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CF= Cash Flow, IRR= Internal Rate of Return, ECF= Equity Cash Flow, rE= Return on Equity, FCF= Free Cash Flow, WACC= Weighted Average Cost of Capital DSRA= Debt Service Reserve Account, ARR= Accounting Rate of Return, PI= Profitability index, PTC= Production Tax Credits, EPC= Engineering Procurement Construction, CAPM= capital asset pricing model, DSCR= Debt Service Cover Ratio, EBIT= Earnings Before Interest and Taxes. Leverage= influence/control. Abstinence= moderation/self discip.
Advantages: -It is an effective policy tool to help developers to raise capital in the marketplace complete financing of wind projects and completion of these projects. Due to continuity of PTC period from last several years, there is average annual growth of 35% in wind industry. Disadvantages: not a long term policy, it has not been sufficient in providing consistency and market certainty.
Concept: It will be cheaper to reduce one unit of GHG in developing country compared to developed country; therefore developing country will implement cheap GHG emission reduction projects in developing country and earn the CERs (Certified Emission Reduction Credits) from CDMs. Advantages: -Developed countries can get CERs to meet their own CO2 emission target at home with lower investment. - Developing countries can get foreign investment and technologies; the clean energy sector will also generate employment. Three Criterion for a CDM project: i) It must be a Sustainable Development Project. ii)The emission reductions must be real and additional: You must prove the project reduces emissions more than it would have occurred in the absence of the project. You must overcome barriers. For example investment and technological barriers. Or without CDM the project cant be implemented. The baseline emissions are the emissions that are predicted to occur in the absence of a particular CDM project. So (Baseline of emissions) (Actual emissions) = you earn credits for this. iii) Methodologies: Any proposed CDM project has to use a baseline and monitoring methodology approved by CDM Executive Board.
7. Incremental CF (Cash Flow): what should be taken into account, initial cash flows
Definition: The additional operating cash flow that an organization receives from taking on a new project over a certain period. It is the difference between a company's cash flow and its potential cash flow, should it undertake a certain project for a certain period. A positive incremental cash flow is a good indication that an organization should spend some time and money investing in new project. Companies must choose the projects that give the highest revenue with minimum capital investment. The duration of payback of investment is so important for investors. Examples of incremental cash flows: 1. Net initial investment outlay: it comprises of cash expenditures, changes in net working capital. 2. Net operating cash flow: the revenue net of expenses and tax liabilities for the time period under consideration.
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3. Net salvage value: is the after tax net cash flow for the termination, liquidation or sale of an investment. 4. Depreciation: the decrease in value of assets.
8. Repowering/ offshore: contribution to the future, and challenges, potential (Lookup further for offshore!)
Definition: Repowering is the process of replacing older power stations with newer ones that either have a greater nameplate capacity or more efficiency which results in a net increase of power generated. Replacement of existing (old) wind turbines before end of lifetime by new (more efficient/more powerful) turbines>> More electricity from wind energy with fewer turbines! Advantages: -Generation of more wind power from the same area of land (electrical output increases). -In most cases, replacing an old wind turbine with a larger more powerful one is economically profitable. -Possible decrease in terms of visual and noise effects. -The quality of the landscape improves. -Operation and maintenance (O&M) cost is reduced. - Taking the incentives into consideration, in the long run it will make more profits>> one incentive being that EEG assures additional bonus on tariff of 0,5ct/kWh (2009) under certain conditions. Challenges: -Financial investment and more government incentives. -Turbine Height restrictions. -Spacing restrictions. -Grid expansion problems. -Relatively long planning period. -Turbines of 2001-2003 are in focus currently Challenges for offshore wind farms: -High noise levels can affect the marine life surrounding the site. Collisions: Ships may only sail in certain areas and in general the closer to the coast, the denser the vessel routes get, so a detailed analysis must be carried before beginning of installation. The Scour phenomenon: Scour is the result of the interaction between a fluid flow field, an obstruction to this flow field (marine foundation) and the sediment bed. -Installation, transportation and maintenance: The demands of ships for transportation are very high. For the operations and maintenance, the weather plays an essential role. Bird mortality: Wind turbines can affect the bird migration paths.
