Power Generation Financial Modelling & Analysis: A Practical Guide Power Generation Financial Modelling & Analysis: A Practical Guide David Whittaker E U R O M O N E Y B O O K S Published by Euromoney Institutional Investor PLC Nestor House, Playhouse Yard London EC4V 5EX United Kingdom Tel: +44 (0)20 7779 8999 or USA 11 800 437 9997 Fax: +44 (0)20 7779 8300 www.euromoneybooks.com E-mail: hotline@euromoneyplc.com Copyright © 2013 Euromoney Institutional Investor PLC ISBN 978 78137 175 This publication is not included in the CLA Licence and must not be copied without the permission of the publisher All rights reserved No part of this publication may be reproduced or used in any form (graphic, electronic or mechanical, including photocopying, recording, taping or information storage and retrieval systems) without permission by the publisher This publication is designed to provide accurate and authoritative information with regard to the subject matter covered In the preparation of this book, every effort has been made to offer the most current, correct and clearly expressed information possible The materials presented in this publication are for informational purposes only They reflect the subjective views of authors and contributors and not necessarily represent current or past practices or beliefs of any organisation In this publication, none of the contributors, their past or present employers, the editor or the publisher is engaged in rendering accounting, business, financial, investment, legal, tax or other professional advice or services whatsoever and is not liable for any losses, financial or otherwise, associated with adopting any ideas, approaches or frameworks contained in this book If investment advice or other expert assistance is required, the individual services of a competent professional should be sought The views expressed in this book are the views of the authors and contributors alone and not reflect the views of Euromoney Institutional Investor PLC The authors and contributors alone are responsible for accuracy of content Note: Electronic books are not to be copied, forwarded or resold No alterations, additions or other modifications are to be made to the digital content Use is for purchaser’s sole use Permission must be sought from the publisher with regard to any content from this publication that the purchaser wishes to reproduce (books@euromoneyplc.com) Libraries and booksellers and ebook distributors must obtain a licence from the publishers (books@euromoneyplc.com) If there is found to be misuse or activity in contravention of this clause action will be brought by the publisher and damages will be pursued Typeset by Phoenix Photosetting, Chatham, Kent Contents Acknowledgementsix About the author xi 1 Introduction Background to the world market 3 Energy units of measure and calculations Installed capacity Annual capacity factor Fuel costs Operations and maintenance costs Capital costs and plant life Building the power generation option appraisal financial model 13 Financial modelling best practice 13 Scope18 Designing the financial model 18 Layout18 Layout exercise 19 Timeline19 Timeline exercise 20 Monthly calculations 20 Monthly calculations exercise 22 Monthly cash flow 22 Monthly cash flow exercise 23 Annual corporation tax 23 Annual corporation tax exercise 23 Annual cash flow 24 Annual cash flow exercise 24 Summary24 Summary exercise 24 Finalising the existing option appraisal financial model 24 Exercise finalising the existing option appraisal financial model 28 Sources of error 28 Self testing the financial model 28 Top level analytical review 28 Key output review 30 Flex and sensitivity review 31 Exercise self testing the financial model 31 10 10 10 10 11 v Contents Using the model 31 Disclaimers32 Power generation projects 33 Natural gas combined cycle gas turbine 33 Coal fired 37 Energy from waste 41 Solar thermal 44 Hydroelectricity48 Tidal power 52 Geothermal55 Wind farms: onshore 58 Wind farms: offshore 62 Funding options for the power generation sector 65 Project finance as a source of funding 65 Financial modelling best practice 66 Designing the financial model 70 Layout70 Layout exercise 72 Timeline72 Timeline exercise 73 Construction73 Construction cost exercise 73 Financing73 Financing exercise 78 Tariff receipts 78 Tariff receipts exercise 79 Operating costs 79 Operating costs exercise 80 Working capital 80 Working capital exercise 83 Accounting84 Fixed asset accounting 84 Borrowing costs 84 Interest during construction and bid costs 84 Accounting exercise 85 Taxation85 Taxation exercise 85 Dividends86 Dividends exercise 86 Profit and loss account 87 Profit and loss exercise 87 vi Contents Cash flow 87 Cash flow reforecast exercise 88 Balance sheet 88 Balance sheet reforecast exercise 88 Checks89 Checks exercise 89 Sensitivities89 Sensitivity exercise 92 Checks92 Checks exercise 92 IRRs93 IRRs exercise 94 Lenders’ ratios 94 Lenders’ ratio exercise 95 Summary95 Summary exercise 95 Optimising the tariff 95 Energy tariff optimisation exercise 97 Sensitivity logic 97 Sensitivity exercise 100 Debt sculpting 100 Debt sculpting exercise 106 Sources of error 106 Self testing the model 106 Top level analytical review 107 Key output review 107 Flex and sensitivity review 107 Limited scope financial model reviews 107 Design review 108 Analytical review 109 Degree of integration and reconciliation of financial statement forecasts 109 Flex testing and sensitivity review 109 Parallel or shadow modelling 110 Macro review 110 Exercise self testing your project finance model 