SIDS PPA Finance: Morten Hørmann, RE Finance Specialist, COWI A/S

SIDS PPA Finance
Morten Hørmann, RE Finance Specialist, COWI A/S
26 NOVEMBER 2019
1 DAY 1: BASICS OF RENEWABLE ENERGY PROJECT FINANCE
Who are we?
Morten Gabriel Rasmus Anita Jurgens

Hørmann Zeitouni Dilling • COWI
• COWI • COWI • Economist
• COWI
• Engineer • Legal expert • Specialized in
• Economist
• Specialized in • Specialized in financial analysis
• Specialized in and costing of
renewable procurement of
renewable energy energy project renewable renewable
modelling development energy energy
26 NOVEMBER 2019
Course concept
Complexity
Contractual
design in PPA
Stakeholders
and PPA
structure
Impacts of
PPA design
Financial
analysis
26 NOVEMBER 2019
3 DAY 1: BASICS OF RENEWABLE ENERGY PROJECT
FINANCE
Keep it simple
› Making things complex and difficult is easy
› Simplifying and streamlining is very difficult
› But the rewards for simplifying are that much greater
› Learning
26 NOVEMBER 2019
FINANCE
Focus on the PPA
› Agreement between producer and › Ensures the offtaker receives what it

offtaker of electricity on the price, is paying for
quality, quantity etc.. of electricity
› Without a PPA? No private equity,

› Ensures stability, confidence and no financing.
transparency
› Necessary for long term loan financing
› Draws in private equity
26 NOVEMBER 2019
Course overview
Day 1 Day 2 Day 3 Day 4

Basics of Financial Complex
renewable modelling of Stakeholders negotiations for
energy finance PPA contracts finalizing PPAs
Basic exercises Roleplaying Exercises on

Exercises on
on RE project exercises on project size and
PPA modelling
finance PPA bidding currency risk
26 NOVEMBER 2019
FINANCE
DAY 1
Basics of Renewable Energy Finance
› How Renewable Energy projects are › Basic exercises on RE project

financed finance i.e. not in consideration of
PPA contract aspects yet
› Basics of cash flow modelling and
importance of financial indicators
26 NOVEMBER 2019
Financing Renewable
Energy
26 NOVEMBER 2019
Project financing vs corporate/balance financing
› Renewable energy projects are very › Firms may use loan financing to
often structured around a “Special invest in new or replacement
Purpose Vehicle” capacity
› Owns and operates the RE assets › Loans have recourse in the Firm’s
› Is a separate unit total balance sheet rather than just
the asset
› Loans taken by the SPV have no
recourse outside the SPV › Perceived as less risky by lending
institutions
› only security is the assets and the
revenue stream from those assets
› This is project financing › This is corporate financing
26 NOVEMBER 2019
Public private partnerships
26 NOVEMBER 2019
Project cost components
Non-exhaustive list
CAPEX
• Generators
• Civil works
• Electrical infrastructure
• Management
OPEX
• Operations: e.g. salaries of staff and land lease

• Maintenance: Scheduled and Non Scheduled
Penalties
• Delays
• Over/under production
Financial transaction costs
• Cost of capital: Interest on loans, return on equity

• Cash reserves
• Exchange rate risk
Taxes
• Corporate income taxes

• VAT, duties, energy taxes
26 NOVEMBER 2019
Project revenues
Energy PPA tariff
• Main parameter of the PPA contract

• Primary output • Guarantee of cash flow for debt service
• Satisfies demand
• Crowd out fossil fuels Curtailment compensation
• Important for variable renewable energy

