undivided interest. Such arrangements may be for all, or a portion, of the undivided interest. As discussed in UP 15.2, practice in the utility and power industry is to account for undivided interests in a joint plant using proportionate consolidation. Using the proportionate consolidation method, a reporting entity accounts for an undivided interest as if it were a separate unit of property (e.g., the reporting entity’s financial statements include plant and related depreciation expense representing its undivided interest in the plant). Lease accounting applies to separate units of property, plant, or equipment. Therefore, because a joint plant arrangement is accounted for as a separable portion of property, we believe an undivided interest may be the subject of a lease. As such, reporting entities should account for arrangements pertaining to an undivided interest as a lease if the ASC 842 criteria are met. See UP 15.4.2 for further information on joint plant arrangements.
Question UP 2-2
Can arrangements that convey the right to a natural resource or assets other than property, plant, or equipment contain a lease?
Can arrangements that convey the right to a natural resource or assets other than property, plant, or equipment contain a lease?
PwC response
No. Contracts that transfer the right to use assets other than property, plant, or equipment do not qualify for lease accounting. As discussed in ASC 842-10-15-1, contracts to explore for or use a natural resource, such as natural gas or oil, are outside the scope of the lease guidance and should be accounted for under other applicable US GAAP.
2.2.2 PPAs: Is there an identified asset?
For a power purchase agreement to be subject to lease accounting, fulfillment of the contract must be dependent on an identified power plant. Figure UP 2-1 highlights some key indicators to consider when performing this evaluation.
Figure UP 2-1
Evaluating whether an agreement involves an identified power plant
Evaluating whether an agreement involves an identified power plant
Terms |
Considerations |
Plant is explicitly specified
|
|
Source of supply is not specified |
|
This evaluation may be straightforward if a contract explicitly specifies the power plant the seller will use to fulfill its obligation. The analysis can be more complex, however, if no plant is explicitly specified but there are contractual, operational, or economic factors that could suggest that the contract implicitly specifies a particular plant. For example, this may occur when, practically, the contract can only be fulfilled by a plant in a specified location or using a specific fuel source.
In evaluating whether the contract involves an identified power plant, the reporting entity will also need to consider whether the seller has substantive substitution rights and if the identified asset is physically distinct. Evaluating whether there is an identified asset should be based on the rights and obligations provided in the contract as well as the physical structure of the facility. Some arrangements may contain more than one identified asset which may be explicitly or implicitly specified.
These considerations are further discussion in the following sections.
2.2.2.1 Asset is explicitly or implicitly specified
Long-term power purchase agreements often explicitly specify the source of supply. In such cases, fulfillment of the agreement is generally dependent on the specified plant.
In other cases, an arrangement may contain a lease, even if the plant is not explicitly specified, as described in ASC 842-10-15-9.
An asset typically is identified by being explicitly specified in a contract. However, an asset also can be identified by being implicitly specified at the time the asset is made available for use by the customer
Consistent with this guidance, the lack of a contractually identified facility does not necessarily result in a conclusion that an arrangement does not contain a lease; further evaluation may be required. Key considerations in evaluating whether a plant is implicitly specified are whether it is contractually, regulatorily, and physically possible to fulfill the contract from another source, and, if so, whether it would be economically feasible to do so.
Some factors that should be considered in performing this evaluation include:
- Was the agreement negotiated based on supplying power from a specific location or facility, or was a power plant built for purposes of servicing the contract?
- Can the supplier access other generating sources, and, if so, is it economically feasible to fulfill the contract from those other sources?
- Are there any regulatory limitations that would prevent supplying the contract from another source?
- Does the contract include operational or similar specifications that could be met by only one facility?
- Does the contract specify a fuel source (e.g., renewable, natural gas) and, if so, would it be feasible to source this type of power from the market?
- How is the contract priced and would it be economically feasible to fulfill the obligation from the market? For example, assume the supplier owns a coal plant and the marginal market price is based on natural gas-fired generation. If the contract is priced based on generation from a coal-fired facility, it may not be economical to supply from the market. In this case, the supplier’s coal-fired facility may be implicitly identified, unless the seller has access to other coal-fired generation.
- Where are the supplier’s other potential sources of supply geographically located in relation to the delivery point? Are the plants available to fulfill the contract or are they already contracted to another party? What are the incremental costs of using an alternative source?
In addition, a contract may include exhibits that contain location maps, delivery points, or plant operating information, or there may be other side agreements that provide further evidence that a plant is implicitly specified.
