Economic & Financial of CDM

Introduction to Renewable Energy

Introduction to Renewable Energy Technology

Nearly all energy sources, except geothermal resources, originate from the sun, with fossil fuels representing solar energy stored in organic materials transformed into hydrocarbons through geological processes In contrast to hydrocarbon fuels, solar energy is clean and virtually limitless, as the sun is expected to shine for another billion years Key technologies for harnessing energy from the sun's radiant energy include various natural processes that capture and convert this abundant resource.

Wind (derived from the sun.s radiant heating and movement of the earth.s atmosphere)

Biomass (conversion of biological matter into energy)

Hydropower (derived from the sun.s hydrological cycle)

Many technologies are capable of generating mechanical and thermal energy directly; however, their primary application has shifted towards electric power production This article provides a brief overview of each technology and its specific method for generating electricity.

Solar radiation can be harnessed to produce electricity through two primary technologies: photovoltaic (PV) and solar thermal Photovoltaic systems directly convert sunlight into electricity, achieving conversion efficiencies of 12% to 20% without concentrators, and 22% to 28% with concentrators These systems utilize solar cells made from specially treated semiconductor materials, where one layer (the n-layer) carries a negative charge and the other layer (the p-layer) carries a positive charge This configuration creates a barrier that generates a current and voltage when sunlight excites the electrons, causing them to flow across the cell The flow of electrons is facilitated by metallic contacts arranged in a grid pattern on the cell.

Photovoltaic (PV) cells are interconnected to form modules, which, along with their supporting structures, are referred to as an array Each module is assigned a peak power rating based on its output under standard test conditions Arrays are specifically designed to fulfill the electricity needs of various applications.

Modules usually provide electricity in the form of direct current (DC) at 12 or

Photovoltaic technology, operating at 24 volts, is appealing due to its simplicity, minimal moving parts, and low maintenance requirements It performs best under optimal conditions, such as long, clear, cold, sunny days To ensure electricity availability during nighttime and cloudy weather, batteries are utilized to store excess energy generated during daylight Most applications require complete systems that encompass batteries, inverters, and control systems for effective operation.

Best Practices Guide Chapter 1: Introduction to Renewable Energy Technology

USAID/Office of Energy, Environment and Technology

Research and development advances have lowered PV costs dramatically. Costs are still high, but continue to drop Capital cost is currently US$4,500 - 10,000/kW (compared to wind at about

The cost of photovoltaic (PV) systems is approximately $1,000 per kilowatt, and pricing can vary based on order size Despite high energy costs, averaging around $0.40 per kilowatt-hour, PV technology is not extensively used However, its benefits make it a suitable choice for off-grid applications.

Solar Thermal systems consist of four main components: a collection component, a working fluid circulation system, a storage component, and controls Together, these elements efficiently convert solar radiation into usable heat for a variety of applications The types of collection components play a crucial role in this process.

Flat-plate heat-pipe collectors

Evacuated-tube heat-pipe collectors

This guide will focus mainly on the first three, which have a greater possibility of being deployed on small-scale levels at reasonable costs.

Flat-Plate hydronic collectors have a delivery temperature typically between

Domestic water heating systems primarily utilize thermosyphon technology, which enables natural circulation driven by the density differences between hot and cold water These systems generally achieve an efficiency rate of approximately 30% to 35%.

Flat-plate heat pipe collectors utilize a thermosyphon mechanism through the phase change of the working fluid, achieving delivery temperatures comparable to hydronic collectors With an efficiency range of 28% to 32%, these collectors are well-suited for domestic water heating applications.

Evacuated-tube heat pipe collectors utilize vacuum tubes to minimize heat loss and enhance efficiency Within these clear glass tubes, water or other fluids are contained, optimizing thermal performance.

- 5 - vacuum, and efficiency is typically 45% - 70%, which makes higher temperatures and coldweather use possible as a result.

Energy generated from solar thermal is usually consumed directly by the end user, such as in domestic hot water heating or space heating or cooling.

Sometimes in larger applications energy can be stored and used for other applications, such as mechanical energy.

Cost characteristics for solar thermal are calculated based on the application and are expressed in terms of capacity because there are negligible operating costs.

The cost of capacity for water heating:

Flat-plate hydronic 4.00 US$/(liter/day)

Flat-plate heat pipe 3.50 US $/(liter/day)

Evacuated-tube heat pipe 5.00 US$/(liter/day)

The cost of energy for electricity using a parabolic trough varies, but ranges from about 0.11-

The cost of energy generation varies significantly among different systems, with stand-alone systems priced at approximately 0.17 US$/kWh, while natural gas hybrid systems range from 0.08 to 0.10 US$/kWh Although paraboloidal dish systems currently generate electricity at a high cost, they are projected to become more cost-effective, potentially reaching around 0.07 US$/kWh by 2010 Similarly, power tower systems, while currently expensive, are anticipated to decrease in cost to about 0.05 US$/kWh in the future.

Wind energy harnesses the power of moving air to generate electricity through wind turbine/generators, which typically comprise a tower, rotor (including blades, hub, and shaft), gearbox, generator, control equipment, and power conditioning equipment These systems convert the rotor's rotational energy into electrical power, often utilizing a gearbox in larger units to enhance generator speed To safeguard against high winds and extreme weather, wind systems are equipped with braking mechanisms Due to variations in wind speed, which can differ globally, regionally, and locally, synchronous or induction generators are employed to accommodate fluctuating electrical frequencies The effectiveness of wind turbines heavily relies on the duration and intensity of wind patterns, which often exhibit seasonal trends.

Cost effective, large-scale wind turbines, as shown

To effectively harness wind energy, large wind farms require an annual average wind speed of 13 mph (5.8 m/s) at a height of 10 meters, while small wind turbines can operate with just 9 mph (4 m/s) Many regions are now integrating small wind turbines with other energy sources, such as photovoltaic systems and diesel generators, to create more dependable hybrid systems Over the past decade, wind energy has become increasingly competitive, particularly in larger-scale installations (over 10 MW), which often provide a lower cost per kilowatt-hour Technological advancements, particularly in blade design, have significantly contributed to these cost reductions.