Capacity
Capacity remuneration
• System services, e.g. balancing,
• Replacing thermal generation can be
reserve capacity, frequency difficult due to the loss of system services
response, inertia
26 NOVEMBER 2019
Basics of project financial
analysis
26 NOVEMBER 2019
Cash flow modelling
› The cash flow waterfall is one of the most

important elements in project finance
› Allocates available cash to different recipients by
seniority/priority
› Vital in demonstrating that the cash flow generated
by the project is enough to cover all liabilities
› In order from top to bottom is:
› Interest income
› Tax
› Maintenance CAPEX
› Senior and junior debt service
› Movements in the debt reserve account DSRA
› Cash sweep
› Returns to equity.
26 NOVEMBER 2019
Funding
› Loans are the primary source of › Special purpose loans during construction are
financing for RE projects also common
› High interest rate
› Senior loans are long term and the first
› Very little security in physical assets
in line to be repaid from available cash.
› Converted into senior and junior loans at the
› Securities in the physical assets commencement of operations
› Junior loans with no security in

physical assets are sometimes required › Duration of the loans (the tenor) does not
need to equal the technical life of the project
› Significantly higher interest rate
› Loan tenors shorter than the project life are
› Are only repaid after senior loans have common
been served. › The loan tenor will very likely be shorter than the
duration of the PPA contract
26 NOVEMBER 2019
WACC
› The Weighted Average Cost of Capital 14.0%

Commercial operation
(WACC) is a measure of the average cost of Equity
12.0%
employing the capital needed for the project
› The WACC simply weighs the interest rate 10.0%
PPA contract
of each source of capital by the sources’ Loan + equity
8.0%
share of total CAPEX
Constructio
› Differences in loan tenor, PPA contract 6.0%
duration and technical life can complicate
n
4.0%
the concept of WACC
› The WACC is a key concept used in several 2.0%
financial indicators such as NPV and LCOE 0.0%

and to asses IRR. 1 9 0 2 1 0 2 3 0 2 5 0 2 7 0 2 9 0 3 1 0 3 3 0 3 5 03 7 0 3 9 04 1 0 4 3 0 4 5
20 2 2 2 2 2 2 2 2 2 2 2 2 2
26 NOVEMBER 2019
NPV
2019 2020
› The Net Present Value (NPV) of a

project is the simplest indicator of a $100 $100*(1+i)
financially sound project
› Positive NPV means the return on $100/(1+i) $100
investment will be higher than
expected
› NPV discounts all costs and revenues
from the project to present value by
using the WACC as discount rate
› Allows comparison of CAPEX today
with a revenue stream in the future
26 NOVEMBER 2019
LCOE
› The Levelized Cost of Electricity › LCOE does not take into

› Main indicator for comparison of consideration:
economic performance of different › Changes to cash flow
energy projects › Risks
› LCOE compares: › Incentives
› Discounted value of all project costs
› Discounted value of the electricity
generated by the project
› LCOE is the average cost of one unit
of electricity over the lifetime of the
project
26 NOVEMBER 2019
IRR
› Internal Rate of Return

› A measure of the discount factor
needed to make the NPV equal to zero
› Can be compared to the WACC for a
quick assessment of the financial
feasibility of the project NPV = 0
› IRR higher than the WACC indicates
that the project will yield a higher
return on investment than expected
› At times, this value is also referred to
as the Project IRR.
26 NOVEMBER 2019
DSCR/DSRA
› Debt Service Coverage Ratio › Debt Service Reserve Account

› An indicator of the ability of the project to › A cash reserve account
serve its debt
› Targeted at providing additional cash in
› Calculated as the cash available for debt
service divided by the debt service obligations
periods where the DSCR would
otherwise fall below the minimum DSCR
› Calculated for each period in the financial
target
analysis
› DSCR values above 1 indicate that the project › In periods with excess cash the DSRA
is able to serve its debt in that period can be filled up again
› Minimum DSCR over the entire project › The DSRA is particularly useful in
lifetime should never fall below 1, and projects with high variability in
financial institutions may require a minimum revenues, e.g. variability in RE
DSCR that is much higher. generation due to seasonality.
26 NOVEMBER 2019
Depreciation
› Depreciation is the gradual decline in the

value of physical assets as they are worn 0
down -20,000,000
-40,000,000
› Depreciation is an accounting measure -60,000,000
› It does not have to replicate the exact value of -80,000,000
the physical assets -100,000,000
-120,000,000
› Depreciation is often based on rules rather than -140,000,000
actual value -160,000,000
› Three common ways to estimate depreciation -180,000,000
are: -200,000,000
› Straight line
Decreasing value Straight line Digit sum
› Decreasing value
› Digit sum
26 NOVEMBER 2019
Taxes
› Corporate income tax

