Innovation of the year: Tesco Treasury and Baringa Partners

Energy Risk Awards 2021: Retailer’s pioneering renewables strategy shakes up UK PPA market

Alex Ashby, Tesco

Retail giant Tesco is blazing a trail in the UK renewables market as it pursues an ambitious agenda to become carbon net zero by 2035. Following a 2017 pledge, the company now uses only renewable electricity in its stores, something it has achieved mainly through buying offsetting certificates. However, it also set itself the much more challenging target of procuring at least 15% of that electricity directly from new-build renewable projects by 2020. This jumps to 50% by 2030.

“Buying certificates was never viewed as a long-term solution,” says Alex Ashby, head of treasury markets at Tesco. “We wanted to source power from truly additional renewable generation projects.”

To do this, Tesco, which accounts for around 1% of UK electricity demand, needed to build a portfolio of long-term power purchase agreements (PPAs) committing it to off-take electricity from the new projects for a number of years. With government support for mature renewables technologies like onshore wind and solar being increasingly rationed, corporate PPAs are increasingly important in unlocking funding for new-build merchant projects, providing developers and financiers with the revenue certainty they need to begin the project. Tesco embarked on this merchant PPA strategy, which had not been done before in the UK, in partnership with energy consultancy Baringa Partners.

“When we first went to market, there had been no merchant renewable energy capacity financed in the UK,” says Ed Eyre, a director at Baringa Partners. “This is a brand new business model.” 

Tesco began by tendering for around 25% of its UK demand and it was oversubscribed by 38 times. “The market response was absolutely incredible,” says Ashby. “There were quite a few projects just waiting for funding, and to have an investment grade name like Tesco willing to commit to buying the power for 15 years plus, was enough to get the investment they needed to start being built.”

Over a period of around 12 months, the firm selected nine new-build wind and solar sites spread throughout the UK. Three of these have now been built and are generating. By November 2020, Tesco had signed nine PPA contracts with four developers. The PPA portfolio assets are expected to generate an average of around 600 gigawatt hours per annum and save around 100,000 tonnes of carbon each year.

The overriding challenge of the project was to ensure that the shift in the way Tesco bought electricity was risk-managed so that the firm remained competitive and retained shareholder value. Much of this hinged on the structure of the PPA deals, with Tesco reworking existing PPA structures to redistribute risk more efficiently between developers, financiers and off-taker. The process evolved with time, said Eyre.

“The first PPAs we signed were largely based on price. We were looking for the most deliverable projects at the right price,” he says. “As we built the portfolio, we then needed to think about risk at a portfolio level – for example, having a diverse geographic and technology spread.”

The team also tackled price risk through a floating price PPA, a concept they believe is a UK first. “When you look at long-term numbers, the distribution of cashflows can be quite large,” says Ashby. “Bringing in some floating volumes was by far the best risk management we could do.”

“Financiers are becoming increasingly comfortable with merchant risk, so they don’t need a 100% fixed price,” adds Eyre.

Another way of addressing risk was to have a range of maturities on the PPAs. “A maturity profile gives us optionality,” says Ashby. Having deals maturing over different timeframes gives Tesco the chance to adapt or renegotiate contracts on a rolling basis. “Optionality manages so many of those unknown risks,” he adds.

Another major concern was regulatory risk. Tesco took a strong line to ensure a fair balance of risk between off-taker and generator. Similarly, handling credit risk on such long-term contracts was also a tough negotiating point, with generators believing they represented minimal exposures. “We did a detailed flow down of the materiality of credit risk, how it was managed and how it was backed up with the right credit support,” says Eyre. “That was something that we’ve definitely moved the market on.”

Ashby agrees: “We created a new template in the market, we did not just sign what was there. We matched it to our own risk appetite so we could achieve Tesco’s scale. Our suppliers have also benefited through the sharing of our agreements.”

As a result of this PPA strategy, Tesco now meets 21% of its group demand with additive renewable generation. Its interim goal is to raise that to 40% by 2025.

“It isn’t easy, but we believe it’s the right thing to do,” says Ashby. “We also think there’s a risk of not doing it. Through creating this portfolio we feel we’ve locked in optimal value for our investors and shareholders for now and in the long term.”