2.2.2.2 Is the asset physically distinct?
An identified asset must be physically distinct. A physically distinct asset may be an entire asset or a portion of an asset, as discussed in ASC 842-10-15-16.
A capacity portion of an asset is an identified asset if it is physically distinct (for example, a floor of a building or a segment of a pipeline that connects a single customer to the larger pipeline). A capacity or other portion of an asset that is not physically distinct (for example, a capacity portion of a fiber optic cable) is not an identified asset, unless it represents substantially all of the capacity of the asset and thereby provides the customer with the right to obtain substantially all of the economic benefits from use of the asset.
Although determining whether an identified plant is physically distinct is generally straightforward in a power purchase agreement, this determination may be more challenging in other contracts common within the power and utilities industry, including electric transmission contracts, transportation contracts, or natural gas storage. When an identified asset in a contract lends itself to use by more than one party, reporting entities should carefully evaluate whether the identified asset is physically distinct.
2.2.2.3 Substantive substitution rights
Even if a physically distinct plant is specified in the contract, the purchaser does not have the right to use the identified asset if the supplier has a substantive substitution right throughout the period of use. ASC 842-10-15-10 provides criteria to consider in evaluating whether the lease includes substantive substitution rights.
Even if an asset is specified, a customer does not have the right to use an identified asset if the supplier has the substantive right to substitute the asset throughout the period of use. A supplier's right to substitute an asset is substantive only if both of the following conditions exist:
- The supplier has the practical ability to substitute alternative assets throughout the period of use (for example, the customer cannot prevent the supplier from substituting an asset, and alternative assets are readily available to the supplier or could be sourced by the supplier within a reasonable period of time).
- The supplier would benefit economically from the exercise of its right to substitute the asset (that is, the economic benefits associated with substituting the asset are expected to exceed the costs associated with substituting the asset).
Prior to concluding that there is an identified plant, the reporting entity should evaluate any contract provisions that permit substitution from an alternative source and determine whether those rights are substantive. If a plant is implicitly specified because the supplier does not have any alternative supply sources to fulfill the contract, substitution rights do not exist. In order to be substantive, a substitution right must exist for the entire period of use. Provisions that allow a supplier to substitute an asset on or after a specific date or upon occurrence of a specific event would not preclude the arrangement from being a lease prior to the substitution date.
Due to the nature of a power plant’s operations, most power purchase agreements specify the seller’s performance requirements during scheduled and unplanned outages. In some cases, the seller may have an option to supply the energy from another source at any time, either with permission from the purchaser or at its discretion. Even though a source of supply is explicitly specified, these types of provisions may raise questions about whether the contract is dependent on an identified plant (i.e., if substantive substitution rights exist).
ASC 842-10-15-14 specifically addresses the impact of substitution rights during outage periods on the determination of whether the contract is dependent on an identified asset.
The supplier’s right or obligation to substitute an asset for repairs or maintenance, if the asset is not operating properly, or if a technical upgrade becomes available, does not preclude the customer from having the right to use an identified asset.
Consistent with this guidance, if a plant is explicitly specified in the contract, the ability to provide replacement power from other sources during outage periods is not a substantive substitution right. In addition, if replacement power is allowed for reasons other than outages, but it is subject to the consent of the off-taker, we would generally conclude that the contract contains an identified plant. Penalties or other costs incurred to provide replacement power may make substitution uneconomical for the supplier, in which case, the substitution rights would not be substantive.
If, alternatively, a power purchase agreement allows the seller to substitute power at its discretion with no permission required from the off-taker, there are alternative sources of supply available (e.g., from a different plant or from the market), and there are circumstances in which the seller would benefit economically from using an alternative supply source, the plant would not be an identified asset because the supplier’s substitution rights would be considered substantive. As a result, the contract would not contain a lease.
Note that there is no specific measurement threshold to be met, and judgment is required to determine how significant the supplier’s economic benefits should be for the substitution rights to be substantive. If the purchaser does not have transparency into the practicality or economics of the supplier’s substitution rights, it should assume the rights are not substantive and that the contract contains an identified asset. See LG 2.3.1.4 for additional considerations in evaluating whether substitution rights are substantive.
ARCHIVED 2.2.2.4 Examples
The following examples illustrate the application of the guidance on identified assets.