The average lifespan of a modern turbine design is approximately 20-25 years, during which capital costs are amortized While economies of scale can reduce capital costs, larger turbines tend to have a wider price range A general guideline suggests a cost of around US$1,000 per kW capacity, with the marginal tower cost estimated at US$1,500 per meter Installation expenses encompass foundations, transportation (typically under US$15,000), utilities such as telecommunications, and substation components like transformers and cabling, with costs varying based on soil conditions and proximity to power lines.

Operation and maintenance costs generally increase throughout the life of a wind power project.

Costs range from about US$0.008 to US$0.013 per kWh generated, and increase at a rate of about

The annual operational cost is projected to be 2.5%, with the upper limit reaching US$0.013 per kWh, which accounts for significant equipment overhauls, particularly for rotor blades and gearboxes that experience increased wear and tear Additional expenses encompass ongoing plant monitoring and biannual equipment inspections.

Renewable Energy Applications and Changing Market

Recent advancements in renewable energy technologies have significantly reduced costs, leading to a nearly threefold increase in their application over the past 15 years Technologies such as photovoltaics (PV), solar thermal, wind, and biomass are now effectively utilized in both subsidized and commercial small-scale projects Additionally, wind power is gaining traction in large-scale commercial power generation initiatives.

The surge in oil prices has significantly contributed to the growing adoption of renewable energy sources As the costs of oil and gas rise, renewable energy options become increasingly economical For instance, two renewable energy sources demonstrate their ability to replace oil and gas in various common applications.

Figure 1 Comparison of Energy Sources and Applications

Expensive for large volumes or deep wells

Kerosene Appropriate for small scale

Appropriate Not appropriate Not appropriate

Expensive Appropriate for short duration

Appropriate Appropriate for short duration

Diesel generator Appropriate for large scale

Appropriate Expensive for small applications

Appropriate for medium and small scale

Appropriate Appropriate for some cases

Multilateral lending agencies are increasingly focusing on cross-sector applications to effectively meet the energy needs of approximately two billion people who currently lack access to reliable energy sources.

Best Practices Guide Chapter 2: RE Applications and Changing Markets

Cross-sector applications of renewable energy include:

Project facilities and other buildings and equipment

Community water supplies (including disinfection)

Community refrigeration and ice-making

Agriculture (post harvest management/food processing)

Roads (illuminated signs, emergency phones, street lighting, signals)

Renewable energy technologies offer commercial and operational advantages as well These advantages are particularly important in remote areas not served by electric utility companies.

Even when conventional utilities offer service, there are some advantages to renewable energy technologies, which include:

1 Modularity, providing redundancy and resilience in the event of failure of utility supply;

2 Low or no fuel requirements;

3 Life-cycle costs which can be less than for equivalent service from fossil fuel options;

4 Hybrids (PV and/or wind plus diesel generators) which can provide 24-hour high-quality power; and

5 PV and wind equipment that often require less maintenance and provide greater reliability than diesel generators in many field conditions.

Several direct and indirect savings and other economic benefits can accrue from the use of renewable energy technologies to displace fossil fuels Several of these are as follows:

Reduction in fuel delivery costs

Reduction of hazardous air emissions

Spillover effects from induced investments in power supply

Increased salvage value of power generating equipment

Recent advancements in technology and significant cost reductions across all major renewable energy sectors have been remarkable Notably, the continuous decrease in photovoltaic module prices since 1970, projected to persist through 2015, highlights this trend Additionally, the declining cost of electricity generated by wind turbines further underscores the progress in renewable energy affordability.

Figure 2 Actual and Projected Photovoltaic Module Costs, 1970-2015

Figure 3 Cost of Electricity from Wind Turbines in California, 1985- 1995

Despite the ongoing decrease in the costs associated with renewable energy technologies and the significant demand for such energy in developing nations, substantial investments in this sector are still hard to secure Identifying key factors that can enhance the market potential for renewable energy is crucial for attracting these investments.

To effectively implement renewable energy programs, it is essential to secure grant or technical assistance funds for project preparation, which typically requires one to three percent of total project costs These resources may not always be recoverable, particularly for projects that are unfeasible or fail to attract funding Potential financing sources for project preparation include multilateral development banks, the Global Environment Facility, bilateral grant aid, contributions from developing countries, private investors, and electric utilities A comprehensive list of these financing options is available at the end of this guide.

Enhancing market potential in the energy sector requires raising awareness about the opportunities offered by innovative and cost-effective renewable technologies This can be achieved through targeted education and training programs for professionals in the energy industry, as well as for financiers and regulators.

Many countries are undergoing structural reforms in their energy sectors, which can facilitate commercial electricity supply and attract private investment These changes are expected to enhance the profitability of renewable energy investments.

To achieve long-term success in renewable energy investments, it is crucial to focus on thorough preparation and financing from the beginning Additionally, ongoing training, maintenance, and support services are essential throughout the project's lifespan Many potentially successful renewable energy initiatives have faltered due to a lack of attention to these vital services.

Best Practices Guide Chapter 3: Barriers to Commercializing RE Technologies

Barriers to Commercializing Renewable Energy

A singular project finance strategy does not exist for renewable energy initiatives, as these projects differ widely in scale, capacity, energy resources, output sales, technological status, and various other factors Therefore, financial strategies must be innovative and adaptable to effectively address the unique challenges associated with renewable energy projects.

Some of the major financing barriers include:

High Capital to O&M Cost Ratio

Renewable energy systems typically incur low fuel and operation and maintenance (O&M) costs; however, their initial capital costs are significantly higher than those of fossil fuel generation systems This high ratio of capital to O&M costs highlights the substantial upfront financial burden associated with renewable energy projects, which must be financed and amortized over their operational lifespan Consequently, the elevated initial capital costs present a barrier to securing project financing for renewable energy initiatives.