111 Using the model 111 Private equity as a source of funds 111 Using Excel VBA An introduction to Excel VBA Protect functionality Unprotect functionality Menu functionality Auto open functionality 115 115 118 119 119 123 vii Contents Auto close functionality Using a timeout facility for demo financial models Unhide sheets Hide sheets Exercise Excel VBA 123 124 126 127 127 Reviewing and auditing power generation financial models 129 Scoping133 Work plan 168 Coding review 170 Analytical review 173 Data book and legal documentation 173 Tax173 Accounting173 Review comments 173 Iterations and base case clearance process 173 Sensitivities174 Second senior review 174 Partner sign off 174 Financial modelling management issues 175 Project managing financial modelling projects 175 Exercise176 The use of template and generic financial models 176 Exercise generic and template financial models 176 10 Approaches to risk Data tables Scenario manager Goal seek Custom scenarios Risk exercise 11 Conclusion 177 177 177 178 178 179 181 Glossary183 viii Acknowledgements I would like to dedicate this book to my family In particular, my daughter Daniella Whittaker who at the time of writing this book has completed her first year at school and is developing her reading, writing and arithmetical skills at a great level of advancement I look forward to the day when she can fully appreciate my books ix Power Generation Financial Modelling & Analysis: A Practical Guide Exercise For the energy sector finance model project that you have undergone during the course of this book prepare a task related timeline which will allow you to manage a more junior modeller and remain in control of the deliverable The use of template and generic financial models A template financial model is a basic structure or financial model structure where the logic is later added to make the financial model project specific It has all the bare bones like the timeline, sheet names and the more basic calculations The advantage that a template financial model has is that it is enough to give a quick start It is easy to understand and can be tailored to specific project requirements You not have to build the core components from scratch For the template to be leveraged on a number of jobs, it needs to be well designed and well implemented There is an added disadvantage in that upfront costs are required, but if the template is used for enough projects then the payback is obviously achieved A generic financial model is where the model is all things to all men The financial modeller will add all the functionality which can possibly be encountered Indeed, in our opinion it is about getting a sensible and required balance It is defined as an all-inclusive financial model that seeks to have as much functionality or logic to cater for almost all possible logic requirements If you strike the balance correctly, you will get a quicker start than a template and you can significantly reduce the development time taken from the template financial model approach The disadvantage of trying to be all things to all men, means that the financial model can become too complex, too large and too slow to calculate Excel has its limits Models greater than 80 megabytes will be slow Generic models can be error prone and high risk If the model is audited once or twice for a few projects by different companies you will be looking at high model audit fees due to the need to look at the whole model before providing an opinion In order for a generic financial model to be successful, the model needs to be well designed and well implemented using an FMBP type approach The costs upfront will be significantly more than a template model and consequently a higher project volume is required for the generic model to be a worthwhile investment The author’s personal advice is to try to steer away from a generic financial model and he would encourage the adoption of a template financial model where there is a possibility Exercise generic and template financial models For the energy sector finance model that you have built during the course of this book draw a half page list – one side listing a generic model’s features and the other side listing a template energy sector finance model Try to consider eliminating parts to find a value added template model If you can crack this area, it will really help you and your organisation’s financial modelling productivity You could even go on to adjust your final energy sector finance model built to date to reflect your new optimum functionality 176 Section 10 Approaches to risk There are certain approaches that can be taken to measure financial and business risk that can be undertaken in an Excel modelling environment for energy projects In this section we will discuss the various approaches to risk that can be taken Data tables This is a method in Excel that shows a combination of results for a key output of a combination of variable or input changes In summary, a data table is simply a range of cells that shows the results of substituting different values into the logic of the financial model The limitation of this technique for risk analysis is that you can only have a or variable data table at the most Examples of the use of data tables can be seen in Illustration 90 (see Illustration90.xlsx), where we have used our generation option analysis model as a basis for demonstrating the usefulness of data table analysis In ranges AL6 to BF18, we have calculated input data tables for each of the major variables or input assumptions, showing the effect around the