EXAMPLE UP 2-1
A plant is specified but replacement power is permitted in the event of outages
A plant is specified but replacement power is permitted in the event of outages
Ivy Power Producers (IPP) owns and operates the Maple Generating Station, a 500 megawatt (MW) natural gas-fired facility. IPP enters into a 20-year power purchase agreement with Rosemary Electric & Gas Company (REG). Under the terms of the agreement, IPP agrees to sell to REG all of the capacity, electric energy, and ancillary services either available from or produced by the Maple Generating Station. The agreement also provides that IPP may satisfy its obligations from another source only during a forced outage or scheduled maintenance. The agreement includes availability criteria and IPP is required to operate the facility in accordance with prudent utility practice. Failure to meet the contract terms would result in market-based penalties for nonperformance.
Is the contract dependent on an identified plant?
Analysis
Yes. The agreement provides REG with the use of the Maple Generating Station for a 20-year period. Although IPP is permitted to provide replacement power in the event of an outage, performance under the agreement is otherwise dependent on the specified plant. IPP does not have the ability to control the facility for its own use or for the purpose of satisfying other contractual arrangements. The ability to use replacement property during plant outages is contemplated in ASC 842-10-15-14 and therefore does not preclude there being an identified asset. As a result of these considerations, the parties would conclude that the agreement is dependent on an identified plant.
EXAMPLE UP 2-2
A plant is specified but replacement power is permitted in the event of outages or with the permission of the off-taker
A plant is specified but replacement power is permitted in the event of outages or with the permission of the off-taker
Assume the same facts as Example UP 2-1, except that IPP can supply replacement power at any time with the consent of REG. In addition, it continues to be able to supply replacement power in the event of an outage at the Maple Generating Station.
Is the contract dependent on an identified plant?
Analysis
Yes. The ability to provide replacement power in the event of an outage does not affect the conclusion that the agreement is dependent on an identified facility. Further, the ability to provide replacement power at any time with REG’s consent still gives the off-taker the ability to control the plant. IPP cannot use the facility for another purpose at its own discretion. As such, the contract involves an identified plant.
EXAMPLE UP 2-3
A plant is specified but the supplier can substitute an alternative source without permission from the off-taker
A plant is specified but the supplier can substitute an alternative source without permission from the off-taker
Assume the same facts as in Example UP 2-1, except that IPP can substitute power from other sources at its discretion. There are certain contractual requirements regarding the quality and type of substitute power to ensure compliance with requirements of the applicable regional transmission organization, but there are no other contractual limitations that would prevent substitution.
Is the contract dependent on an identified plant?
Analysis
It depends. Although the arrangement identifies a specific facility, the supplier’s ability to substitute power from alternative sources will lead to the conclusion that the contract is not dependent on an identified plant if its substitution rights are substantive. In evaluating whether IPP has substantive substitution rights, the parties should assess whether the conditions in ASC 842-10-15-10 are both met. Specifically, IPP and REG should consider the following:
- Does IPP have the ability to substitute? That is, are there alternative sources of supply available that can be accessed without legal, contractual, or economic penalties?
- Would IPP benefit economically from the substitution? Are there alternative sources of supply available with pricing that would benefit IPP in the event of substitution (e.g., there is no penalty for substitution and the price of the alternative supply is less than the identified plant)?
Unless both of the above conditions are met, IPP’s substitution right would not be substantive, and the contract would be dependent on an identified plant. For example, if Maple Generating Station is in an isolated area and it is not economically feasible for IPP to supply from another source, the arrangement likely would involve an identified plant. In contrast, if IPP owns another natural gas-fired plant that could be used to source the contract with REG, and the cost of switching plants would not exceed the benefit to IPP, then IPP may have substitution rights, and Maple Generating Station would not be an identified asset.
EXAMPLE UP 2-4
A plant is specified but it includes more than one generating unit
A plant is specified but it includes more than one generating unit
Assume the same facts as Example UP 2-1, except that the Maple Generating Station (MGS) is comprised of five separate 100-MW generating units. REG agrees to purchase all of the power and capacity produced by MGS Unit 1, MGS Unit 2, and MGS Unit 3. Each of the units is separately metered and has a separate intertie to the power grid. The power and capacity from MGS Units 4 and 5 are sold to Pine Tree Electric Company in a separate contract.
Is the contract between REG and IPP dependent on an identified plant?
Analysis
Yes. This contract is dependent on identified property, plant, or equipment, the Maple Generating Station. As noted in ASC 842-10-15-16, a portion of an asset may be an identified asset if it is physically distinct. In this fact pattern, IPP is able to determine how much capacity and energy is produced by each unit because the units are separately metered. Thus, REG’s contract is dependent on MGS Unit 1, MGS Unit 2, and MGS Unit 3. This would be the case even if the units connected to the power grid through a single interconnection.