High Project Development to Investment Cost Ratio

Renewable energy projects typically face a higher ratio of development costs to investment compared to conventional projects This is largely attributed to their dispersed nature, smaller scale, and the absence of established infrastructure that aids in project development Additionally, the legal, regulatory, and engineering transaction costs associated with these projects tend to be more complex and elevated, lacking the economies of scale that larger conventional projects enjoy.

Renewable energy projects typically involve smaller investments, making them less attractive to commercial banks, utilities, and established independent power producers (IPPs) These entities often shy away from such projects due to the high costs of due diligence and the perceived risks associated with smaller-scale investments.

Difficulty Guaranteeing Project Cash Flow

Ensuring a project's cash flow is crucial for securing financing, typically necessitating long-term fuel supply contracts and potentially a plant-operating agreement to guarantee costs Additionally, a robust power purchase agreement is essential for securing revenue Renewable energy projects frequently engage with multiple fuel suppliers to manage these requirements effectively.

Renewable energy sources like solar, wind, and hydro often face challenges in ensuring fuel availability, as their output is heavily influenced by environmental conditions Furthermore, these projects typically involve multiple power purchasers, many of whom lack the financial capability to offer binding long-term commitments for purchasing the generated energy.

Best Practices Guide Chapter 3: Barriers to Commercializing RE Technologies

Weak Basis for Non-Recourse Financing

Small, independent and newly established renewable energy project developers often lack the institutional track record and financial inputs necessary to secure non- recourse project financing.

Renewable energy technologies are emerging as commercial solutions, yet they remain unfamiliar to many project financiers While information on these systems is not always easily accessible to potential investors, this is evolving with increasing Internet access The landscape is shifting, as numerous renewable energy technologies are quickly gaining traction in the market.

Globally, renewable energy projects are often initiated by smaller organizations that face financial constraints, limiting their ability to access essential funding Consequently, these entities struggle to attract equity investors and secure necessary debt financing for their initiatives.

Renewable energy projects face various characteristics that can hinder project financing To effectively address these challenges, it is essential to implement innovative and robust project appraisal and investment strategies, which are outlined in the following project guidelines.

Best Practices Guide Chapter 4: Economic Appraisal of RE Investments

Economic Appraisal of Renewable Energy Investments

Economic Appraisal of Renewable Energy

A thorough economic evaluation of the proposed project is essential during both pre-feasibility and feasibility analyses, especially when seeking financial support from banks In the context of financing renewable energy technologies, four key characteristics are crucial in defining the project's scope and objectives.

Scale: Scale or capacity of the renewable energy project will determine the level of financing that is needed;

Consumers play a crucial role in assessing the risks and challenges linked to securing project revenue Evaluating the creditworthiness of numerous small consumers presents greater difficulties compared to that of a single buyer.

Technology Status: Renewable energy projects based on mature and commercially proven technologies are much easier to finance than those utilizing experimental technologies.

Renewable energy projects are heavily dependent on weather conditions such as sunlight, wind, and rain, which directly influence their energy output When adverse weather events like drought occur, these projects face significant risks, leading to unpredictable power sales and revenue streams Therefore, during the appraisal of such projects, it is essential to assess the associated risks and the potential fluctuations in expected revenue based on historical weather patterns.

The table presented outlines various renewable energy technologies and their potential project characteristics, categorized by scale—large, medium, small, or micro It also distinguishes between grid-connected, isolated-grid, and non-grid projects, while considering the technological status and the predictability of weather conditions that influence these projects.

Figure 4 Renewable Energy Technology and Characteristics Used to Determine

Wind power M/S/Mi G/IG/NG M/NC P/U

Solar PV S/Mi G/IG/NG NC/E P/U

Scale: L = Large >20 MW; M = Medium 1 20 MW; S = Small 100 kW 1MW; Mi Micro < 100kW

Consumers: G = Grid connected; IG = Isolated; NG = Nongrid

Technology Status: M = Mature; NC = Newly Commercial; E = Experimental

Historic Weather Conditions: K = Known; P= Predictable; U = Unknown

Appraisal and Selection of Renewable Energy Projects

The appraisal stage of a project cycle is crucial for evaluating various aspects of a potential project It involves assessing the administrative feasibility of implementation, conducting marketing and technical appraisals to determine overall viability, and analyzing the project's financial sustainability throughout its planned lifespan Additionally, it is essential to measure the expected economic contribution to national growth and, if publicly funded, evaluate how the project aligns with the country's social objectives while ensuring cost-effectiveness Lastly, the appraisal must include an assessment of the project's environmental impacts, considering both costs and benefits associated with its implementation.

Currently, the distinctions between pre-feasibility and feasibility studies have become blurred.

The rising costs of studies have led to a decrease in the time allocated for dual research projects Additionally, advancements in engineering, financial, and market data have made it easier to access precise information Typically, the most reliable data for a specific renewable energy project can be obtained from similar projects within the same country.

Successful projects should be carefully studied for lessons learned.

Typical generic issues that the appraisal must answer include:

Do we have the administrative capacity to carry out the project?

Is there a demand for the project?

Do we have information about the market?

Can we get sufficient technical data to define the type of equipment needed?

Does the country (if public sector) or the company (if private sector) have the financial capacity or access to sufficient funds to carry out the project?

Can the project be carried out on schedule?

If in the private sector, how will this investment contribute to overall profit?

If public sector, how will this project contribute to the economic growth of the country?

What are the distributional benefits?

Who benefits and by how much, who pays and by how much? Are there other social objectives achieved (stabilization, diversification, environmental conservation)?

What are the technical options and what can they do?

What are the levelized costs (capital, operating, maintenance, replacement) of the renewable energy options in comparison to convention energy sources?

What is required to ensure reliable and sustainable operations?

What advantages and disadvantages do renewable energy technologies have relative to fossil fuel-based options?

Do renewable energy systems make sense where the grid is present?

Are there standardized or model procurement packages for various renewable energy systems?