base variable with a plus or minus 10% increment to either side The variables tested against the net present value (NPV) Looking at AN8, we can see a data table inserted for the megawatt (mW) installed assumptions You will notice in row 13 the base case NPV results in all cases, a great check Scenario manager Excel’s scenario manager allows us to create multiple scenarios in order to measure risk for a variety of outcomes with ease Illustration 91 (see Illustration91.xlsx) provides us with an example of two defined scenarios as follows • Scenario looks at the effect of a forced outage percentage of 15% and a variable operations and maintenance (O&M) rate increase of 10% per megawatt-hour (mWh) on payback, payback months, NPV and internal rate of return (IRR) • Scenario looks at the effect of a forced outage percentage of 15% and unavailable capacity rate of 20% per annum on payback, payback months, NPV and IRR In order to implement the scenarios we must always ensure that the key outputs that we want to run the scenario against are in the same sheet as the inputs that are being changed for the specific scenario In order to set up a scenario in Excel 2007 to 2013 you simply select the ribbons in the following order: Data, What Ifs, and Scenario Manager 177 Power Generation Financial Modelling & Analysis: A Practical Guide You select Add to enter the scenario name, the cells to change and enter the description in the comments box We recommend that all of the inputs used for your scenario planning are given a logical range name which is similar to the labels of the input variable or the key output The Summary button is selected in order to produce the scenario report as in the Scenario Summary sheet in the financial modelling example The advantages of using the scenario manager for risk analysis can be summarised as follows • We can run and store a vast number of scenarios with ease that can be seen at any time • It prompts the financial modeller to define and document the scenario The disadvantages of using the scenario manager for risk analysis can be summarised as follows • The outputs to run the scenario against must be performed on the same worksheet as the original inputs that need to change This is not compliant with recognised best practice financial model design standards of keeping a separation between inputs, calculations and outputs • We cannot see the underlying schedules that support the key outputs, that is, the cash flow forecasts, which would be useful to review for reasonableness using analytical review techniques Goal seek Excel’s goal seek formula allows the financial modeller to work backwards to find a desired result This is useful in a decision making or negotiating scenario In order to run a goal seek in Excel 2007 to 2013 you simply select the ribbons in the following order: Data, What Ifs, and Goal Seek You simply set the target to the required value by changing a defined assumption Illustration 92 (see Illustration92.xlsx) provides us with an example of a goal seek decision making scenario: • to achieve a target IRR of 20% what must the tariff per kilowatt-hour (kWh) be? In order to run the goal seek for the above, you simply target the IRR (see AJ152 of the Assumptions sheet) to equal 20% by changing the value in the cell B128 of the Assumptions sheet Custom scenarios You may have noted above that the scenario manager is indeed limited and only allows you to see the effect on the key outputs In order to allow us to see the effect on the cash flow forecasts (and indeed the other output schedules in your financial model) we can use the 178 Approaches to risk custom approach to scenarios The custom approach to scenarios can be seen in Illustration 93 (see Illustration93.xlsx) Turning our attention to the Scenarios sheet of the illustration we can see that we have set up some input assumptions for two variants or scenarios that differ from the base case The low case is outlined with ability to vary the fuel purchase price, variable O&M, fixed O&M and the economic useful life The high case is outlined with ability to vary the fuel purchase price, variable O&M, fixed O&M and the economic useful life In order to activate or select the scenario, a dropdown box has been added to allow us to switch between cases and see the results However, for those of you who are not familiar with how to set up dropdown boxes in Excel here are the guidelines From the Excel ribbon in Excel 2007 to 2010 select Data, then select Data Validation, and then select Validation Criteria Allow list Select the required list of labels for selection, that is, High, Medium or Low At the top of each sheet in the financial model it is advisable to show the name of the case run This can be seen in cell A3 of the Monthly cash flow sheet In order to implement the logic for each scenario when the dropdown box option is selected it is necessary to add the logic to trigger the scenario This can be seen in the Assumptions sheet For example, if we look at cell AI27 we can see two “*IF” statements added after the original formula for this and the other three variables affected The percentages are applied when the high or low case is selected It is important to note that the base case results and inputs are maintained when we switch between base case and the low case, and vice versa Risk exercise Based upon the option appraisal financial model built to date, add functionality using the data tables Use the goal seek functionality to see what tariff per kWh is required to achieve a 30% IRR After completing this, please set up