In contrast, if the contract stated that REG would receive the output from units 1, 2, and 3, but there are no separate meters, the contract would be with respect to Maple Generating Station as a whole, not its individual units. The parties would then need to consider whether REG is receiving substantially all of the economic benefits from MGS (see Example UP 2-xx). The conclusion would be the same if the contract entitled REG to 60% of the output from MGS, without specifying individual units.
2.2.3 PPAs: Does the purchaser have the right to control the use of the identified asset?
Once a reporting entity concludes that an arrangement involves an identified asset, it needs to evaluate whether the agreement conveys to the off-taker the right to control that asset (in this case, the plant). Control over the use of the plant can be for a portion of the term of the contract. In accordance with ASC 842-10-15-4, control over the use of the identified asset has been transferred if the following two criteria are met:
- The purchaser has the right to obtain substantially all of the economic benefits from use of the identified plant.
- The purchaser has the right to direct the use of the identified plant.
If the arrangement involves an identified plant and both of the requirements in ASC 842-10-15-4 are met, the contract contains a lease.
Factors to consider in evaluating whether an arrangement conveys the right to control an identified plant are further discussed in the following sections. The analysis assumes that the arrangement involves an identified plant (see UP 2.2.1 for further information).
2.2.3.1 Right to obtain substantially all of the economic benefits
The first criterion in the control assessment is whether the off-taker has the right to obtain substantially all of the economic benefits derived from the plant.
The standard does not define “economic benefits,” but instead provides examples of how the economic benefits may be obtained (e.g., by using, holding, or subleasing the asset). ASC 842-10-15-17 specifies that this evaluation should consider economic benefits derived from use of the plant, including output, by-products, and other economic benefits.
Excerpt from ASC 842-10-15-17
The economic benefits from use of an asset include its primary output and by-products (including potential cash flows derived from these items) and other economic benefits from using the asset that could be realized from a commercial transaction with a third party.
A customer (off-taker in the case of a power purchase agreement) does not control an asset if another party has the right to more than an insignificant portion of the economic benefits. This assessment would exclude benefits obtained solely from owning the asset (e.g., proceeds from sale of the asset). Further, this evaluation is not a probability analysis as to which party is likely to receive the benefits but instead focused on the contractual rights of the respective parties. The assessment should consider the level at which the plant is expected to operate, based on the plant’s condition and capacity at the inception of the contract, and other factors such as maintenance schedules, the type of plant, and its scheduled use. We believe it is acceptable to base this evaluation on actual or projected revenue over the contract term; however, potential future changes to the plant (e.g., additional capacity) should not be considered.
If the off-taker’s contractual rights are for only a portion of the existing capacity of an asset, and it does not have the option to acquire additional capacity, the arrangement is unlikely to be a lease, even if no other customers are expected to contract for the remaining capacity. If the off-taker, however, has the option to increase the volume of the output it consumes before it is given to additional customers (right of first refusal), the arrangement likely meets this criterion.
Power purchase agreements often comprise the sale of multiple products (e.g., energy, capacity, steam, renewable energy credits, and ancillary services) and thus include more than one type of economic benefit. In addition, it is not uncommon for an entity to sell products from a facility to more than one counterparty. Figure UP 2-2 summarizes considerations when evaluating some of the potential economic benefits derived from a power plant.
Figure UP 2-2
Economic benefits associated with the use of a plant
Economic benefits associated with the use of a plant
Product |
Economic benefit? |
Assessment |
Ancillary services
|
Yes
|
Ancillary services (e.g., regulation market, synchronized reserve market) are provided from the dedication and operation of a specific facility. See UP 4.5 for further information about ancillary services.
|
Capacity
|
Yes
|
“Iron in the ground” is required to provide capacity; capacity represents the dedication of a specific plant to a counterparty or to a control area to meet reserve requirements and customer needs.
|
Energy
|
Yes
|
Electric energy is produced and delivered to customers from power plants.
|
Renewable energy credits (RECs)
|
Yes
|
ASC 842-10-55-111 explicitly identifies RECs as an economic benefit. See Question UP 2-5.
|
Steam
|
Yes
|
Steam is a tangible product although it is usually insignificant to the total economics of the facility.
|
Government incentives
|
Generally, no
|
Government incentives that are paid or awarded to the owner of a facility and are not related to use of the plant are not economic benefits. Examples include certain tax credits, grants, and other programs that incentivize green power. See Question UP 2-5.
|
Question UP 2-3
How should a reporting entity evaluate whether an arrangement conveys the right to obtain substantially all of the economic benefits from a specified plant when the plant produces multiple products?
How should a reporting entity evaluate whether an arrangement conveys the right to obtain substantially all of the economic benefits from a specified plant when the plant produces multiple products?