B) Commissioning process: In this section there are steps aimed to ensure that the facility will be able to reliably deliver wind energy to the purchaser. C) Sale and Purchase (SPA): Price terms vary depending on the project financing, quality of the wind resource, available transmission resources and other issues. Price terms may remain flat, escalate or deescalate over the life of the project. For example (Minnesotas community based energy development) requires a tariff with higher rate during the first 10 years and a lower rate in the later 10 years. D) Curtailment: TSO may mandatorily curtail the production of wind energy because of constrains of the system, emergency and other reasons. Many PPAs are structured as Take or Pay. E) Transmission issues: Seller is often responsible for the costs of all transmission upgrades necessary to deliver the wind energy to the point of delivery. Purchaser assumes the risk of loss beyond that point. F) Milestones and defaults: Are intended to allow the purchaser and seller to track the projects development progress. Includes acquisition of permits for construction, execution of a construction contract and evidence of sellers purchase of wind turbines. G) Credit: Many Purchasers require sellers to provide some form of credit enhancement to cover expected damages to the purchaser if the project does not meet construction milestones. Sellers require purchasers to provide a security fund or letter to assure payment for electricity produced by the project. H) Insurance: PPA requires that the seller maintain specific insurance policies: -Commercial general liability insurance. -Workers compensation insurance for sellers employees. Automobile liability insurance. -Builders risk insurance. -All-risk property insurance. Business interruption and extra expense insurance. Engineering Procurement Construction (EPC): Its a common form of contracting arrangement within the construction industry. Under an EPC, the contractor will design the installation, procure the necessary materials (except the power equipment) and construct it, through own labor or by subcontracting part of the work. The contractor carries the project risk for schedule as well as budget in return for a fixed price. EPC Contractor is responsible for the final project commissioning. In an EPC contract the sponsor and the contractor define the following: -Scope and specifications of the project. Quality. -Project duration. -Cost. Advantages for sponsor: -Puts in minimum efforts for the project. -EPC gives the owner one point contact. It is easy to monitor and coordinate. -It is easy for the owner to get postcommissioning services. -EPC way ensures quality and reduces practical issues faced in other ways. -Sponsor is not affected by the market rise. -Investment figure is known at the start of the project.
11.Uncertainties: what kind of uncertainties do we have in wind farms, how to analyze (3 Analysis) (Lookup further!!)
Uncertainties regarding AEP, technical availability of the turbines, prices, demand, technological development, competitors behavior, political development affect investment facts (Cash Flows are affected due to higher risk)
Types of analysis: i) Static analysis: a) Sensitivity analysis: examines the sensitivity/ stabilityof an optimal solution. It identifies the factors that influence the project economics the most by varying these key variables: AEP, Prices, Availability, Costs. b) Scenario analysis: commonly focuses on estimating what a portfolio's value would decrease to if an unfavorable event, e.g. the "worst-case scenario", were realized. Several variables are changed simultaneously. 3 different p-Values : -p(50) Base Case/Trend Scenario, -p(75) Conservative Case, -----p(90) Pessimistic Case A common method is the standard deviation of factors (in our case: AEP): -Varying the probability or p-values, -Depict the future
ii) Dynamic analysis: Risk analysis: Uses the computer aided Monte Carlo Simulation: Produces (a lot of) random scenarios which are consistent with the analyst's assumptions of risk incorporated in the key variables. The computer generates random numbers which are selected for each uncertain parameter from a multi- value probability distribution. -Usually 10,000 iterations. Investor gets a risk/return profile (not a single value but a histogram). Garbage-in garbage-out problem if you dont consider correlations between variables
Capital costs for wind energy: A) Price of wind turbine: Constitutes the major part of the capital costs, including cost for transportation and Installation of the WT. B) Grid connection: -Cables required for connection. -Grid Infrastructure (Transmission towers in case of grid expansion). -Substation that connects the Wind farm with the grid. C) Civil work costs: -Civil works for the foundation of the wind turbine. -Civil Construction of Roads. -Required buildings. D) Other fixed costs: Required Licenses, Consulting services and monitoring systems such as SCADA. Cost of wind energy vs conventional technologies
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itself clearly in the market economy in the discount of future goods as against present goods. It is a ratio of commodity prices, but not a price in itself, nor a price determined on the market by the interplay of the demand for and the supply of capital or capital goods. Interest rates are determined by the supply and demand for loan able funds. The demand for loan able funds comes from: Productivity of capital resources investment demand Positive rate of time preference consumers desire for earlier availability Since original interest is a ratio of commodity prices and there prevails a tendency toward the equalization of this ratio for all commodities. In the imaginary construction of the evenly rotating economy, the rate of original interest is the same for all commodities.