The feasibility evaluation serves as an internal appraisal for renewable energy projects, requiring a comprehensive examination and documentation of key elements Among these, assessing electricity demand is crucial, as it forms the foundation for understanding the project's viability and potential impact.

Risk (technical, financial and institutional)

Sensitivity (define project/option viability and parameters)

Using the Time Value of Money

The value of money is closely tied to time, making investments a strategic way to allocate funds now with the anticipation of greater returns in the future Utilizing the discounted cash flow method highlights that cash flows generated in the early stages of a project hold more present value compared to identical amounts received later on, emphasizing the importance of timing in investment decisions.

The discount rate plays a crucial role in analyzing renewable energy projects, as it is influenced by various factors, primarily the opportunity cost of capital This opportunity cost represents the potential returns or production that are sacrificed when capital is allocated to one project instead of another The calculation of the discount factor is essential for accurately assessing the financial viability of these projects.

Figure 5: Equation For Calculating The Discount Factor

Renewable energy investments are often perceived as high-risk by consumers due to their implicit discount rates and the uncertainty stemming from limited information, leading to a demand for higher returns However, from a societal perspective, these investments are actually low-risk and should be assessed with a lower discount rate.

In finance theory the time value of money is thought to increase with greater risk and uncertainty.

If the project being evaluated does not have an internal rate of return equal to or better than this discount factor, then the project should not be undertaken.

Where i = the interest rate or cost of capital n = years from project implementation

There are three important points that should be remembered when using a discount rate:

1 Only one discount rate can be used in any single economic analysis

2 The discount rate used does not reflect inflation; all prices used in the analysis are real or constant dollar prices; and

3 A rigorous analysis of non-monetary impacts (non-market values including changes that might be irreversible) should be undertaken.

This last point is important for renewable energy projects, since they offer significant nonmonetary benefits.

Best Practices Guide Chapter 5: Cost-Benefit Analysis

Cost-Benefit Analysis

The appraisal process has evolved from a traditional method of ranking projects to a more sector-focused approach, enabling data from feasibility studies to inform the design process This evolution helps structure projects to optimize financial and economic returns Consequently, all investments should undergo a systematic capital appraisal process aimed at maximizing these returns.

Provide a basis for selection or rejection of projects by ranking them in order of profitability or social and environmental benefits; and

Ensure that investments are not made in projects that earn less than the cost of capital

(generally expressed as a minimum rate of return).

The initial phase of any economic evaluation involves forecasting cash flow, which represents the difference between a project's revenue and its ongoing expenses Unlike accounting profit, cash flow excludes factors such as depreciation and interest charges, as these are considered in different contexts.

Figure 6 summarizes the main differences between the cash flow and the accounting profits.

Figure 6: Cash Flow Versus Accounting Profit

Revenues When cash comes in When sales occur

Operating expense When cash goes out When expenses occur

Capital allowances Tax shield included as cash flow Included in tax accounts Taxes When tax is paid (one year time lag) When tax is incurred

Cost-benefit analysis (CBA) is a collection of analytical tools designed to evaluate the financial and economic feasibility of proposed investments These tools help in systematically assessing the potential returns and risks associated with an investment decision.

Net Present Value (or Discounted Cash Flow)

The benefit-cost ratio (BCR) is a financial metric that compares the discounted total benefits to the discounted total costs of a project For example, if the discounted total benefits amount to 120 and the discounted total costs are 100, the resulting BCR would be 1.2:1, indicating that benefits outweigh costs.

To ensure a project's acceptability, its benefit-cost ratio must be at least 1 When evaluating mutually exclusive projects, it is essential to select the one with the highest benefit-cost ratio for optimal outcomes.

One significant disadvantage of the Benefit-Cost Ratio (BCR) is its high sensitivity to the selection of the discount rate, which can lead to inaccurate analyses Additionally, the BCR may yield misleading results when comparing projects of vastly different sizes or scales.

The net present value (NPV) approach, also known as the discounted cash flow method, evaluates a project's annual cash flow by converting it into a single value using a selected discount rate, reflecting the time value of money This method effectively incorporates income tax effects and variations in cash flows that may occur annually, ultimately discounting cash flows over time to determine their cumulative present value.

When evaluating alternative investment options, the Net Present Value (NPV) serves as an essential analytical tool Typically, the investment with the highest cumulative NPV stands out as the most appealing choice However, a significant limitation of this method is its inapplicability for comparing projects with different time horizons.

Figure 7 Net Present Value Equation

The Internal Rate of Return (IRR) and the net present value (NPV) method are closely related financial metrics While NPV calculates the present value of future cash flows using a specific discount rate, IRR identifies the discount rate that makes the cumulative net present value of a project equal to zero Essentially, IRR represents the interest rate at which an investment breaks even in terms of net present value.

NPV of all project costs would exactly equal the cumulative NPV of all project benefits if both are discounted at the internal rate of return.

In the private sector, the financial internal rate of return (FIRR) is evaluated against the company's actual cost of capital A project is deemed financially attractive when the FIRR surpasses the cost of capital, with a greater IRR indicating even higher attractiveness Conversely, if the FIRR falls below the company's cost of capital, the project is considered less desirable.

Net Present Value measures the present-value of money exclusive of inflation

The value of dollars received between 1993 and 1996 is significantly diminished compared to having those same dollars in 1993, primarily because of the potential interest that could have been earned by investing that money at the earlier date.

Where: n= number of years (1999-1993=6) f = annual interest rate, 1993-1999

The REAL (inflation-corrected) interest or discount rate (r) is:

For a project to be deemed financially attractive, its economic internal rate of return (EIRR) must exceed the social opportunity cost of capital When projects receive public sector financing, it is essential to adjust the discounted cash flow to reflect social benefits and economic distortions, such as taxes and subsidies Additionally, factors like foreign exchange earnings and employment benefits should be considered, as they contribute to the overall economic value of the project.

Figure 8 Internal Rate of Return Equation

Internal Rate of Return (IRR) is the discount rate (r) at which the net present worth

(NPW) of present and future cash flows equals zero.