PwC response
While there is not a bright line for evaluating whether an arrangement conveys the right to obtain substantially all of the economic benefits from a plant, a customer will not control the plant if the owner has the right to sell more than an insignificant portion of the economic benefits to another party. The calculation is simple if a facility is selling only one product; however, power plants often produce and sell at least three products: energy, capacity, and ancillary services. Because the different products have different units of physical measurement, we believe that the reporting entity should assess the fair value of each of the expected benefits in performing the economic benefit analysis.
In assessing the relative fair value of the total economic benefit from the facility, the numerator and denominator used in the calculation should be expressed in units of currency (e.g., dollars), rather than the unit of measure associated with the output (e.g., megawatt-hours or number of RECs). The calculation is based on the fair value of a reasonable expectation of sales (rather than stated capacity) over the life of the contract (as determined at the contract’s inception).
Question UP 2-4
Should RECs be considered an economic benefit when evaluating whether a contract is or contains a lease?
Should RECs be considered an economic benefit when evaluating whether a contract is or contains a lease?
PwC response
Yes. Renewable energy credits should be considered in the lease evaluation. ASU 2016-02, includes RECs as an example of an economic benefit received from using an asset.
Excerpt from ASU 2016-02 – Leases (Topic 842), Background Information and Basis for Conclusions, paragraph BC135
The Board conclude that, when considering whether a contract contains a lease, a customer should not consider economic benefits relating to ownership of an asset (for examples, tax benefits resulting from owning an asset). However, a customer should consider benefits relating to the use of the asset (for example, renewable energy credits received from the use of an asset or by-products resulting from the use of an asset).
The inclusion of RECs as an economic benefit in the lease accounting analysis is irrespective of whether an entity believes RECs are an output or government incentive (see UP 7).
Question UP 2-5
Should production tax credits be considered an economic benefit when evaluating whether a contract is or contains a lease?
Should production tax credits be considered an economic benefit when evaluating whether a contract is or contains a lease?
PwC response
It depends. As noted in the Basis of Conclusions (paragraph BC135) in ASU 2016-02, “economic benefits associated with ownership of an asset (for example, tax benefits from ownership of an asset),” are not considered in assessing whether a contract is or contains a lease. ASC 842-10-55-111 specifically discusses tax credits related to ownership of a solar facility.
Excerpt from ASC 842-10-55-111
a. Although Supplier will be receiving economic benefits from the solar farm in the form of tax credits, those economic benefits relate to the ownership of the solar farm rather than the use of the solar farm, and thus, are not considered in this assessment.
Further, ASC 842-10-15-17 specifies that the economic benefits from use of an asset that are considered in the lease evaluation include those “that could be realized from a commercial transaction with a third party.”
Thus, investment and production tax credits that are paid to the owner of an asset are not considered economic benefits as they are either (1) not based on use of the asset or (2) are paid by the government and not realized from a transaction with a third party. Legislation included within the Inflation Reduction Act (IRA), however, introduces new tax credits that may be sold to a third party in lieu of claiming the credit on the entity’s tax return.
To the extent the transferrable credits are associated with use of an asset, not its ownership, we believe the credits should be considered as an economic benefit in the lease evaluation, similar to the consideration of renewable energy credits. For example, this may include a transferrable production tax credit that is received for each megawatt hour of wind or nuclear energy that is produced (e.g., Section 45 production tax credits or Section 45U credits). Tax credits that are based solely on owning an asset (i.e., investment tax credits), however, would not be considered economic benefits, even if they can be sold to a third party.
In evaluating lease accounting, a reporting entity should ensure it has a clear understanding of the provisions of any tax credits associated with a power plant facility.
Question UP 2-6
If a customer has the right to substantially all of the economic benefits of an identified plant for only a portion of a defined period of use, does the arrangement contain a lease?
If a customer has the right to substantially all of the economic benefits of an identified plant for only a portion of a defined period of use, does the arrangement contain a lease?
PwC response
Yes, if the other criteria for lease accounting are met. Under ASC 842-10-15-5, control over the use of an asset can be for a portion of the term of a contract and still support a conclusion that the arrangement is a lease during that period.
If the customer has the right to control the use of an identified asset for only a portion of the term of a contract, the contract contains a lease for that portion of the term.
Based on this guidance, if a power purchase agreement provides an off-taker with varying levels of output such that the off-taker receives substantially all of the economic benefits from the plant only in certain periods, both parties should bifurcate the period of use under the power purchase agreement. There would be a lease for the periods in which the off-taker receives substantially all of the benefit from the plant, assuming the off-taker also has the right to direct the use of the plant in those periods (see UP 2.2.4.2 for details on evaluating this criterion).