the two custom scenarios by changing four variables as in the example above for both a high and low case 179 Section 11 Conclusion We have outlined the potential of power generation opportunities around the world We are likely to experience a growth market both in fossil fuels and renewable energy sources We can see the massive potential in emerging markets due to the lack of infrastructure and likely population growth rates Using the various energy sources and funding options, it is possible to exploit such opportunities It is possible to make informed and risk minimised financial decisions based upon the techniques and analysis demonstrated in this book Of course, if the reader undertakes each exercise it will improve both their financial analysis and modelling skills, thus allowing them to add greater value to the decision-making capability for power generation financial transactions and decisions in an organisation The author would like to take this opportunity to wish you every success in deploying such techniques to maximise the potential of power generation business opportunities by leveraging the new financial modelling and analysis skills that this book brings you 181 Glossary ADSCR Annual DSCR (see DSCR) Availability Availability represents the percentage of the year that the plant is in full working order Anaerobic digestion This is the process whereby bacteria is broken down into organic material which is decomposed to make biogas The raw materials used are often waste crops and farm produce Air source heat pumps These are typically used for domestic heating purposes This is a device that transfers heat from the outside to the inside of a building Base load This is the basic constant level of load required for a power plant’s operations Bid costs The upfront costs incurred in the process of bidding for a public private partnership (PPP) contract Bio energy This is a renewable energy source This may be straw, manure, wood, sugar cane and other agricultural by-products Bio diesel This is for use in standard diesel engines It is made from animal fat or vegetable oil BTUs This stands for British Thermal Units It is a unit of energy equal to about 1,055 joules Capacity factor The annual capacity factor is the total electricity generated to the maximum limit that it could produce if operating for 24 hours per day and 365 days per year Calorific value This is a measure of the amount of energy released from the fuel This is usually expressed as units of kCal/kg or mJ/kg Capital investment An investment in long term assets which usually has a life of more than a year, for example, plant and equipment, land and buildings Cash flow Cash flow is a very important area of corporate finance as it is effectively a lifeline for business as it has a major bearing upon the ability to pay and stay liquid and even solvent Combined heat and power The use of a power station to generate both electricity and heat Commitment fee This is a lender’s fee that is based upon a percentage of the undrawn and committed facility amount Community heating systems This is a heating system which has a single source of heat delivery through a network of pipelines to consumers Coal gas This is a flammable fuel made by the distillation of coal Carbon dioxide This is an emission that is often given off through power generation, that is, sulphur or carbon dioxide Combined cycle gas turbine This is a combination of a gas fired turbine and a steam turbine This is often a very efficient combination DBFO Design, build, finance and operate A contract whereby one company undertakes a contract to perform these things for the length of the concession, often 25 or 30 years 183 Glossary Debt service The amount of debt interest and the principal repayments Debt service reserve account The cash required to be held to service future senior lenders’ debt service obligations Design and build contract A contract where a supplier is responsible for designing and constructing an asset District heating This is a heating system which has a single source of heat delivery through a network of pipelines to consumers in a certain district Debt to equity ratio This is the amount of long-term debt expressed as a ratio of the total debt and equity for a company Decommissioning costs This is the cost of removing plant at the end of its economic useful life This is undertaken for nuclear plants and is costly Department of Energy & Climate Change A UK government agency that works to ensure there is clean, secure and affordable energy available Discount rate The interest rate used in calculating the net present value of expected future cash flows DSCR (debt service cover ratio) The ratio of cash available for debt service to the actual debt service Duration curve This is a graph that shows the demand for energy over time in both hours of the day and times of the year Electricity generation This is the process of generating electrical power from sources of primary energy Equity (share/pure) The ownership interest in the special purpose company in the form of shareholder funds invested by the private sector company(ies), typically 5% to 10% of the total funding required Interest is not earned on share equity (as opposed to subordinated debt) Exploration wells These are used when drilling for both gas and thermal heat from the earth Facilities management Management of services relating to the operation of a building Typically includes such activities as maintenance, security, catering and external and internal cleaning Financial close (FC) The point at which all