According to the figure, when the interest rate rises, the interest payments will become more expensive. The borrowers will therefore, demand fewer
loan able funds. On the other hand, higher interest rates stimulate lenders to supply additional funds to the market. B) Nominal interest: In finance and economics, nominal interest rate or nominal rate of interest refers to the rate of interest before adjustment for inflation (in contrast with the real interest rate); or, for interest rates "as stated" without adjustment for the full effect of compounding (also referred to as the nominal annual rate). An interest rate is called nominal if the frequency of compounding (e.g. a month) is not identical to the basic time unit (normally a year). C) Real interest rate: is the rate of interest an investor expects to receive after allowing for inflation. It can be described more formally by the Fisher equation, which states that the real interest rate is approximately the nominal interest rate minus the inflation rate. During the inflation, the nominal interest rate will be a misleading indicator of the true cost of borrowing. The better measure of the true cost of borrowing will be the real interest rate.
14.ECF/re method and FCF/WACC method, which one is better? (Lookup further!!)
ECF Definition: Equity cash flow represents funds a company receives from investors. While the most common form of equity financing is from common and preferred stock sales, companies can also receive direct investment from other companies and large private investors.
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(Formula) ECF = total income (revenues) - total operating costs (O&M costs, land leases, management, taxes other than on incomes auditing, decommissioning reserve ) - taxes (trade tax, income tax) interest + redemption - debt service reserve account (DSRA) Business owners and managers will measure the performance of this financing through a few common metrics. These metrics include return on equity, free cash flow to equity and the debt to equity ratio. Financial performance management is important because investors desire a return on their capital. Return on Equity: is a basic financial performance metric that measures how well the company generates profits from equity cash flow. The basic formula is net income divided by total shareholders equity. Investors look at this metric to determine how well the company can take invested funds and generate more revenue through normal business operations. A negative return on equity means the company is losing money from invested capital, i.e. shareholders are losing a portion of their invested capital. The equity beta (E) is a function of the projects asset or unlevered beta (A) and its leverage (V/ E). That means that the risk measure beta changes with the degree of leverage employed in the company. Equity beta is essential for calculating return on equity (see formula sheet), which is computed by the CAPM equation. The capital asset pricing model (CAPM) is a theory of the relationship between the risk of a security or a portfolio of securities and the expected rate of return that is commensurate with that risk. The theory is based on the assumption that security markets are efficient and dominated by risk averse investors. In other words, the CAPM argues that investors are willing to take on more risk only if they can reasonably expect a higher return. Using this equity cash flow, the derived cost of equity, and the initial equity investment one can easily calculate projects net present value.
FCF/WACC method
Cost of Debt: Interest Rate % charged to your company Cost of Equity: Expected % return of Investor (usually higher). -Can use CAPM (Capital asset Pricing Management) to compute it. Definition (WACC): The WACC is the minimum return that a company must earn on an existing asset base to satisfy its creditors, owners, and other providers of capital.
15.Financial ratios: 3 types. How to define which value they should be?
The most common ratios (risk metrics) used in project finace. Financial Ratios used by banks to estimate the ability of the project to meet the loan requirements. i) Debt Service Cover Ratio (DSCR): Debt sizing>>Measure of a projects ability to produce enough cash to cover its debt. DSCR >1.15 1.20 on P75.
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ii) Loan Life Cover Ratio (LLCR): Number of times the cash flow (discounted basis) can repay the outstanding debt balance over the scheduled life of the loan. LLCR > 1.30 on P75
iii) Project Life Cover Ratio (PLCR): Shows how oftenoutstanding debt can be repaid over the remaining life of the project on a discounted basis. PLCR > 1.50 on P75
16.Risks: solutions
Definition: Risk (Event) = Probability (Event) * Consequence (Event) Risk management is the detection, analysis, evaluation, monitoring and control of risks. Risks can be divided into external or internal risks. Financial: change of interest, credit, bank, equity risk, insolvencies. Legal: legal actions of partners or citizens, penalties, judgements. Political: Changes in feed-in-tariffs a.o., requirements. Technical: other renewable energies are more profitable; networks, emergency shutdowns. Environmental: weather, climate changes, earthquakes, corrosion. Ways to evaluating risks: -needing of effective risk management in a project management. using network plans, risk matrix, risk graphs, Tools like MS Project. -define costs structures check them permanently. -find countermeasures for your project risks and evaluate them. improve your risk management and communicate it to partners
Take-if-delivered: An agreement between two parties to the sale and purchase of a particular commodity at a specific future time. Price (Cannot sell output at profit).
