The IASB has issued the exposure draft Contracts for Renewable Electricity, with comments requested by August 7, 2024.

Here’s part of the summary in the news release:

• Renewable electricity contracts aim to secure the stability of and access to renewable electricity sources. However, renewable electricity markets have unique characteristics. Renewable electricity sources depend on nature and its supply cannot be guaranteed. The contracts often require buyers to take and pay for whatever amount of electricity is produced, even if that amount does not match the buyer’s needs at the time of production. These distinct market characteristics have created accounting challenges in applying the current accounting requirements, especially for long-term contracts.
• To address these challenges, the IASB is proposing some targeted changes to the accounting for contracts with specified characteristics. The proposals would:

• address how the ‘own-use’ requirements would apply;
• permit hedge accounting if these contracts are used as hedging instruments; and
• add disclosure requirements to enable investors to understand the effects of these contracts on a company’s financial performance and future cash flows.

Taking the first of those bullet points, the underlying premise is that “if an entity uses the electricity in its operations, the recognition of the fair value changes in profit or loss for these, typically long-term, contracts does not provide useful information about the performance of the entity.” However, it can be unclear how to apply this premise, for instance:

• Contracts for renewable electricity are…subject to a market design and operation that…either force the purchaser to sell unused electricity back into the market shortly after delivery or, if a purchaser fails to do so, the market operation will ‘repossess’ the electricity and then require the entity to pay a, sometimes punitive, penalty.
• The mismatches between the electricity delivered and the entity’s electricity demand at the time of delivery arise from the characteristics of these contracts…and the design or operation of the electricity market. Even though sales occur because of these mismatches, management’s intention in entering into a contract might be to receive electricity in accordance with the entity’s expected purchase or usage requirements. The entities do not buy and sell the electricity for the purpose of generating a profit from short-term fluctuations in price or dealer’s margin.

The IASB agreed that such contractual characteristics shouldn’t preclude an entity from accounting for contracts to buy renewable electricity as normal purchases. However, “to ensure the new requirements maintain the underlying principle behind the own-use requirements, to reduce the risk of entities structuring transactions or contracts and to include adequate rigour within the proposals,” it set out a list of items to consider: the purpose, design and structure of the contract; the availability of reasonable and supportable information about changes in expected volumes to be used (to ensure that contracts are reclassified as derivatives when the expected volumes to be delivered are no longer in accordance with the entity’s expected purchase or usage requirements); and whether the entity remains a net-purchaser over a reasonable period of time.

It’s notable that two members of the IASB dissented from the proposals, commenting that the suggested approach “appears to be more lenient towards contracts for renewable electricity than …other contracts.” They would have supported an exception from IFRS 9 “for situations in which a purchaser intends to use all of the electricity expected to be produced and supplied under the contract, but nature causes an increase in production above such expectation and the entity is forced to sell such unused excess.” However: “In the proposal, a purchaser in a renewable electricity contract can qualify for the own-use exception even if they know, from inception of the contract, their demand in some periods will be less than expected deliveries and the entity thus expects to sell the electricity supplied under the contract during those periods. Therefore, while applying the exception, the purchaser might sell to the market, at a market price, electricity it knew it would never use, realizing the fair value of that portion of the contract provided it intends to purchase, presumably from the market at a different market price, an equivalent amount of electricity.” They suggest that if fair value information for such contracts isn’t considered useful, this should be dealt with through presentation rather than by providing exceptions to the usual workings of IFRS 9.

I can certainly see both sides of that argument. It’s hard to be entirely enthusiastic about yet another exception to the prevailing principle, with yet another list of factors to work through, presumably entailing once in a while that relatively small differences in circumstances will yield a substantially different accounting treatment. On the other hand, entities transacting in renewable energy contracts should be entitled to apply the “own use” principle as much as any others, albeit that their circumstances are inherently less straightforward than a simple purchaser of raw materials or the like. Anyway, more on the exposure draft in a future post.

The opinions expressed are solely those of the author.