Accounting for contracts referencing nature-dependent electricity

February 17, 2025

Targeted amendments to IFRS 9 ‘Financial Instruments’ and IFRS 7 ‘Financial Instruments: Disclosures.

As entities plan to reduce their carbon footprint, they are often seeking to use green or sustainable electricity; that is electricity generated from nature-dependent sources. As such, contracts for electricity generated from nature-dependent sources such as wind or solar have become more prevalent in many entities’ carbon mitigation journey. These contracts are often structured as long-term Power Purchase Agreements (‘PPAs’), which includes a contractual fixed price for an amount of electricity generated by the nature-dependent energy source. The unpredictability of electricity production, driven by natural conditions like sun and wind, has created challenges in practice in accounting for these contracts.

To address these complexities, the International Accounting Standards Board (‘IASB’) has amended the ‘own use’ and hedge accounting requirements of IFRS 9 ‘Financial Instruments’ and added targeted disclosure requirements to IFRS 7 ‘Financial Instruments: Disclosures’.

These amendments apply only to contracts that expose an entity to variability in the underlying amount of electricity because the source of its generation depends on uncontrollable natural conditions (such as the weather). In assessing the applicability of the amendments, it is thus key for entities to consider if the contract under question in fact references electricity generation which depend on uncontrollable natural conditions. For example, a contract referencing electricity generated by a pumped hydro facility may not be within the scope of the amendments as the output could be controllable and not dependent on natural conditions.

This publication delves into the IFRS 9 and IFRS 7 amendments and related practical considerations.

What are the amendments?

‘Own use’ exemption

PPAs generally fall within IFRS 9’s scope and are accounted for as derivatives measured at fair value through profit or loss (‘FVTPL’) unless they qualify for the 'own use' exemption; however, meeting this exemption can be challenging due to variable nature-dependent electricity generation and market structures that allow for net settlement.

Targeted amendments now provide specific guidance for the 'own use' assessment, which allow entities that are net purchasers of electricity to potentially qualify for the exemption by offsetting sales of unused electricity within the same market.

The applicability of the 'own use' exemption depends on the market structure in which an entity operates. The amendments are expected to only impact participants in net pool markets¹ or contracts involving physical deliveries. Consumers in a gross pool structure², such as the National Electricity Market (‘NEM’) in Eastern Australia, will continue to find it challenging to meet the ‘own use’ exemption, however consumers in other market structures may find that their PPAs with generators, referencing nature-dependent electricity, could now potentially meet the 'own use' exemption under IFRS 9.

Hedge accounting - variable notional amount and highly probable requirement

Currently, IFRS 9 requires entities to designate a highly probable fixed energy volume as the hedged item, which often conflicts with the inherent unpredictability of nature-dependent electricity sources. This unpredictability in both volume and price leads to hedge ineffectiveness when a fixed volume is designated, misaligning the hedge accounting of PPAs linked to actual energy output (‘generators’) or consumption (‘consumers’). Additionally, the requirement that only highly probable forecast transactions qualify for cash flow hedge accounting, limits the volume that can be hedge designated. Thus, currently entities often adopt conservative hedging designations, which do not fully capture the dynamic nature of nature-dependent electricity. For example, clients may designate only P90³ electricity generation volumes in a qualifying hedge relationship.

The latest IFRS 9 amendments provide further guidance when hedge accounting instruments that reference nature-dependent electricity sources. Subject to certain conditions, under the amendments, companies can designate the hedged item as the variable nominal amount of forecasted electricity transactions (sales or purchases from the nature dependent generator), focusing on fluctuations in market prices rather than changes in volume. As such, there could potentially now be no volume difference between the hedging instrument and hypothetical derivative modelling the hedged risk, meaning no ineffectiveness arises for mismatches in quantity between the modelled hedged risk and hedging instrument.

The amendments also note that if the cash flows of the nature-dependent electricity hedging instrument are conditional on the occurrence of a designated forecast transaction, that forecast transaction is presumed to be highly probable. This would only apply to purchasers with PPAs that fail ‘own use’ but are otherwise physically delivered and to generators (sellers).

A purchaser that designates a virtual contract referencing nature-dependent electricity (‘VPPA’) as a hedging instrument would generally designate the hedged item as an amount of forecast electricity purchases that are highly probable considering its operational needs for electricity. In such a hedge relationship, the cash flows under the VPPA are not conditional on the occurrence of the forecast transactions, hence the presumption that the purchases are highly probable does not apply. Practically, this means that an electricity consumer who cash flow hedges the price risk of their forecasted highly probable electricity purchases, must assess if its forecasted electricity purchases are highly probable (ie that physical electricity needs are expected to equal or exceed the volumes referenced in the VPPA). If deemed to be highly probable, consumers can designate the entire variable quantity purchased under a qualifying VPPA as highly probable and the hypothetical derivative will be adjusted to match the quantity in the hedging instrument. However, hedge ineffectiveness could still arise in such hedge relationships due to other factors, such as timing and pricing differences.

On the contrary, generators could for example enter into a VPPA that requires net settlement in cash of the difference between a fixed contract price and the prevailing spot price at the time of sale of each unit of electricity the generator delivers to the spot market. The generator could then designate the Virtual PPA as a hedging instrument of the price risk associated with its forecasted highly probable sales of electricity. Thus, aligning the accounting treatment with economic hedging strategies, which is to hedge the price risk of the volume of electricity the generator produces and delivers to the spot market.

