While the oil and gas price volatility has enhanced the opportunity for developing renewable energy sources to provide security of supply, funding of these projects remains a key challenge. It is essential to have a clearly structured approach to build a financial model that outlines the pathway to commercialization. The most important parameters to build the model are discussed briefly.
Sources of Capital: Debt and Equity
Capital for the up-front cost of building a power project can be procured through a combination of debt and equity investment. Debt can be obtained through public markets (bonds) or private placements (bank loans and institutional debt). Equity can be procured from internal sources or external investors in public or private markets. Investments are analyzed from a risk-return tradeoff with an emphasis on the expected investment return. Equity investors have the potential for unbounded returns from project and will therefore frequently take high-risk investments if the potential rewards are large. Most lenders, on the other hand, tend to be far more risk averse. The debt contract is a fixed obligation and the lender does not profit, past a specific stage, from venture accomplishment.
Key considerations:
How much does capital cost affect IRR?
What is the specific impact on IRR of varying key variables such as cost of capital, O&M costs and rate of interest?
Over a range of capital costs, what long-term electricity prices are needed to achieve an adequate IRR?
What is the quantitative effect of setbacks in erecting plant on the IRR?
What is the effect of various financing compositions & risk alleviation strategies?
What is the optimal debt/equity ratio?
Project Size:
Most renewable energy projects are also small compared to coal and natural gas facilities. Many financing institutions are not interested in small transactions. Even if financing is obtainable, the transaction charge per megawatt is a good deal higher for smaller projects because many of the same financing and development steps must be followed regardless of facility size.
The following table provides a comparison matrix to evaluate a solar power plant against any other alternative power plant.
Key Parameters requiring Sensitivity Analysis:
- Impact of Capital Structure on PV Costs
- Impact of Capital Structure on Solar Power Costs
- Impact of the Return on Equity on PV Costs
- Impact of the Return on Equity on Solar Power Costs
- Impact of Debt Interest Rate on PV Costs
- Impact of Debt Interest Rate on Solar Power Costs
- Impact of Debt Term on PV Costs
- Impact of Debt Term on Solar Power Costs
Illustrative Life of a Project
Source: Deloitte
