Introduction to Project Finance for Renewable Energy: Course Overview

In this blog post, course author Dr Michael Shakib provides an overview of SWITCH On Skills’ newest course, ‘Introduction to Project Finance for Renewable Energy‘.

The course focuses on the principles of project finance for projects such as wind farms, solar farms, and hydroelectric power plants. These principles are not just reserved for renewable energy projects; they hold for any project which involves building and operating large infrastructure.

Concept and Scope

Defining the Concept

Assuming we have planning permission and all the technical aspects are catered for and feasible, we wish to borrow money to build a renewable energy asset that generates electricity. Then we wish to sell the electricity to generate revenue. We use that revenue to operate and maintain the asset while also paying taxes on any profits, paying back loans and interest, and then finally if there’s any money left over, paying back money to private lenders, otherwise known as equity investors.

Understanding Project Finance

What is Project Finance?

Investopedia defines project finance as the funding of long-term infrastructure, industrial projects, and public services using a non-recourse or limited recourse financial structure. The debt and equity used to finance the project are paid back from the cash flow generated by the project. Project financing is a loan structure that relies primarily on the project’s cash flow for repayment, with the project’s assets, rights, and interests held as secondary collateral. This explanation is good enough but it leaves room for more questions and clarification.

Visual Representation

We can take this concept and draw it out visually as a diagram, showing the main aspects of a project with arrows that denote money flowing in and out of the project. Positive showing cash flowing in, and negative showing cash flow out of the project. Notice that all cash flows move through one central point which is the SPV or Special Purpose Vehicle.

Role of the Special Purpose Vehicle (SPV)

Function of the SPV

The SPV coordinates the project and acts as a conduit for cash flows. These projects involve building real infrastructure on real land for many years, and so the first thing to consider might be the land to place our asset upon. An SPV is a legal entity that allows the project to happen. In the UK, a typical type of SPV is a limited company with limited liability. Directors of the SPV make decisions such as identifying land, applying for planning permission, engaging consultants, negotiating with contractors, raising funds, paying debt and dividends, receiving revenue, and producing a financial model to ensure it all works.

Financial Components of the Project

Capital Expenditure

This includes the initial cost of generating equipment, ground works, grid connection, etc. Capital expenditure may be very large, running into the millions or billions depending on the size of the project.

Revenue and Operating Expenses

With all that money being paid out, we need a sound method of getting money back into the project over its lifetime (20 to 25 years). This revenue comes from sales of electricity. Some of the revenue must be spent on maintaining the asset, ensuring it produces adequate electricity yield, paying land rent, insurance, and other operating expenses. We will go through each of these aspects in detail during the course.

Calculating Yield

Energy Yield Calculation

Yield is the term for how much energy the generator produces each year. We can calculate this with a certain level of confidence using free software while recognizing their limitations. For this course, we shall use the following free online software: PVGIS, Renewables Ninja, Open Solar, and Global Wind Atlas. We will also learn how to calculate wind yield from power curves and wind speed data.

Financing the Project

Sources of Financing

If the company does not have the money to fund the project or the technical knowledge to build and operate a generator, project finance principles can help. Money for these projects usually comes from two sources: debt (senior loans from banks) and equity (from sponsors). Lenders scrutinise the project’s feasibility and contracts to mitigate the risk of failure. We will explore metrics such as the debt service cover ratio and cash flow available for debt service.

Equity Sponsorship

Equity investors raise funds based on a solid plan. Typically, the project pays investors dividends each year, though it isn’t obliged by law. Investors benefit if the business is successful and so it’s in their interest to only invest in a project that’s destined to succeed. We will learn to calculate the equity internal rate of return (IRR) which equity sponsors use to decide on investment.

Financial Modelling

Creating a Financial Model

We will use Microsoft Excel to create a project finance model, learning best practices in setup, accounting, and formula usage. This model will help determine the project’s financial viability, calculating cash flows, expenses, revenue, discounted cash flow, NPV, project IRR, and more.

Comparison with Established Models

We will compare our model against a well-established finance model provided freely by the Welsh government energy service.

Course Content and Assessment

Course Topics

By the end of this course, you should be able to understand and calculate the following:

  • – Cash flows (EBITDA)
  • – Construction expenses
  • – Operating expenses
  • – Revenue from solar and wind yield calculations
  • – Discounted cash flow analysis
  • – Net Present Value
  • – Project IRR
  • – Depreciation and capitalisation
  • – Debt, fixed principal, and annuity payments
  • – Equity
  • – CFADS
  • – Debt Service Cover ratio
  • – Equity IRR
  • – Excel techniques and shortcuts
  • – Spreadsheet formatting and best practices

Assessment

The course assessment includes short questions after each section and a final written report, reflecting real-world scenarios. Prior knowledge of using a spreadsheet is advantageous, but we will build the model step by step using examples, finally building up to a fully usable model for the course.

SWITCH-On Skills is funded by the UK Government through the UK Shared Prosperity Fund.

Find out more about SWITCH On Skills here: https://www.now-switch.wales/netzeroskills/switch-on-skills/