iv) Force Majeure Risks: The risk that there will be a prolonged interruption of operations for a project finance enterprise due to fires, floods, storms, earthquakes, or some other factor beyond the control of the project's sponsors. Examples: -Insurance, -Debt Service Reserve Fund, -Reserve established to service interest and principal payments on short- and long-term debt. v) Political risks: Any political change that alters the expected outcome and value of a given economic action by changing the probability of achieving business objectives. It covers a great range of issues. For example, nationalization or expropriation, changes in tax, currency inconvertibility, etc. Examples: -Assurances against a hostile government>> explain to the government how the companys policies are consistent with these priorities. vi) Abandonment risk: Its when the Sponsors walk away from the project. Examples: Abandonment test for banks to run from a project based on historical and projected costs and revenues. vii) Other risks: Syndication Risk>>Examples: Secure Strong lead financial institution. Currency Risk>>Examples: Currency Swaps. Interest rate exposure>>Examples: Interest rate swaps.
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Wind Speed (m/s) Cut-in speed: The speed at which the turbine first starts to rotate and generate power is called the cut-in speed and is typically between 3 and 4 meters per second.
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Rate output wind speed: The power output reaches the limit that the electrical generator is capable of. This limit to the generator output is called the rated power output. Cut-out speed: As the speed increases above the rate output wind speed, the forces on the turbine structure continue to rise and, at some point, there is a risk of damage to the rotor. As a result, a braking system is employed to bring the rotor to a standstill. This is called the cut-out speed and is usually around 25 meters per second Definition>> Power curve warranty: is aimed at ensuring the efficiency of the turbines. Warranty indirect via AEP; assumptions about wind speed distribution and/or air density; uncertainty depending on real situation on site and nature of difference in power curve values. Difference is not measurable for all WTGs after installation (roughness, barriers, turbulences). Site calibration prior to installation is necessary. Damage payments in case of proven non-compliance will be based on relative generation yield losses.
Power curve warranty usually 95% of AEP (annual energy production) referenced to the theoretical / warranted power curve.
Decision making process>>ensuring power warranty: Collecting the historic Data; wind shear, wind veer, turbulence, wake effects and icing. blade condition, turbine suitability, control algorithm, wind farm layout, maintenance and downtime, and error and alarm states,,, All the Present error Data's which are Recorded By the SCADA is analyzed. Once a detailed understanding of present performance has been attained, using the techniques described above, it is possible to project forward to predict long-term energy production. Improvement Points: Subtle improvements in energy production; understanding any deviations from expectations; if appropriate, revaluation of project with a low uncertainty prediction.
Power curve deviations: expected performance, unexpected performance Corrective steps>> identification of constrained power performance; removal of constrained power performance.
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Definition>> Availability: it is the proportion of time; a system is in a functioning condition. No system can guarantee 100.000% reliability; no system can assure 100.000% availability. Reliability involves processes designed to optimize availability under a set of constraints, such as: -time, -cost, -and efficiency. The availability of a power plant varies greatly depending on the type of fuel, the design of the plant and how the plant is operated. For example P.P availability (in ideal fuel or recourses existence). -Thermal, Coal and Nuclear P.P. availability (70-90) %, -Gas Turbine station (80-96)% ,peaking PP, -Wind &Solar 98%. Availability Warranty is aim at ensuring the reliability of the wind turbine. Availability defined as a timely relation of WTG when it is not available due to manufacture faults. Availability Warranty put the responsibility on the manufacture or the supplier according to the contract. Availability warranty estimation>> F (availability functional unit) = N (actual numbers of hours in operation)/ T (numbers of hours in one contract year) The WTG owners paying a lot for a satisfied Availability Warranty!! The availability warranty depends on the manufactures and differs from one to another therefore the period of the Availability Warranty is an important issue for the investors. For Example SEIMENS allows turbines owners to choose availability warranty up to 20 years and extended component defect warranties for up to 12 years.
18.Debt capacity
Definition: Debt capacity is the ability to borrow. It refers to the amount of funding that an organization can borrow up to the point where its corporate value no longer increases. Debt capacity involves the assessment of the amount of debt that the organization can repay in a timely manner without forfeiting its financial viability. Determination of debt capacity>> done by one of the financial ratios mentioned earlier: Debt Service Cover Ratio: Ratio of 'Cash flow Available to Pay Debt' or 'Earnings before Interest, Taxes, Depreciation to debt payments due during that period.
