Heavy Industry Goes Renewable
Cummins, a global industrial manufacturer in the Fortune 200, signed its first virtual power purchase agreement (VPPA) with EDP Renewables (EDPR) North America in August 2017 for 75 megawatts (MW) of wind capacity over 15 years. Heavy industry has been slow in signing off-site renewables deals. This deal isn’t just noteworthy for Cummins’ leadership in its sector; it also offers a wide range of environmental and social benefits and provides insight into how those benefits of a power purchase agreement (PPA) can be used to win internal buy-in for an off-site renewables deal.
Cummins is the world’s largest independent engine manufacturer. In 2016, it had revenue of $17.5 billion and spent $150 million on energy, part of which went to more than 19 gigawatt-hours of electricity. Cummins was founded in Indiana, where it is headquartered today, and has long had a focus on corporate citizenship, including environmental stewardship in its communities. It has been making serious moves in the direction of clean energy.
Cummins revealed a heavy-duty electric truck in August 2017, beating Tesla’s release of its own electric truck by three months. Cummins has been actively pursuing energy efficiency and greenhouse gas reduction in its facilities since 2006, when it set its first goal of 28 percent greenhouse gas intensity reduction from a base year of 2005, which it met in 2010. In its third such goal, set in 2015, Cummins has committed to cutting its energy intensity by 32 percent from 2010 to 2020, as well as to reducing its carbon footprint and using fewer natural resources. It’s already achieved a 24 percent reduction.
The current goal includes a commitment to increase renewable energy, and Cummins’ 2017 VPPA delivers on that promise on a large scale. The company has a total of 8 MW of solar capacity across 13 of its installations with plans for more, but it wanted to scale up. The VPPA secures 75 MW of wind capacity in a single deal. To get the equivalent amount of renewable energy on-site, Cummins calculates it would have to build one square mile of solar panels at a cost of about $380 million. The VPPA, on the other hand, has no up-front costs beyond the transaction costs, provides a partial hedge against market prices, and may provide either limited profit or loss to Cummins, depending on energy market prices over the 15-year deal term.
The heavy industry sector has procured little utility-scale renewable energy before now. General Motors and Lockheed Martin, both members of Rocky Mountain Institute’s Business Renewables Center (BRC), are among the few to have signed PPAs for utility-scale renewables.
Cummins’ Indiana Virtual PPA Deal
The VPPA Cummins signed will help an existing 600 MW wind farm in Northwest Indiana expand by 75 MW (enough to power approximately 20,000 homes) and will produce electricity slightly in excess of Cummins’ usage at all of its Indiana facilities, equal to about 50 percent of its US usage and 28 percent of its global usage. The Cummins team was adamant that the deal had to add new renewable energy capacity to the grid, not just gather renewable energy credits. Hashing out the details with EDPR was easy because of EDPR’s experience in the state and because it, too, is headquartered in Indiana.
Kelly Snyder, senior originator for the eastern region at EDPR, said Cummins was a great client to work with. “The fact that they were home grown and located in Indiana made it easier,” she said. The local nature of the project site and the developer fit in with Cummins’ desire to be a good citizen in their community. “Through the site visit that Cummins did,” said Snyder, “both parties could see that they align on values.”
The PPA is virtual, meaning that the purchaser will not take direct delivery of the power, but instead agrees to a contract of differences between the market price and the agreed power purchase price. Such agreements allow purchasers to add renewable power onto the grid in optimal locations, where there is abundant wind or solar resource and where there is little curtailment of variable renewable power. A VPPA also provides the renewable power developer a guarantee of long-term price stability, which is crucial to allowing such a large project to secure financing.
Cummins’ 2017 carbon footprint was 770,000 tons of CO2 equivalent (tCO2e); the VPPA the company signed will avoid 165,000 tCO2e per year by means of a single deal once the project comes online around January 1, 2019. Cummins will also retain the renewable energy credits from the wind farm expansion.
The Environmental and Social Benefits of the Project
The Meadow Lake Wind Farm is located in Benton and White Counties. Benton County has benefited from wind power to the point that it has added not just jobs but, for the first time, paramedic services. EDPR had been working in the area since 2008 and arranged for the Cummins team to meet with local stakeholders and learn about their experiences with wind turbines, and the team found them to be enthusiastic about what wind power had brought to their communities.
The deal team was very careful of potential community reaction and reputational risk, especially working in their home state of Indiana; they considered the community to be their “boss’s boss.” Cummins reviewed environmental assessments and mitigation plans with EDPR’s environmental team, which is working with the US Fish and Wildlife Service to develop a habitat conservation plan for the project and already knew the area well. The team also worked with the Indiana branches of the Environmental Defense Fund and the Nature Conservancy.
The Deal Process
The deal team was initially limited to staff focused on environmental and sustainability issues but grew to include employees from finance, treasury, tax, environmental strategy and compliance, legal, and purchasing. They involved Cummins’ CEO, Tom Linebarger, from a very early stage and worked with the CEO and leadership to figure out what the company valued most, which drove project selection and contract structure.
Cummins concluded that its renewable energy decisions would be driven by a few core principles: that transactions be cost-competitive and transparent in their accounting, that they increase the real-world supply of renewable energy (this is what is called “additionality”), and above all, that they must create environmental benefit for Cummins, the community, or both. The team was interested in VPPAs from an early stage because of the potential for very large-scale reductions in greenhouse gas emissions. They also liked the balance between financial risk, community benefit, and environmental impact, and believed that no other step could deliver as much environmental benefit with so little downside risk, but top leadership was very skeptical of industry claims about VPPAs, especially energy price projections. Cummins set out to test such claims for itself. Eventually, they also engaged expert outside counsel and buyer’s advisor, Schneider Electric (founding BRC member) to advise them on the deal. And they joined the BRC and took advantage of the tools and resources it offers, partly to validate what the buyer’s agent was saying. They ran Monte Carlo simulations on historical price data to determine the probability of different outcomes over the deal term and estimate downside risk. When they concluded that the VPPA was still better value for money in terms of dollar invested per environmental benefit delivered than other options, they had something they could take to their CEO and board with confidence.
Lessons for Other Buyers
Cummins’ experience shows how decisive internal support is. Those whose buy-in is critical for the final decision, including treasury and accounting, are often unfamiliar with PPAs. The Cummins team saw the value of getting senior leaders involved early and maintaining strong internal alignment across functions and leaders. They benefited from understanding the risks inherent in a long-term energy deal, communicating them clearly to internal stakeholders, and identifying mitigation strategies.
Cummins signed the deal because it was the most cost-effective way to work toward the greenhouse gas reduction goals it set for itself. The vast majority of buyers do not attempt to pitch the PPA internally in terms of dollars and cents, even though many deals do wind up in the money, because there are better purely financial investments. The Cummins team also benefitted from having already taken significant greenhouse gas reduction actions, which gave them credibility when they posited that a VPPA was the next best investment to take further action.
Virtual power purchase agreements are complex and are unfamiliar to most corporates. But Cummins’ experience shows that they are not somehow more appropriate for the Googles of the world. They are a valuable tool that can provide the most cost-effective and, in the end, easiest option for even a major player in heavy industry to achieve environmental and sustainability goals.
You can download Choosing Off-site Renewable PPAs for Environmental and Social Impact: A Case Study on Cummins‘s Virtual Power Purchase Agreement in Indiana here.