EXAMPLE UP 2-5
Evaluation of whether the off-taker receives substantially all of the economic benefits
Evaluation of whether the off-taker receives substantially all of the economic benefits
Ivy Power Producers (IPP) owns and operates the Maple Generating Station, a 500 megawatt (MW) natural gas-fired facility. IPP enters into a 5-year power purchase agreement with Rosemary Electric & Gas Company (REG), a regulated utility. Under the terms of the agreement, IPP agrees to sell to REG capacity, electric energy, and ancillary services either available from or produced by the Maple Generating Station to meet the demand needs of REG’s customers. REG expects its customer needs will escalate over the term of the agreement and therefore contracts with IPP to receive a percentage of the output from the Maple Generating Station as follows:
Year 1 |
Year 2 |
Year 3 |
Year 4 |
Year 5 |
Average |
60 |
60 |
100 |
100 |
100 |
84 |
Does REG receive substantially all of the benefit from Maple Generating Station under the power purchase agreement?
Analysis
Yes, for a portion of the agreement. Following the guidance in ASC 842-10-15-5, IPP and REG would evaluate each year of the power purchase agreement separately. REG will only receive a portion of the economic benefits in contract year one and year two, but will receive 100% of the benefit in contract years three through five. Assuming the other criterion are met, REG would have a lease of the Maple Generating Station in years three through five.
2.2.3.2 Right to direct the use of the identified plant
ASC 842-10-15-20 includes guidance for determining which party to the contract has the right to direct the use of an identified asset under two broad scenarios: (1) all relevant decisions about how and for what purpose the asset is used during the period of use are predetermined, and (2) certain of the relevant decisions are not predetermined. ASC 842-10-15-25 provides examples of decision-making rights that affect the economic benefits derived from using the asset, including when, where, whether, what, and how much output is produced.
Examples of decision-making rights, that, depending on the circumstances, grant the right to direct how and for what purpose an asset is used, within the defined scope of the customer’s right of use, include the following:
- The right to change the type of output that is produced by the asset
- The right to change when the output is produced (for example, deciding when an item of machinery or a power plant will be used)
- The right to change where the output is produced
- The right to change whether the output is produced and the quantity of that output (for example, deciding whether to produce energy from a power plant and how much energy to produce from that power plant).
Generally, the location (where) and products (what) produced are not applicable in evaluating relevant decisions in a power purchase agreement given the nature of a power plant. The reporting entity should, nevertheless, evaluate whether the off-taker or supplier directs the remaining relevant decisions that affect the economic benefits derived from the plant during the period of use (i.e., the right to change when, whether, and how much energy is produced).
Further considerations in evaluating the right to direct the use of a power plant in specific types of arrangements (i.e., predetermined or not) are discussed in the following sections.
All relevant decisions are predetermined
Renewable power facilities typically require minimal active operation after the initial construction phase. In such cases, the decisions related to how and for what purpose the facility may be used are often specified in the contract and neither party can change how and for what purpose the plant is used during the contract period. ASC 842-10-15-20 provides two situations that indicate that a customer has the right to direct the use of an identified asset. ASC 842-10-15-20(b) describes the situation when the relevant decisions are predetermined.
The relevant decisions about how and for what purpose the asset is used are predetermined (see paragraph 842-10-15-21) and at least one of the following conditions exists:
- The customer has the right to operate the asset (or to direct others to operate the asset in a manner that it determines) throughout the period of use without the supplier having the right to change those operating instructions.
- The customer designed the asset (or specific aspects of the asset) in a way that predetermines how and for what purpose the asset will be used throughout the period of use.
As such, when all the relevant decisions are predetermined, the off-taker has the right to direct the use of the plant if it has the right to operate the plant or designed it in a way that predetermines its purpose. The design assessment may be especially important for renewable energy facilities as the off-taker may be involved in determining the site as well as asset specifications such as size, which may determine how and for what purpose the facility will be used. An off-taker that contracts to buy energy from a windfarm and is responsible for determining the facility’s location as well as the number and type of turbines generally would have the right to direct its use as it was responsible for key decisions around its specifications.
Not all of the relevant decisions are predetermined
The relevant decisions are typically not predetermined in fossil fuel plants (e.g., natural gas, coal) as decisions during the period of use impact the economics of the plant and are deemed to be substantive.
