Capacity payments

What are capacity payments?

Payments for being available to supply electricity, as opposed to payments for the electricity itself. In a capacity market, the system operator runs auctions years ahead, and successful generators, storage operators and demand response providers receive a fixed price per megawatt for each delivery year, in return for being available when the system is stressed. In bilateral PPAs, particularly with state buyers, the tariff often splits into a capacity charge, paid for the plant's availability whether or not it runs, and an energy charge per megawatt-hour delivered.

Why is capacity revenue recognised over time?

The generator's promise is to stand ready to deliver power whenever required during the delivery period. The customer benefits from that readiness continuously, whether or not the plant is dispatched, so the obligation is satisfied over time. A time-based measure of progress, recognising revenue evenly, usually reflects the pattern best, unless the obligation is weighted to particular seasons, such as winter peaks, in which case the measure should reflect that pattern. See over time or point in time.

Capacity payments: a year of a capacity agreement

A 400 MW gas plant has a capacity agreement for a delivery year at US$ 40,000 per MW per year, US$ 16 million in total, paid monthly. If it fails to deliver when the system operator issues a stress event warning, it pays penalties. Based on its availability record, it expects penalties of about 0.4 million in the year and concludes that including the rest of the consideration is highly probable not to reverse.

If an outage during a stress event leads to a penalty larger than expected, the estimate is updated and the difference is recognised in the period. Penalties paid to the system operator, the customer, reduce revenue rather than being an expense. Energy the plant sells into the market when dispatched is a separate source of revenue, recognised as it is delivered.

How are capacity and energy charges in a PPA treated?

The capacity charge pays for the plant standing ready over the contract period, and the energy charge for the power delivered. In many contracts these are a series of distinct daily services, and the variable energy charge can be allocated to the day it relates to. In practice the capacity charge is recognised over each period of availability, adjusted for availability deductions, and the energy charge as power is delivered. Fuel costs passed through in the energy charge are part of revenue if the generator buys the fuel as principal.

When does a capacity contract contain a lease?

A long-term tolling or capacity agreement with a single buyer can contain a lease if it relates to a specified plant, the buyer takes substantially all its output and the buyer has the right to direct how and when the plant runs, for example by deciding dispatch and supplying the fuel. Then the generator is a lessor: if the lease transfers substantially all the risks and rewards, for example because it covers most of the plant's life and the capacity charges recover its cost, it is a finance lease, and the generator recognises a lease receivable rather than the plant. Independent power producers selling all their output to a state buyer under long-term agreements often face this question. See IFRS 16 lessor accounting.

What about batteries and ancillary services?

Battery storage projects often combine capacity payments with payments for ancillary services, such as frequency response, where the operator stands ready to adjust output in seconds, and with trading revenue from buying power cheaply and selling it when prices are high. Ancillary service contracts are usually stand-ready obligations recognised over time; trading revenue depends on whether the operator acts as a principal in buying and selling power. See battery storage projects.

How does US GAAP compare?

ASC 606 reaches similar conclusions on stand-ready obligations and penalties. ASC 842 applies the same broad lease test, although its practical expedients and the treatment of variable payments in lessor accounting differ in detail. See variable consideration.

This guide is general information. It is not tax or legal advice for your situation.