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| The mini-hydro plant |
As with any other investment project, the economic feasibility of micro hydro projects must be proven to attract the interest of investors.
It
is also of key importance in enabling financial institutions to supply
the funds necessary to finance the project in addition to the promoter’s
own funds.
This will be possible if the project is “bankable”.
Questions a promoter has to answer prior to the decision to invest is taken include the following:- What are the costs incurred by the project of MHPP?
- What will be the revenues?
- Does the project generate a reasonable rate of return to their own investment funds?
- What are the financial sources?
- What will be the revenues?
- Does the project generate a reasonable rate of return to their own investment funds?
- What are the financial sources?
Costs
The cost of an MHPP
is site-specific. It depends on the necessary civil works, the
generating equipment and the electrical transmission/distribution lines.
While the cost of the generating equipment is almost a linear function
of power size (in kW), the cost of civil works depends on the physical
characteristics of the site. Similarly, the cost of the electrical lines
depends on the type of grid and on the distance to the connection
point. The terms for connecting to the grid differ widely in the EU with
some countries deliberately leaving only part of the cost to
developers, while in other Member States (eg Spain, Germany) all the
costs are born by the investor.
Other development costs have to be taken into account: engineering studies, environmental impact studies and the legal fees to submit the project for approval to the different public bodies involved.
Besides
the investment costs, which have to be paid off during the initial life
of the project in the form of depreciation, operation and maintenance
costs (O&M) have also to be estimated and depend mainly on the
permanent personnel involved, on the insurance costs and on repair and
maintenance contracts concluded with specialized firms. Certain expenses
which will not be encountered every year, like major repair/maintenance
of machinery and replacement of brushes, will also have to be taken
into account.
Payment of the debt and interest on bank loans will
also need to be estimated. Usually the whole calculation is made in
current costs in order to avoid making estimates of inflation.
The following graph correlates the investment cost in Euro/kW installed capacity for different power ranges and heads.
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figure
8 - Investment costs for MHPP
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Cost
evaluation must be conducted carefully because such projects are
capital intensive and costs depend very much on the characteristics of
the site. In brief, the following typology of costs applies to micro
hydro projects:
Initial costs
Feasibility studies and
project development are typical items of MHP projects. They include
hydrological and environmental assessment, preliminary designs, permits
and approvals (for water, land use and construction), land rights,
interconnection studies, power purchase agreements (PPA), project
management and financing fees.
One of the aims of the SPLASH Project, through its methodology of the implementation of local plans is to minimizing the development costs of the micro hydro power projects.
One of the aims of the SPLASH Project, through its methodology of the implementation of local plans is to minimizing the development costs of the micro hydro power projects.
As
several constraints are analyses simultaneously, over a large area
within the plans, several sites could be potentially developed.
Therefore, cost analysis and the economical risks could then be assessed
in an easier manner and comparisons done. In this order, the support to
decision makers and stakeholders could become a handy tool for micro hydro power development.
Construction costs
This type of
costs is incurred after the decision to go ahead with the project is
taken. Such costs include engineering, insurance premiums, civil works
and equipment.
Operation and Maintenance
These are regular costs that occur on a yearly basis and include transmission line maintenance,
general administration, repairs and contingencies. Operation and
maintenance cost most importantly include maintenance of the civil works
and the equipment of the microhydropower plant.
Revenues
Revenues
come from specific purchase contracts signed with the electric
utilities. Depending on the legislation, electric utilities are usually
obliged to buy the electricity generated from renewable energy resources
on a priority basis.
In some countries there are specific
incentives given to investment in electricity production using RES.
According to these special schemes, hydro, wind power and photovoltaic
projects can apply for special loans with low or even zero interest
rates, or receive other types of investment subsidies. Prices paid to
MHP producers vary considerably among European countries. In the tariff
structure different components can be found, according to the country: a
market price, an avoided carbon price, a green certificate price or
other forms of promotional elements.
Figure 9 illustrates some of
the differences between countries. The different support schemes can
affect greatly the development of micro-hydro plants. Whereas a fixed
feed-in tariff reduces uncertainty and guarantees cash flow for a
determined duration, market-based schemes can sometimes reveal
themselves too uncertain and therefore unattractive to developers. Even
if price alone is not the only factor to take into account for an
investment decision, the detailed summary of individual countries’
situation found in Appendix III might prove helpful.
To estimate
his revenues, the promoter of an MHPP has to estimate the production and
sales during the different periods defined in the tariff legislation.
Usually the tariffs have an hourly and seasonal structure to take into
account the shape of the load demand curve and the marginal costs of
electricity production during every period.
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| figure 9 - Differences in tariff structure |
Project Financing
Project
financing is a key element for decision – making in capital – intensive
projects and it is a common rule that developers rely on capital
markets and other types of lending to obtain the required funding.
The
appropriate structure for funding depends much on the promoter and on
the specific financing sources available (e.g. loans through government
incentive programs, government grants). Also, if a PPA is signed, it can
be of great help in a project finance scheme, because it provides a
guarantee of revenues.
The main sources of equity funding are
private capital (from the promoter), shares issued to the public, loans
and grants from the government. Debt funding is associated with loans
given by banks, lease companies and government agencies. The share of
debt on total funding depends on the guarantees offered by investors and
on the expected profitability of the project.
Assessing The Profitability Of An MHPP Project
Different
summary measures are usually considered for the economic and financial
appraisal of investment projects. Among the most frequently used
measures we can identify the following: the pay-back method, the rate of
return on equity (ROE), the net present value (NPV) or the internal
rate of return (IRR).
Definitions
- Payback period: number of years necessary to recover the investment. Usually we encounter payback periods from 5 to 10 years when assessing profitable MHPP projects, which themselves can have a life span of 25 years or more. This varies according to the investment needed, tariffs applied and O&M expenditure.
- ROE: percentage annual average return (net of depreciation) on the initial investment. It is used as a proxy for the average profit rate, which must be compared with the opportunity cost for capital or with the remuneration of an alternative investment.
- NPV: sum of the discounted cash flows over the life time of the project assuming a discount rate.
- IRR: discount rate that equals the inflows (receipts) and the outflows (costs).
To
calculate these indicators a cash-flow table for the life time of the
project has to be generated. Figure 10 gives an example of a cash flow
table and of the value calculated for the above listed indicators.
The Economic Evaluation
The
following table presents a typical cash-flow assessment of a project,
adequate to run simple feasibility studies. No assumption is made
concerning the way the project is to be financed. If the values
estimated for IRR and/or NPV are acceptable for the decision maker, a
deeper analysis must be conducted in order to submit the project for
final decision and to the banking institutions.
In this example
all the figures are in constant prices and according to the estimated
IRR, it appears that the project is bankable and will give the investors
a profit rate higher than 7,29% if the project can be successfully
financed by the banking system at an interest rate lower than 10%. This
project is a refurbished old mill and represents a 50 KW installation,
run-of-river and is considered to take advantage of a feed-in-tariff.
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| figure 10 - Project Cash-flow (an example) |
We
have not taken the value of externalities associated with an MHPP into
account. These externalities may either be positive or negative and are
sometimes decisive for the approval of the project by public bodies.
Environmental
burdens, tourist upgrading of a region, job creation at a local level,
income generation by municipalities are some examples of externalities
to consider during the assessment.