Dispatch rights should always be considered in determining whether the customer directs the use of the plant. Dispatch rights may impact the economics of peaker plants more than base load plants (or plants that are contracted for full-time operation) and therefore should be evaluated along with the nature of the plant and other relevant decision-making rights conveyed in the contract.
In a must-take power arrangement, when the lessee is required to take all of the output produced by the facility, judgment will be required to determine which party directs the use of the underlying plant and whether the arrangement contains a lease. If the lessor can force the lessee to take all the output produced, and the lessor also controls the fuel source such that it can determine when and how much the plant produces, the lessor would likely have the right to direct the use of the plant, such that the arrangement would not be a lease.
Question UP 2-7
Does the purchaser’s ability to control dispatch in a tolling agreement convey the right to direct the use of the plant?
Does the purchaser’s ability to control dispatch in a tolling agreement convey the right to direct the use of the plant?
PwC response
Yes. In a typical tolling agreement, the purchaser is responsible for providing fuel to the plant operator for conversion into energy. The off-taker also directs the timing of dispatch. The seller usually is not required to deliver energy unless the fuel is provided. In this case, the off-taker directs the use of the asset during the term of the contract through its dispatch right, allowing the off-taker to dictate whether and when the plant should operate and how much energy should be produced. Since the off-taker controls when the asset operates (even though it does not physically operate the facility), it has the right to direct the use of the plant during the lease term.
This evaluation may be different in a non-tolling purchase power agreement. For example, if a customer contracts for 100% of the energy and capacity from a natural gas-fired plant on a full-time basis, the customer would not have dispatch rights, as the contract is for full-time operation. In that case, whether and where the output is produced are predetermined by the terms of the contract and the nature of the plant. As such, the parties should evaluate whether either party can change how much output is generated and when the output is generated in order to determine if the purchaser has the right to direct the use of the plant.
Question UP 2-8
Do operating requirements specified in an arrangement impact the evaluation of the right to direct the use of the plant?
Do operating requirements specified in an arrangement impact the evaluation of the right to direct the use of the plant?
PwC response
Generally, no. Power purchase agreements often specify certain operating requirements, including the obligation to operate and maintain the identified plant following “prudent utility practice.” Protective rights over operations generally would not convey the right to direct the use of the plant, as these are not decision-making rights. Examples of such provisions may include:
- negotiated operating requirements to be executed by the owner,
- a requirement to follow prudent operating practices, or
- a provision that allows the purchaser to monitor the seller’s compliance with prudent utility practice, or other safety or environmental standards.
As discussed in ASC 842-10-15-23, protective rights typically define the scope of the right to use the identified plant. As such, they should not be a factor in determining who controls the plant. However, monitoring rights that allow the purchaser to step in and/or replace the operator for performance issues may demonstrate that the purchaser has the right to direct the use of the plant.
Question UP 2-9
Is the right to direct the use of the plant conveyed to the purchaser if the parties to an agreement share responsibility for operations and maintenance?
Is the right to direct the use of the plant conveyed to the purchaser if the parties to an agreement share responsibility for operations and maintenance?
PwC response
No. In some cases, responsibility for operations and maintenance may be shared by the parties to an agreement (e.g., one party may be responsible for operations and routine maintenance while the other party performs major maintenance). As discussed in ASC 842-10-15-26, rights that are limited to operating or maintaining the asset are examples of decision-making rights that generally do not grant the right to direct how and for what purpose an asset is used.
Examples of decision-making rights that do not grant the right to direct how and for what purpose and asset is used include rights that are limited to operating or maintaining the asset. Although rights such as those to operate or maintain an asset often are essential to the efficient use of an asset, they are not rights to direct how and for what purpose the asset is used. Such rights (that is, to operate or maintain the asset) can be held by the customer or the supplier. The supplier often holds those rights to protect its investment in the asset. However, rights to operate an asset may grant the customer the right to direct the use of the asset if the relevant decisions about how and for what purpose the asset is used are predetermined.
A reporting entity should first identify any relevant decisions that could be made during the period of use. These decisions may vary depending on the nature of the plant (e.g., fossil vs. renewable or baseload vs. peaker) and the specifics of the power purchase agreement (e.g., tolling agreement). For example, dispatch may be predetermined in a contract for energy from a solar facility whereas this would be an important decision making right in a contract for energy from a natural gas-fired peaker plant.
If all relevant decisions are predetermined, the parties should assess whether the purchaser designed the plant. Unless the off-taker was involved in designing the asset or has sole authority to operate or instruct others to operate the plant (such that the supplier cannot change any of the operating instructions), the off-taker would not have the right to direct the use of the plant.