Where P and F n are known, solve (by iteration) for IRR.

For uniform annual savings (D) over n years resulting from a present capital expenditure (CC): irr , n CRF

The Capital Recovery Factor (CRF) represents the relationship between uniform annual savings and the present value of a cash flow stream, serving as the minimum savings required for an investment to be deemed cost-effective.

The payback period is a fundamental metric for assessing a project's financial viability, indicating the time needed for cumulative revenues to recover the initial investment through annual cash flows Generally, a shorter payback period signifies a more appealing investment However, in development contexts, this measure may not accurately reflect the superiority of projects, particularly disadvantaging long-term initiatives like renewable energy, which often have extended gestation periods.

The Least-Cost Analysis method identifies the most cost-effective approach to achieve a specific goal, measured in non-monetary benefits For instance, when aiming to provide a village with a fixed amount of potable water, various alternatives such as wind pumping, run-of-river offtake, or impoundment are considered All associated capital and recurring costs are calculated, followed by economic adjustments and discounting of the costs for each alternative The option with the lowest Net Present Value (NPV) is deemed the most efficient and least costly solution.

Structuring Renewable Energy Projects for

Financial structuring involves distributing the risks and returns of a project among its participants, ensuring that expected returns align with the investor's risk tolerance Risk-averse investors receive lower but more secure returns, while those willing to take on more risk have the potential for higher, albeit less certain, returns Renewable energy projects can be financed through various instruments, which can be categorized into three major types.

Equity financing involves high-risk investments that anticipate significant returns, either supporting a specific project or providing funds to the company executing it Equity investors retain the right to participate in decision-making processes to safeguard their investments.

Debt financing presents a medium risk with moderate expected returns, distinguishing it from equity investments Unlike equity investors, lenders do not hold shares in the project; instead, they provide capital to earn interest Since lenders are prioritized for repayment before any distributions to shareholders, they experience lower risk compared to equity holders Consequently, the potential returns for lenders are confined to risk-adjusted market interest rates.

3 Grants.No expected returns Governmental and international organizations offer grants

(donations) to promote environmental and developmental policies. Renewable energy projects are often eligible for these funds.

Of course each of the above types of investment capital are usually combined to capitalize the initial investment.

The Power Purchase Agreement and other Instruments for Securing an Efficient Investment

While every project financing has its own special features, the basic structure is often either:

A limited or non-recourse loan, repayable out of project cash flows; or

A purchase of an interest in the project output (translated into sales proceeds) in consideration for the payment up-front of a capital sum either as a forward purchase or a production payment

A power purchase agreement (PPA) is a crucial contract that outlines the obligations of a private power producer and the power purchaser, including specific conditions such as maximum output and total electrical generation in kilowatts.

Best Practices Guide Chapter 6: Structuring RE Projects for Financing

The purchaser agrees to compensate the producer at predetermined tariff rates for 28 hours of power generation within a specified timeframe, ensuring payment whenever the facility is available and capable of producing electricity.

The Power Purchase Agreement (PPA) serves as the primary revenue source for debt repayment and investor returns, making it crucial for lenders As a result, the agreement's terms are shaped by lenders' goals to maximize revenue potential while minimizing risks A key risk to mitigate is the possibility of reduced or terminated revenue streams, regardless of the underlying causes Consequently, if the perceived risks for the power producer increase, purchasers should anticipate higher prices.

The task of establishing specific performance guarantees, future adjustments to the tariff, and penalties or bonuses for exceeding or failing to meet performance guarantees are the heart of the

PPA and usually require lengthy discussions Stakeholders in the project will include not only the purchaser, producer and lending institutions but also the construction contractor, equipment suppliers, and O&M organizations.

A Security Package encompasses a range of contractual arrangements, key agreements, and government undertakings designed to mitigate risks for lenders and investors By establishing legally binding obligations, financial structures, and operational procedures, the Security Package provides a comprehensive framework for safeguarding investments and ensuring compliance.

Lenders rely on the Security Package to ensure loan security, allowing them to take control of the company and appoint their own management if any agreements are breached The core agreements that constitute this package are essential for protecting the lender's interests.

Security Package include, among others, the following:

Equipment and fuel supply (if any) agreements

Best Practices Guide Chapter7: Assessing the Investment Risk

Assessing the Risk of Renewable Energy

Assessing the Investment Risk of Renewable

Renewable energy projects carry inherent risks for all stakeholders, including project developers, power purchasers, and lenders Typically, developers assume risks that are both foreseeable and manageable, or for which they receive appropriate compensation However, if developers cannot offer sufficient guarantees to meet lenders' requirements, lenders will look to secure government or sovereign guarantees.

The ability of all parties to understand the nature of the risk and agree on how risks are to be shared is often the key to developing a successful project.

Risks fall into several different categories The major types of risk and potential mitigation activities include:

Lenders assess the creditworthiness of all parties involved in a venture to evaluate their reliability and expertise This process often includes reviewing the track record and management skills of the parties To mitigate credit risk, borrowers may need to provide cash guarantees to contractors for engineering, procurement, and construction (EPC) contracts, ensuring financial security and trustworthiness throughout the project.

EPC contractor usually is required to submit a performance bond.

Construction and development risk refers to the possibility that borrowers and contractors may fail to complete projects on time, within specifications, and on budget Banks evaluate this risk by examining the feasibility study's methodology and assumptions To mitigate risks, measures should be implemented during pre-inspection, warranty periods, and equipment trials Large EPC contractors are invested in the efficient operation of equipment and are often willing to share risks Lenders and project owners typically require performance bonds and completion guarantees from all involved parties Additionally, project sponsors can obtain commercial insurance and export credit guarantees for equipment, while turn-key projects offer another method for sharing construction and development risks.

Operating or commercial risk encompasses the challenges posed by local and international market dynamics, including competition and access issues This risk is influenced by both physical barriers, such as transport and communication breakdowns, and commercial barriers, which involve potential buyers facing restrictions from central government authorities Additionally, the reliance on outdated technology and the integration of new advancements can significantly impact market competitiveness, particularly in the fast-evolving renewable energy sector.

