Basis Risk in Power Contracts
Definition
Basis risk in power contracts is the risk that the price a hedge or contract settles against differs from the price the project actually receives. Most financial PPAs and hedges settle at a liquid trading hub, while the project sells its power at its own node. AES describes basis risk as 'the difference in performance between the hedge instrument and the underlying exposure (usually the pricing node of the generation facility).' When the node trades below the hub, the project earns less than the contract price suggests.
Why it matters
A virtual PPA or hedge at a hub can look like fixed revenue, but the project still carries the gap between hub and node. In congested areas with much similar generation, that gap can be large and persistent. Investors should check the settlement point of every contract, the historical node-to-hub spread, and whether any of it is hedged.
Common misconceptions
- •A fixed strike price at a hub is not a fixed realized price at the project.
- •Basis is not limited to price; volume shape and timing differences add to it.
- •Congestion rights hedge part of the spread for a defined path and period, not all of it.
- •The label is only a starting point. Investor outcomes usually depend on the governing documents, cash-flow priority, valuation policy, disclosure quality, and manager discretion surrounding the term, not just the shorthand definition used in marketing materials.
Technical details
Worked example (illustrative)
Virtual PPA strike: $40 per MWh, settled at the hub.
Month's hub price: $35. Project's node price: $28. Output: 1,000 MWh.
Market sale at the node: 1,000 x $28 = $28,000.
PPA settlement from the buyer: ($40 - $35) x 1,000 = $5,000.
Total $33,000, or $33 per MWh: $7 below the strike, equal to the hub-to-node spread.
Questions to ask
Where does each contract settle, and where is the project paid?
What has the node-to-hub spread been, by hour and season?
Is any of the spread hedged, for how long and at what cost?
How investors apply the term
Investors usually apply this term by tying the definition back to the controlling documents and then asking which cash flows, rights, restrictions, or valuation assumptions it changes. A useful review looks at the term alongside fees, leverage, liquidity, reporting frequency, and manager discretion rather than treating it as a standalone concept.
The practical diligence test is simple: identify who benefits if the assumption is wrong, who has control when conditions change, and what evidence the investor receives after closing. Terms that cannot be reconciled to documents, cash movements, and monitoring data should be treated as marketing shorthand until proven otherwise.
Frequently asked questions
- What happens when a PPA settles at a hub but power sells at a node?
- The project receives the node price for its power and a contract settlement based on the hub price. If the node is below the hub, the settlement does not fully make up the difference and the project's realized price falls below the strike. The worked example below shows the reconciliation.
- How is basis risk hedged?
- With congestion or financial transmission rights between the node and the hub, or by contracting at the node. SB Energy's Angela financing lets the project 'participate in the CRR Market to hedge locational basis risk from the Project Node to the Project Hub,' within lender-set trading limits.
- Is basis always a cost?
- No. The node can trade above the hub. SB Energy reported 'generally favorable basis and node pricing in Texas' in 2025. Basis moves with transmission constraints and nearby generation, so a favorable spread can reverse.