Examples LG 2-9, LG 2-10, and LG 2-11 within LG 2.3.2.3 illustrate evaluating the right to control the use of an identified facility in a power purchase agreement and natural gas capacity contract. The following example also addresses the right to direct the use of a power plant.
EXAMPLE UP 2-6
Evaluation of whether the off-taker has the right to direct the use of a power plant
Evaluation of whether the off-taker has the right to direct the use of a power plant
Ivy Power Producers (IPP) owns and operates the Maple Generating Station, a 500 MW natural gas-fired facility. IPP enters into a 20-year power purchase agreement with Rosemary Electric & Gas Company (REG), a regulated utility. Under the terms of the agreement, IPP agrees to sell to REG all of the capacity, electric energy, and ancillary services either available from or produced by the Maple Generating Station.
The agreement also includes the following key terms:
Dispatch - IPP is obligated to supply power only if fuel is delivered. REG can decide when to call electricity from the facility, subject to operational parameters. If REG does not call the power, IPP retains the right to produce power for the sale to other purchasers.
Operations and maintenance - IPP is contractually responsible for the day-to-day operations and maintenance of the plant in accordance with prudent utility practice. IPP will propose timing of all scheduled maintenance and will perform unscheduled maintenance as required. The plant has a management committee that has oversight of the timing of scheduled maintenance, response to system emergencies and forced outages, and other mutually agreed matters impacting the operations and maintenance of the facility. Both IPP and REG may designate one or more representatives to this committee; however, each party receives only one vote, and unanimous agreement is required.
Which party has the right to direct the use of the facility?
Analysis
Since the Maple Generating Station is a natural-gas facility, relevant decisions about (1) whether and when to produce energy and (2) how much energy to produce are not predetermined. Therefore, IPP and REG need to evaluate which party holds the decision-making rights under the contract to determine which party has the right to direct the use of the facility.
IPP’s rights under the agreement are limited to operating and maintaining the facility. As described in ASC 842-10-15-26, these rights do not grant the right to direct how and for what purpose an asset is used.
REG directs the use of the facility during the term of the agreement through its dispatch right (i.e., its right to dictate when the facility should operate and produce energy). Since REG controls the decisions to operate the facility (even though REG does not physically operate the plant), it has the right to direct the use of the plant.
2.2.4 Power purchase agreement examples within ASC 842
Figure UP 2-3 shows the examples in ASC 842-10-55 illustrating the assessment of whether certain power purchase agreements are or contain a lease.
Figure UP 2-3
Examples illustrating the identification of a lease
Examples illustrating the identification of a lease
Example |
Codification reference |
Details |
Example 9 – Contract for Energy/Power
Case A
|
Illustration of a contract to purchase all of the electricity produced by a new solar farm for 20 years that contains a lease
|
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Example 9 – Contract for Energy/Power
Case B
|
Illustration of a contract to purchase all of the power produced by an explicitly identified power plant for three years that does not contain a lease
|
|
Example 9 – Contract for Energy/Power
Case C
|
Illustration of a contract to purchase all of the power produced by an explicitly identified power plant for ten years that contains a lease
|
2.2.5 Evaluating virtual power purchase agreements for leases
Renewable power facilities are increasingly entering into virtual power purchase arrangements (VPPAs) in which a customer physically purchases only the renewable energy certificates (RECs) generated by the facility. The generator sells the power produced by the facility into the local electric market and receives market price for the power. In turn, it “net settles” the difference between the market price and a fixed price per MWh specified in the VPPA with the customer.
VPPAs are frequently used by developers of renewable facilities to secure long-term fixed pricing for the output produced and to mitigate exposure to price volatility in the power markets, facilitating financing of construction of the facility. Because renewable assets produce RECs to evidence the generation of “green electricity,” a VPPA from a renewable resource provides a customer with a way to source RECs, even if it cannot physically receive the green power that is produced. The typical counterparty in a VPPA is a business purchasing RECs to support its net zero or emissions reductions goals.
In evaluating whether the VPPA is a lease, the counterparties would need to consider whether the off-taker has control of the plant, including receiving substantially all of the economic benefits and the right to direct the plant’s use. In a VPPA, the customer purchases the RECs but typically does not have the right or obligation to take delivery of the energy. Further, the off-taker typically has no involvement in dispatch or operations and maintenance and thus would not direct the use of the facility. As such, the criteria in ASC 842-10-15-4 are not met and the VPPA would not contain a lease.
PwC. All rights reserved. PwC refers to the US member firm or one of its subsidiaries or affiliates, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see www.pwc.com/structure for further details. This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.
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