Political risk primarily encompasses the confiscation, expropriation, or nationalization of project assets More broadly, it includes potential changes in the political landscape that can lead to significant commercial and financial risks.

Imposition of new taxes, tariffs, export restrictions;

Best Practices Guide Chapter7: Assessing the Investment Risk

Imposition of more stringent environmental regulations; and,

Taxes or prohibition of repatriation of profit and debt service.

Power projects face significant political risk due to their importance to national infrastructure and security To mitigate this risk, obtaining insurance from commercial providers or official agencies, including export credit departments and multilateral development banks, is essential.

Financial risk encompasses various factors such as exchange rate fluctuations, rising interest rates, increasing commodity prices, inflation, global commodity price changes, and protectionist measures like tariffs To mitigate these risks, it is essential to incorporate hedging strategies within the financial package, utilizing tools such as currency and interest rate swaps, as well as interest rate caps and floors.

Regulatory and legal risks can arise from unequal access to the legal system for foreign parties, who may face challenges such as limited court access and the non-enforceability of foreign judgments Additionally, the principles of fairness and predictability in legal proceedings may significantly differ in foreign jurisdictions compared to the United States or other investor home countries.

In recent years, all new projects, including those in renewable energy, must include an environmental impact statement that outlines compliance with environmental standards and potential fines for violations Certain industries may also be required to secure an environmental performance bond to compensate communities for any environmental breaches Additionally, companies can implement environmental monitoring programs and pursue insurance coverage for environmental hazards and accidents, which may be combined with force majeure coverage.

Force Majeure encompasses risks from natural disasters and accidents, including fires, floods, storms, and earthquakes These potential losses can typically be mitigated with commercial insurance Lenders often mandate that borrowers secure coverage for force majeure-related losses during the construction and start-up phases to ensure the debt service and fixed costs of initial loan proceeds are protected.

Understanding the specific risks associated with a project is crucial, as it allows for the implementation of effective mitigation strategies that satisfy lender requirements.

A simple tool for this purpose is a Risk Matrix, which lists, in columnar format, the:

Classification or type of risk;

Consequences for the lender; and

Best Practices Guide Chapter 8: Formulating Investment and Financial Plans

Formulating Investment and Financial Plans

An investment plan is crucial for securing a loan, as banks require it to assess the project's viability This plan aims to enhance the likelihood of success while minimizing risks by thoroughly analyzing all financial elements involved It must outline the total financial requirements, expected revenues, projected costs, and anticipated cash flows, along with clearly defined assumptions regarding the project.

An effective investment plan must be straightforward and clearly articulate the financial rationale for supporting the proposed investment, as banks prioritize financial viability Renewable energy projects often focus more on technology and environmental benefits than on their commercial potential, which can overlook the essential financial aspects required by shareholders Thus, it is crucial for the investment plan to thoroughly address key financial considerations, including the project's expected rate of return, self-financing prospects, projected cash flow, and the capital structure of both the firm and the project.

Renewable energy investment plans typically share key components, despite variations among institutions When presenting to a lender, it's essential to cover specific topics that outline the project's viability and potential returns.

Figure 11 Renewable Energy Investment Plan

Concise description of the most important aspects of the project

(e.g., partners, sponsors, investment cost, requested role of the bank, etc.)

The Sponsors The parties involved: major stakeholders in financial success, and other main parties: contractors, investors and advisors.

This analysis has to answer the question: Is there a demand for the project.s product? Long term power purchase agreements or steam off-take agreements can provide the evidence necessary.

Project Scope Description of the technical and physical aspects of the project, e.g who is the vendor, O&M aspects, is skilled staff available

Project Implementation Time schedule with responsibilities for the different tasks

Project Management Qualifications of the management (industry/project work experience)

Key regulations and permissions required Environmental issues associated with the project

Project Costs and Timetable Estimated cost of implementation and time schedule for disbursements

Financing Plan Preliminary idea about the structure of financing: who will provide how much funds.

Financial Projections Key points from the financial analysis including:

Source: Adapted from InnoTec Systemanalyse GmbH, Guide to Financing Energy Technologies in Non-

How to Approach Financing Institutions

Financing institutions recommend that potential borrowers engage with them early in a project to receive guidance on procedures and structuring options, while also staying updated on key developments throughout the project cycle.

For the initial stage, the bank will require a complete investment plan describing the project sponsors, the business and project rationale and the type of investment the project sponsor requires.

For large-scale projects, engaging a financial advisor is crucial, as they possess in-depth knowledge of the local market and regulatory environment This expert can guide the project sponsor on optimal structures and conditions while leveraging their network to secure funding from lending banks The financial advisor typically prepares an information memorandum that details the project's economic viability, including key assumptions about costs, market demand, and exchange rates, along with profiles of the project sponsors.

Technical experts play a crucial role in the project feasibility study by preparing or validating its findings Their involvement often extends beyond initial assessments, as they monitor the project's progress and ensure compliance with performance covenants and tests outlined in financial documents.

Engaging an experienced international law firm may be essential based on the complexity of the documentation and the international composition of the parties involved Project sponsors should review the legal, tax, and regulatory framework of the host country during their preliminary feasibility assessment Often, obtaining a local lawyer's opinion is a prerequisite for finalizing project documentation Involving legal experts early in the process is crucial to ensure the financing structure is effectively designed, necessary security arrangements are established, and that expected tax benefits and financial incentives are accessible.

After the Bank's Operations Committee approves the structure, project sponsors will negotiate detailed financing terms and sign a term sheet that serves as the foundation for legal documentation The Bank typically mandates an independent review of project assumptions and environmental compliance, a process commonly known as due diligence.

Successful renewable energy projects share key factors that influence their outcomes Primarily, lenders focus on the commercial viability of the project, emphasizing the importance of market analysis and a strategy that ensures local consumers are willing and able to pay for the service Additionally, assessing and mitigating risks is critical, necessitating support from governments and financial institutions, alongside guarantee and insurance arrangements with construction and operational parties A robust ownership structure is essential for effective risk management, which is further demonstrated through a comprehensive security package.