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Static risk metric which banks use for debt sizing. Min Range: Greater than 1.15-1.2 Interest Coverage Ratio: The ratio is calculated by dividing a company's Debt capacity = Net Present Value of all CEDSs (EBIT) by the company's interest expenses for the same period.
The lower the ratio, the more the company is burdened by debt expense. High risk vs low risk cash flows>> High Risk Project has higher margin, shorter-term and declining debt service; higher volatility of cash flow. Low risk has flat debt service, and longer term and higher IRR on equity. Cash Flow Available for Debt Service (CADs) = Electricity Revenue (Quantity x Price) + other Revenues (CO2, interest income etc.) - variable Costs (O&M Costs, Trade Tax) - fixed Costs Cash Flow Eligible for Debt Service (CEDs): CADs has to fulfill the DSCR-requirements of the bank. thats why only a part of CADs can be levered: we call it CEDs. CEDs = CADs/DSCR Debt capacity = Net Present Value of all CEDs
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Electricity forward contracts are the primary instruments used in electricity price risk management. Electricity forwards are essentially custom-tailored supply contracts. Electricity futures have the same payoff structure as forwards. Electricity futures, like other futures, are highly standardized in contract specifications: -trading locations, -transaction requirements, -settlement procedures When hedging against electricity spot price movements, we will consider using futures contracts as oppose to forward contracts because: i) they are more reflective of higher market consensus and transparency than the forward price. ii) They are more relevant to the issue of hedging because the majority of electricity futures are settled by financial payments rather than physical delivery.
>Comparison
Forward Contract
Futures Contract
Negotiated directly by the buyer and seller Depending on the transaction and the requirements of the contracting parties. Depending on the transaction The contracting parties
Opposite contract with same or different counterparty. Counterparty risk remains while terminating with different counterparty. Customized to customers need. Usually no initial payment required.
Structure:
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Guarantees:
No guranantee of settlement until the date of maturity only the forward price, based on the spot price of the underlying asset is paid
Both parties must deposit an initial guarantee (margin). The value of the operation is marked to market rates with daily settlement of profits and losses.
With taxes: The first (Firm U) is unlevered: that is, it is financed by equity only. The other (Firm L) is levered: it is financed partly by equity, and partly by debt. >>> VL=VU+TCD Without taxes: VL=VU where VU is the value of an unlevered firm = price of buying a firm composed only of equity, and VL is the value of a levered firm = price of buying a firm that is composed of some mix of debt and equity. M&M theorem (script 2): A financial theory stating that the market value of a firm is determined by its earning power and the risk of its underlying assets, and it makes no difference whether a firm finances itself with debt or equity. Capital structre does not matter. Remember that a firm can choose between three methods of financing: issuing shares, borrowing or spending profits (as opposed to dispersing them to shareholders in dividends). M&M Proposition II: states that the value of the firm depends on three things: 1) Required rate of return on the firm's assets (Ra). 2) Cost of debt of the firm (Rd). 3) Debt/Equity ratio
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of the firm (D/E). Without Taxes: A higher debt-to-equity ratio leads to a higher required return on equity, because of the higher risk involved for equity-holders in a company with debt. Ke =Ko+ D/E( Ko - Kd } Ke = Required rate of return on equity, or cost of equity. Ko = Company unlevered cost of capital (ie assume no leverage). Kd = Required rate of return on borrowings, or cost of debt. D/E = Debt-to-equity ratio. With taxes: The same relationship stating that the cost of equity rises with leverage, because the risk to equity rises, still holds. The formula however has implications for the difference with the WACC (Weighted average cost of capital). The weighted average cost of capital (WACC) is the minimum return that a company must earn on an existing asset base to satisfy its creditors, owners, and other providers of capital, or they will invest elsewhere. Use of M&M proposition: These propositions are true assuming the following assumptions: no transaction costs exist, and individuals and corporations borrow at the same rates. These results might seem irrelevant, but the theorem is still taught and studied because it tells something very important. That is, capital structure (ways to finance assets) matters precisely because one or more of these assumptions is violated.
utilities / sponsors with strong financing capacity provide all necessary financing (use their own cash resources) Financing using capital market products stock market bond market Project Finance without / with limited recourse to the sponsor mostly used by large and risky projects debt is provided by banks and other financial institutions project equity is paid-in by the sponsors or external investors
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