› Corporate income tax is typically a
percentage of earnings after interest on debt
has been paid
› Depreciation can have a big impact on tax
payments
› VAT and import duties
› Relevant especially when project components
are imported
› Public funding of RE projects is sometimes
achieved via tax credits
› Partially lifts the tax burden from RE projects
26 NOVEMBER 2019
Currency
› Many RE projects are funded by › Developments in the exchange rate

International Financial Institutions can severely impact debt service
(IFIs) › DSCR needs to be evaluated under
› Loans are provided in an worst case assumptions on the
international currency development in exchange rate
› Loans are paid back in international
currency
› Revenues and operational costs are
often generated in the local currency
26 NOVEMBER 2019
26 NOVEMBER 2019
Guided tour of the model
26 NOVEMBER 2019
26 NOVEMBER 2019
Exercises Day 1
26 NOVEMBER 2019
Getting used to the model
› Always work in a copy

› That way you can just open a fresh Main Results
version if something goes wrong Key indicators 140 20%
Million
120
PPA Price(USD/MWh) 93.5 10%
› Open the model

100
NPV 6,105,916
80 0%
Equity NPV -3,969,474
60
IRR 8% -10%
40
Equity IRR 11%
› Navigate to introduction
-20%
Simple WACC (before taxes) 8% 20
Compound WACC 8% 0 -30%

Minimum Senior DSCR 1.36 -20
-40%
Minimum Junior DSCR 0.00 -40
› Familiarize yourself with the colour codes NPV GBI

NPV Investment subsidy
Break even (years)
0
0
11.5
-60 -50%
Cumulative project equity Accumulated EIRR until respective year

LCOE (USD/MWh) 114.4
› Navigate to the User Interface Project cash flow

40,000,000
› Adjust the size of the results pane

20,000,000
0
-20,000,000
-40,000,000
› Play around for a while

-60,000,000
-80,000,000
-100,000,000
-120,000,000
› Don’t be afraid to mess up. You opened a

-140,000,000
-160,000,000
copy – right? Investment cost Operational cost Revenue Taxes Accumulated discounted project cash flow
26 NOVEMBER 2019
Setting the stage
› Choose Technology and uncertainty

› Set Nominal capacity
› Set first year of construction and
construction time
› Set technical life
› Try changing uncertainty level and

technology
› What happens to the results?
26 NOVEMBER 2019
Input data Edit CAPEX data
› Add a new CAPEX element

› Use CAPEX2 – rename to something
relevant (e.g. your name)
› Return to the User Interface
› Include the new CAPEX element in
the analysis
› Do the same with OPEX

› Choose either fixed or variable OPEX
26 NOVEMBER 2019
Financing
› Set up a financing structure

› A mix of equity, senior and junior loans
› Investigate how loan tenure and
interest rates affect project KPIs
› Input corporate tax rate
› Investigate how exchange rate
uncertainty impacts project KPIs
› Is the minimum senior DSCR lower
than 1?
› Include loan financing of a DSRA
26 NOVEMBER 2019
Feasibility
› What is the internal rate of return (IRR)

of your project?
› What can you do to improve it?
› Lower CAPEX?
› Lower OPEX?
› Lower uncertainty on energy production?
› Higher PPA tariff?
› What makes the most sense?
› How does a higher IRR affect the DSCR?
26 NOVEMBER 2019
Sensitivity analysis using
the model
26 NOVEMBER 2019
Running sensitivities
26 NOVEMBER 2019
Tornado plot PPA tariff -89% 90%
CAPEX -58% 58%
› Predefined functionality WACC -49% 46%
› Classic tornado plot Cost of Equity -26% 25%