Political commitment is crucial for the success of renewable energy investments Effective energy projects thrive in environments with clear government policies and strong coordination among ministries and agencies Countries that maintain transparent procedures and minimal market intervention are more likely to see successful renewable energy initiatives Furthermore, project developers should prioritize building strong relationships with local authorities to enhance project feasibility.

Best Practices Guide Chapter 9: Financial Institutions and Programs

Financial Institutions and

Sources of equity financing include project developers, venture capitalists, equity fund investors, equipment suppliers, multilateral development banks, and institutional and individual investors.

A project developer is responsible for transforming an initial idea into a tangible project, typically by investing the necessary upfront capital By utilizing this initial investment, the project developer aims to secure a larger equity stake in the project, ensuring a significant return on investment as the project progresses from concept to completion.

Venture Capitalists.The venture capitalist specializes in investing in new companies Because venture capitalists join companies in their earliest and riskiest stages, they expect to earn unusually high returns.

Equity fund investors contribute capital to projects in exchange for equity shares, anticipating returns that are typically two or more times higher than those from debt investments However, these investors assume significant risks, as they receive distributions only after all financial and tax obligations are fulfilled.

Reliable and experienced renewable energy equipment suppliers not only construct, install, and operate renewable energy systems but also provide equipment financing options These vendors often deliver turnkey solutions and may offer favorable financing terms to enhance accessibility for their clients.

Regional Development Banks Regional development banks include the

Bank (ADB), Inter-American Development Bank (IDB) and International Finance Corporation

(IFC), and others They not only provide debt financing, but can also provide minority equity financing,

Institutional and Individual Investors.These are organizations or individuals willing to invest in projects on an equity basis expecting to earn high returns on their investments.

Key sources of debt financing include international and national commercial banks, multilateral development banks (MDBs), and the International Finance Corporation (IFC) Additional sources comprise debt/equity investment funds, equipment suppliers, and private investors Commercial banks are instrumental in syndicating debt for significant projects, thereby reducing their individual risk exposure.

Subordinated debt serves as a unique financing option that lies between traditional debt and equity Typically offered by friendly investors or project partners, this type of debt ranks below primary debt in the event of project default To compensate for the increased risk involved, subordinated debt generally carries a higher interest rate compared to standard debt instruments.

Sources of grant financing include the World Bank.s Global Environment Facility, international and bilateral agencies, foundations, and national and local agencies.

The Global Environment Facility (GEF) plays a crucial role in providing grant financing for renewable energy initiatives, with a specific focus on projects aimed at reducing greenhouse gas (GHG) emissions By targeting renewable energy projects, the GEF enhances their competitiveness compared to traditional fossil fuel energy sources Additionally, the GEF serves as the interim financial mechanism for various environmental efforts.

United Nations Framework Convention on Climate Change (UNFCCC).

International and Bilateral Development Agencies Many international and bilateral development agencies such as the United Nations Development Programme (UNDP), the

Netherlands Ministry of Development Cooperation (DGIS), Danish Development Assistance

Agency (DANIDA), etc., can and do provide grant assistance for renewable energy projects.

Foundations A number of philanthropic agencies such as the Ford

Rockefeller Foundation have, on occasion, provided grant funds for renewable energy projects in order to demonstrate environmental and social benefits.

National and local agencies play a crucial role in supporting renewable energy projects in various countries, with India serving as a prime example The country has established a national Ministry for Non-Conventional Energy Sources (MNES) alongside State Renewable Energy agencies, facilitating the development and implementation of sustainable energy initiatives.

Figures 12 and 13 summarize the major types of investment services provide by multilateral development agencies and private sector investors, respectively.

Figure 12 Multilateral Development Agency Support for Renewable Energy Projects

Figure 13 Private Sector Investor Support for Renewable Energy Projects

New Agencies and Institutions Supporting Renewable Energy Project Finance

In recent years, various multilateral, bilateral, and private sector initiatives have been launched to promote investments in renewable energy projects Multilateral development banks (MDBs) recognize the importance of shifting energy sector investments towards sustainable development A notable example is the World Bank's Asia Alternative Energy Unit (ASTAE), which focuses exclusively on renewable energy and energy efficiency projects Since its establishment, ASTAE has significantly contributed to the World Bank's lending efforts in this sector.

US$500 million for renewable energy projects in the Asia region The International Finance

Corporation (IFC) has recently launched a US$I00 million Renewable Energy and Energy

Efficiency Fund (REEF) which is designed to invest in private sector projects. The Asian

Development Bank recently approved a US$100 million loan to the IndianRenewable Energy

Development Agency (IREDA) for biomass cogeneration projects in India. These and other examples suggest that the MDBs are increasing their level of financial support for renewable energy projects.

Bilateral development institutions have increasingly backed renewable energy initiatives in developing countries due to their significant social and environmental advantages Recently, various bilateral agencies have intensified their support for these projects, aligning with programs that offer global environmental benefits Furthermore, investments in renewable energy can be facilitated under the UNFCCC mandate for Jointly Implemented Activities.

(AJI) projects A number of bilateral agencies, including those in the United States, the

Netherlands, Canada, Japan, Norway and Germany have initiated active AJI programs that include support for renewable energy projects.

Best Practices Guide Chapter 10: Renewable Energy and the Global Environment

Implications of Renewable Energy for the Global

Implications of Renewable Energy for the

Renewable Energy Technologies and Greenhouse Gas Abatement Strategies

In 1992, over 155 countries signed the United Nations Framework Convention on Climate

Change (UNFCCC) at the United Nations Conference on Environment and Development.the

The Rio Earth Summit established a crucial objective aimed at stabilizing greenhouse gas concentrations in the atmosphere According to Article 2 of the Convention, this goal is to prevent dangerous human-induced interference with the climate system, ensuring a sustainable future for the planet.

