Author: Craig Memery
Contributor: Brett Dutton
During the desktop investigation and the site visit, you will have considered and evaluated the physical properties of a site to indicate the technical viability of a wind farm project. This is a good start, but all projects need to be financially viable as well. At this stage, its time to have a look at the commercial aspects of your proposed wind farm sites. Many excellent sites have been ruled out because the project economics do not stack up.
In the case that you have identified more than one site that looks technically suitable, the process of early financial modeling can help to identify the best site. There is more detailed business planning and financial modeling down the track, but for now we will just make some simplistic assumptions.
Why model financials at such an early stage?
The pre-feasibility site selection process essentially involves starting off with lots of potential sites for consideration, and investigating each of them for technical, environmental or planning constraints. As this process continues, you will begin knocking out unsuitable sites, continuing with more detailed investigations, and eventually arriving at a small number of suitable sites.
The central issue faced by all wind farm developers is the risk of wasting time and money investigating an unviable site. Any project may fail at any time. The trick is to do the inexpensive pre-feasibility work as diligently as possible so that projects you identify as high potential have the highest chance of progressing all the way through to development.
Eventually the investigation will lead to you financial viability. By this stage it is considered a given that all of the sites still under consideration have favourable physical properties and willing landowners. Now is the time to run some basic sums to see if they stack up in terms of financial viability. This is very difficult to do at such an early stage given that you probably don't have any wind speed data, you may not have decided how many turbines you will have, and of course contract negotiations for turbines are still some way away.
It's fundamentally important that the investment required to construct a wind farm is exceeded by the returns from sales of electricity. There's more information about doing those sums below.
A basic financial model
To establish if a project is going to be profitable you need to conduct a financial assessment - or model the financial inflows and outflows that the project will experience. These inflows and outflows should be modelled for each year over the life of the project.
Examples of outflows are:
- the total cost of the wind turbines, civil and electrical construction, installation, planning approvals, the monitoring tower etc (otherwise known as Capital Expenditure or CAPEX - see definition below)
- repayment of bank loans
- payment of dividends to investors
- operational costs — the cost to get someone to maintain your system periodically so that it continues to produce the energy you expect over its lifetime
Examples of inflows are:
- the revenue you get from selling your power
- investor funds
- bank loans
- the community group's own capital
All of these inflows and outflows vary with time so you need to express them in a time line. This is typically done in a spreadsheet to make sure that:
- you can afford to continue your project each month
- the project will be profitable on average over it's life time of 20 or 25 years.
This is simplistic and in reality the financial model for a wind farm is a very complex spreadsheet.
The following approach explains how to assess the financial viability of short-listed sites, and rank sites accordingly. Obviously other factors such as significant constraints or risks identified may also affect your final ranking of sites.
Financial assessment for site evaluation
By conducting a financial assessment of your wind farm sites you can estimate which sites are likely to be more profitable.
There are a number of possible approaches for undertaking a financial assessment:
- Return on investment
- Payback period
- Net present value
- Levelised cost of energy
Definitions
Capex
Capital expenditure, 'capex' is the up-front cost of building a wind farm, such as:
- development costs
- wind turbine purchase
- civil and electrical site works
- wind tubine installation
- grid connection
Opex
Operational expenditure, 'opex' are the ongoing costs of operating a wind farm, such as:
- wind turbine maintenance and repairs
- lease payments to landowners
- business and management costs
Revenue
Revenue is the income from owning a wind farm, which is usually from one or both of the following two sources:
- the sale of energy
- the sale of Renewable Energy Certificates.
In order to calculate annual revenue, you will need to be able to estimate the amount of generation each year in megawatt hours (MWh), and assume a value for the sale of energy and/or renewable energy certificates ($/MWh).
Return on investment
Return on investment (or rate of return), is the profit made by the wind farm expressed as a percentage of the sum originally invested.
Rate of return = Average net income / Average investment
When comparing potential wind farm sites, the higher the rate of return, the more attractive the project.
Payback period
The payback period is the length of time taken for an investment to repay itself, or 'break even', after which time the project is turning a profit.
When comparing potential wind farm sites, the shorter the payback period, the more attractive the project.
Net present value
Net present value is often used to assess long-term projects, and is appropriate for wind farms which have a typical operating life of 25 years.
The basic concept behind net present value is that a dollar today is worth more than a dollar in the future, so future earnings and expenditure is discounted according to when they occur over the project lifetime. Net present value expresses the expenditures and revenue over the life of the wind farm as today's dollar value.
The net present value is calculated by applying a discount rate to future earnings and expenditure. A discount rate is a percentage figure which represents the annual change in the value of money, along with the cost of any finance.
The best way to calculate net present value is to create a spreadsheet with a column for each year of the wind farm's life, and then calculate the profit or loss for each year:
Profit/ loss = revenue - (capex + opex)
Then multiply the profit or loss for that year by the discount rate.
PS: I am not sure what an appropriate discount rate would be for a wind farm, this may be something Hepburn could help with? I think we should give a rough guide, e.g. 5%, or provide a source where groups can calculate their own discount rate.
Once you have the profit or loss for each year of the wind farm's life expressed in today's dollar, you can simply add these up. The wind farm with the highest net present value will be the most attractive project.
Value of energy, levelised cost of energy
The value of energy ($/MWh) is the amount of income you can derive from selling the energy and/or Renewable Energy Certificates.
The levelised cost of energy is the cost of energy generated by the wind farm, measured in $/MWh, over the life of the wind farm. It is determined by dividing the net present value (capex and opex) by the total generation (MWh).
To break even (neither make a profit nor a loss) the levelised cost of energy must match the value of energy (also in $/MWh). If the levelised cost is lower than the energy sale price, the wind farm will return a profit.
The levelised cost of energy is also used to compare one generation source to another. For example, in many parts of the world, the LCE for wind energy is less than that of nuclear energy.
If you assume that the value for energy for each of two different potential wind farms is the same, you can use the levelised cost of energy to compare and rank wind farm sites: the lower the levelised cost of energy the better.
A simple model
Checklist
- Decide on a financial assessment approach
- Calculate a financial return for each short-listed wind farm site
- Rank sites using the results of the financial assessment
- Review ranking in terms of other factors such as significant constraints or risks
- Decide which project to progress to the feasibility stage