Practical considerations:

The IFRS amendments are effective for annual reporting periods beginning on or after 1 January 2026, with early application permitted. Australian entities, complying with the Australian Accounting Standards and Interpretations issued by the Australian Accounting Standards Board (‘AASB’) should await formal adoption from the AASB before implementing any amendments.

The amendments are applicable only to contracts referencing nature-dependent electricity that expose an entity to variability in the underlying amount of electricity because the source of electricity generation depends on uncontrollable natural conditions (for example, the weather). Contracts referencing nature-dependent electricity include both contracts to buy or sell nature-dependent electricity and financial instruments that reference such electricity.

PPAs between generators and consumers in a gross pool market structure, such as the NEM in Eastern Australia, typically don't qualify for the own use exemption as the principal energy sold would not be considered to be physically delivered to the contract counterparty (consumer). Thus, in a gross pool market a PPA between a generator and consumer would generally be accounted for as a derivative instrument, within the scope of AASB 9.

Before evaluating the ‘own use’ exemption, consumers will first need to determine whether the PPA is scoped into other accounting standards, such as IFRS 10 ‘Consolidated Financial Statements, IFRS 11 ‘Joint Arrangements’, or IFRS 16 ‘Leases’.

If not scoped into the forementioned accounting standards, for a PPA to qualify for the ‘own use’ exemption, the consumer must be, and expect to continue being, a net purchaser of electricity throughout the contract period. This requirement considers market conditions where consumers may need to sell unused electricity, distinguishing these transactions from trading activities intended to profit from short-term price changes.

An entity is considered as a ‘net purchaser’ if:

it buys sufficient electricity in the spot market or under failed ‘own use’ contracts to offset sales of any unused electricity received under the nature-dependent electricity contract; and
those purchases (‘offsetting purchases’) are made in the same market in which the entity sold any unused electricity under the nature-dependent electricity contract.

These conditions ensure that the PPA is used for the entity's own requirements rather than for trading purposes.

No, existing qualifying instruments cannot retrospectively be designated in a hedge relationship. Qualifying instruments can only be designated prospectively from the date of initial application of the amendments. Further, if an instrument is designated as hedging instrument after the trade date, it will usually have a non -zero fair value and designations of such instruments may require expert assistance.

Additionally, the instrument of a discontinued hedge relationship cannot be re-designated retrospectively from the date of amendments.

An entity should apply the requirements for contracts referencing nature-dependent electricity prospectively to both new and existing contracts (if not already part of a hedge relationship) that are designated on or after the date of initial application of those requirements.

At the date of initial application, an entity is permitted to discontinue any existing hedge relationships in which a contract referencing nature-dependent electricity has been designated as the hedging instrument, if that same hedging instrument is designated in a new hedge relationship. Therefore, the redesignation of these instruments is allowed under the new requirements. However, since the redesignation date might differ from the instrument's trade date, expert assistance may be needed to assess the implications of de-designating and re-designating such hedge relationships.

While the amendments help reduce hedge ineffectiveness related to variability in the nominal amount of qualifying hedge instruments, other sources of ineffectiveness (such as timing, basis and other contractual features) may still exist.

For instance, timing differences can arise when an entity's electricity purchases (assume electricity consumption in factory) in the spot market happen only during the day, whereas the PPAs are settled continuously, leading to discrepancies in the market prices used for measuring the hedged item and the hedging instrument.

Additionally, a basis price element can create ineffectiveness if an entity purchases electricity in a different market than where the PPA-related sales occur, resulting in a mismatch between the prices used to measure the hedged item and those used for the hedging instrument. For example, if a consumer has entered into a Power Purchase Agreement (PPA) that settles at the Victoria spot price while it buys physical spot electricity that is settled at the New South Wales spot price. Though it is to be noted that, instances of basis differences are not commonly observed in Australia.

Entities with PPAs referencing nature-dependent electricity that are accounted for as ‘own use’ contracts (may not be applicable to gross pool participants), are required to disclose features that lead to variability in electricity amounts and risks of unused electricity, along with unrecognized commitments and related financial impacts.

Additionally, for contracts referencing nature-dependent electricity designated as hedging instruments, an entity should disaggregate the information about terms and conditions of hedging instruments required by IFRS 7, so that this information is presented separately for contracts referencing nature-dependent electricity.

Entities may need to evaluate whether the amendments apply to their current electricity contracts that rely on natural conditions, as the contract terms might not explicitly indicate that the electricity generation source is subject to uncontrollable natural factors. For PPAs currently designated in hedge relationships, assess whether the designation needs to be updated. This may result in the de-designation of an existing hedge relationship and re-designation in a new hedge relationship at the date of initial application.

To further delve into the amendments and their practical application further, speak to your contact at PwC.

References

¹ An electricity trading arrangement where generators only sell energy that they have not already sold through bilateral contracts.

² An electricity trading arrangement where generators are required to sell all the energy they produce in the pool.

³A conservative estimate which represents level of the annual electricity generation that is predicted to be exceeded 90% over a year.

Contact us

Manuel Kapsis

Partner, Corporate Reporting Services, PwC Australia

Tel: +61 422 649 424

Shehan Fonseka

Partner, Treasury Advisory, PwC Australia

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Gordon Thomson

Partner, Assurance, PwC Australia

Tel: +61 418 335 035