To achieve the UNFCCC's main goal, signatory countries must create action plans aimed at reducing greenhouse gas (GHG) emissions The energy sector is a significant contributor to anthropogenic GHGs, particularly carbon dioxide (CO2) and methane (CH4) Therefore, implementing the UNFCCC necessitates adjustments in the energy mix and production methods within these nations Renewable energy technologies are essential in this new energy framework, as they offer low or zero GHG emissions.

Research and development of renewable energy technologies began in the 1970s, primarily aimed at replacing fossil fuels, which were anticipated to become scarce Although fossil fuel prices did not significantly hinder global economic growth, the urgent need to address rising greenhouse gas emissions and their effects on climate change has become a crucial driving force for transitioning away from fossil fuel power generation By widely adopting renewable energy technologies, we can significantly reduce greenhouse gas emissions and work towards a more sustainable energy future.

The UNFCCC highlights that implementing commercially viable renewable energy technologies can lead to a reduction in greenhouse gas emissions without incurring higher economic costs compared to traditional systems In cases where these technologies are not yet cost-competitive, further advancements are necessary to enhance their economic viability.

The Kyoto Protocol has implemented flexible mechanisms designed to help achieve emissions targets, enhancing the financial viability of renewable energy investments and facilitating the funding of projects that offset carbon emissions.

New Opportunities using Flexible Financing Mechanisms

The energy sectors of developing countries are projected to see the most significant increase in greenhouse gas (GHG) emissions, primarily because these nations currently exhibit low energy consumption levels compared to their per capita GDP As these countries focus on boosting their per capita GDP through development plans, a corresponding rise in per capita energy consumption is almost unavoidable.

Best Practices Guide Chapter 10: Renewable Energy and the Global Environment

As global consumption rises, greenhouse gas emissions from developing countries are projected to exceed those of OECD countries in the near future The Kyoto Protocol, part of the United Nations Framework, incorporates three flexible mechanisms to address these emissions.

Convention on Climate Change (UNFCCC) to assist in meeting the emissions targets articulated in the Protocol: Joint Implementation (JI), Emissions Trading, and the Clean Development

Joint Implementation enables Annex I parties of the UNFCCC to collaboratively meet their emissions reduction targets set by the Kyoto Protocol These Annex I parties, which include industrialized nations and economies in transition, can engage in emissions trading to buy and sell greenhouse gas (GHG) emissions allowances, facilitating compliance with their targets Additionally, the Clean Development Mechanism (CDM) allows Annex I countries to partner with non-Annex I countries on projects that promote sustainable development and lower GHG emissions The emission reduction credits generated from these CDM projects can be utilized by Annex I nations to achieve their emissions limitation goals.

JI procedures and the CDM may be utilized to support the financing of qualifying renewable energy projects that will be implemented in developing countries and economies in transition.

The mechanisms can provide technical as well as financial assistance. However, the rules and modalities that will govern these flexible mechanisms are still under discussion and negotiation.

They are not expected to be operational for several years.

Best Practices Guide Annex: Participant Case Study Exercise

Preliminary Design and Financial Analysis for an Off- Grid Rural

Electricity Supply Project Using Renewable Energy

This exercise offers practical training in the design and financial assessment of typical renewable energy projects, while also allowing for the evaluation of associated environmental considerations.

Renewable energy presents significant opportunities for enhancing rural social and economic development, particularly in off-grid communities This initiative aims to design and analyze the financial aspects of an off-grid rural energy supply project, aligning with the commitments of various national and provincial governments to expand rural electrification programs The project will utilize key technical parameters and cost data, encouraging readers to leverage insights from similar past initiatives while recognizing the innovative approach of using renewable energy technologies for providing essential electricity services to rural areas Assumptions regarding the business model and its financial implications will be necessary for effective implementation.

In developing countries, off-grid electrification presents a significant opportunity for practical renewable energy applications, utilizing technologies such as solar photovoltaic (PV), small hydro, and small wind power These renewable options often emerge as the most cost-effective solutions for remote areas, outperforming conventional small diesel generators, which are typically more economical only in centralized systems with concentrated loads Additionally, favorable wind or hydro resources can render small wind, micro hydro, or hybrid systems competitively priced over their lifecycle Furthermore, many communities face challenges in effectively operating and maintaining diesel generators, making renewable alternatives a more viable choice.

Household lighting represents the most significant potential for off-grid energy use, comprising numerous small and widely scattered individual loads Solar home systems (SHS) can effectively meet these lighting needs, making them an ideal solution for off-grid households.

Even in large-scale projects serving thousands of households, the generating capacity remains minimal compared to traditional power initiatives The implementation of off-grid projects is driven by public policy aimed at providing basic electricity services to underserved populations unlikely to receive grid connections soon While some unelectrified communities can benefit from grid expansion, many are too remote, making decentralized power systems—such as diesel, renewable energy, and hybrid solutions—more appropriate for their needs.

Best Practices Guide Annex: Participant Case Study Exercise

The project outlined here represents the first stage of a comprehensive investment initiative aimed at reaching 1,000 off-grid communities where extending the electrical grid is impractical Each community's market potential is carefully evaluated to ensure effective investment and sustainable growth.

1 Households, mainly for lighting - about 200 households on average

2 Public service centers - one school and one health clinic per community

3 Economically productive applications - two per community, each requiring 1.0 kWe on average.

Many communities have additional service needs, such as water supply, public lighting, and telecommunications, all of which require electricity Furthermore, there are often multiple economically productive applications within these communities that could greatly benefit from a renewable energy-based electricity supply.

Calculate: At 100% market penetration the project will cover a total of

public service centers, and 2,000 economically productive applications.

Tiêu đề	Economic & Financial Evaluation of Renewable Energy Projects
Tác giả	Gene Owens
Trường học	Institute of International Education
Chuyên ngành	Alternative Energy Development
Thể loại	best practices guide
Năm xuất bản	2002
Thành phố	Washington, DC

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Số trang	55
Dung lượng	261 KB