› x% variation in inputs leads to ?% increase/decrease in
project NPV Senior rate -23% 22%
› Indicates which parameters have the biggest impact on

the results
OPEX -19% 19%
Equity share -16% 16%
› Press the update button

Senior Tenor -3% 2%
› Change the percentage change
-100% -80% -60% -40% -20% 0% 20% 40% 60% 80% 100%
› Try pressing the button again 6 % increase 6 % decrease
26 NOVEMBER 2019
Tariff sensitivity 110
Tariff sensitivity - Wind
105
100
Required tariff EUR/MWh

95
› Changes inputs 90
85 CAPEX base
› CAPEX 80 CAPEX + 10 %
75 CAPEX - 10 %
› AEP 70
› Re-estimates the PPA tariff

65
60
130 135 140 145 150 155 160 165
› Shows how sensitive the expeted PPA AEP, GWh/year
tariff is to variations in CAPEX and AEP

› Define which sensitivity runs to run
› Start at 49
› end at 96
› Run sensitivities
26 NOVEMBER 2019

SIDS PPA Finance: Morten Hørmann, RE Finance Specialist, COWI A/S

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SIDS PPA Finance

Morten Hørmann, RE Finance Specialist, COWI A/S

Morten Gabriel Rasmus Anita Jurgens

› Making things complex and difficult is easy

› Simplifying and streamlining is very difficult

› But the rewards for simplifying are that much greater

› Agreement between producer and › Ensures the offtaker receives what it

› Without a PPA? No private equity,

› Necessary for long term loan financing

› Draws in private equity

Day 1 Day 2 Day 3 Day 4

Basic exercises Roleplaying Exercises on

› How Renewable Energy projects are › Basic exercises on RE project

› This is project financing › This is corporate financing

• Operations: e.g. salaries of staff and land lease

Financial transaction costs

• Cost of capital: Interest on loans, return on equity

• Corporate income taxes

Energy PPA tariff

• Main parameter of the PPA contract

• Important for variable renewable energy

› The cash flow waterfall is one of the most

› Junior loans with no security in

› The Weighted Average Cost of Capital 14.0%

duration and technical life can complicate

financial indicators such as NPV and LCOE 0.0%

› The Net Present Value (NPV) of a

› The Levelized Cost of Electricity › LCOE does not take into

› Internal Rate of Return

› Debt Service Coverage Ratio › Debt Service Reserve Account

› Depreciation is the gradual decline in the

› Three common ways to estimate depreciation -180,000,000

› Corporate income tax

› Many RE projects are funded by › Developments in the exchange rate

› Always work in a copy

version if something goes wrong Key indicators 140 20%

› Open the model

Compound WACC 8% 0 -30%

› Familiarize yourself with the colour codes NPV GBI

Cumulative project equity Accumulated EIRR until respective year

› Navigate to the User Interface Project cash flow

› Adjust the size of the results pane

› Play around for a while

› Don’t be afraid to mess up. You opened a

› Choose Technology and uncertainty

› Try changing uncertainty level and

› Add a new CAPEX element

› Do the same with OPEX

› Set up a financing structure

› What is the internal rate of return (IRR)

› How does a higher IRR affect the DSCR?

CAPEX -58% 58%

› Predefined functionality WACC -49% 46%

› Classic tornado plot Cost of Equity -26% 25%

› Indicates which parameters have the biggest impact on

Equity share -16% 16%

› Press the update button

Required tariff EUR/MWh

› Re-estimates the PPA tariff

› Shows how sensitive the expeted PPA AEP, GWh/year

tariff is to variations in CAPEX and AEP

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