contracts are signed by all parties involved in a project Financial incentives There are various financial incentives offered by governments to generators of renewable energy sources In the UK, these are in the form of renewable energy certificates, renewable heat incentives and feed in tariffs Flue gases This is a gas that exits into the atmosphere via a flue, for example, from a boiler or steam turbine Forced outages The hours whereby a power plant is not operational due to breakdowns rather than a planned maintenance program Fossil fuels This is oil, coal and gas that come from the natural fossilisation process over centuries Funding requirement The amount of long-term funding in terms of debt or equity required for the construction phase 184 Glossary Feed in tariffs These are offered as financial incentives by governments In the UK these are applicable for renewable energy projects up to mW GAAP Generally accepted accounting principles Geothermal This is a source of energy which is extracted from the thermal properties of the earth Gigawatts A gigawatt is equal to one billion watts Ground source heat pumps These are pipes buried in the ground that extract heat from the ground Hydroelectricity This is electricity generated by the use of gravitational force of falling or flowing water IAS International Accounting Standards, for reporting of accounts to enable common standards between countries The European Union requires all companies listed on a stock exchange in an EU country to comply with IAS Interest during construction The amount of interest accrued on funding the construction phase IFRS International Finance Reporting Standards Installed capacity Installed capacity represents the maximum power output of a power plant output usually expressed in megawatts (mW) or kilowatts (kW) IRR This relates to a discounted cash flow technique which finds the discount rate where the net present value (NPV) equals zero Thus the name, internal rate of return The IRR is a result that arises from a series of cash flows which can be compared with the weighted average cost of capital (WACC), that is, where the IRR is greater than the WACC then accept as the NPV is likely to add to the company valuation Joules This is a measurement of the amount of work done by applying force One watt per second equals one joule One kilowatt-hour has 3,600 seconds, that is, 60 minutes in an hour and each minute has 60 seconds kWh equals 3,600 kJ Kilowatt A unit of power equal to 1,000 watts Levelised costs This is a comparative metric that calculates the average cost over the economic useful life of the plant per mWh of electricity Libid An acronym which represents an interest rate which stands for London Inter Bank Bid Rate This is the interest rate at which banks bid for funds in the euro market Libor An acronym which represents an interest rate which stands for London Inter Bank Offer Rate This is the interest rate at which banks will lend funds to each other at different maturities Liquidity A measure of a company’s holding of cash or cash equivalents LLCR Loan life cover ratio; the ratio of the net present value of cash available for debt service during the term of the senior debt to the outstanding balance of the senior debt 185 Glossary Loan stock (or subordinated debt) Also termed equity, different from share/pure equity A loan from shareholders to the special purpose company Interest is earned on the loan and paid to the shareholders Maintenance reserve account The cash required to be held to service future life cycle obligations M&E Mechanical and engineering work Megawatt A megawatt is equal to 1,000 watts Megajoule This is one million joules National grid This is a distribution network for transmitting electricity Net present value (NPV) The discounted value of a series of future costs, benefits or payments, that is, the value of future cash flows in today’s money Nuclear energy This is energy created through radioactive decay processes Offshore wind energy This is a collection of wind farms in water used to generate electricity from wind Onshore wind energy This is a collection of wind farms located on the land used to generate electricity from wind Photovoltaic This is a process of electricity generation where solar radiation is captured through photovoltaic cells Private equity This is the investment of funds in a private limited company by an investment company The private equity company assists with the company’s growth and has a planned exit date Refinancing The process by which the terms of the finance put in place at the outset of a private finance initiative (PFI) contract are later changed through negotiation with the senior lenders, to create refinancing benefits for the shareholders and public sector authority, for example, improved interest rates and repayment terms Renewable heat incentive These are UK financial incentives credited to operators for using renewable energy sources Renewable Obligation Certificate (ROC) This is the main mechanism for promoting largescale generation of electricity in the UK It was introduced in 2002 Electricity suppliers present renewable obligations certificates to Ofgem in the UK ROCs are paid for each unit of eligible output at a rate of a megawatt hour Renewable energy These are sources of energy that are naturally and continuously replenished These sources include: wind, rain, tides, sun, wave and geothermal Risk transfer The passing of risk under contract from one party to another Senior debt The major funding component (typically 90% of the funds required for construction, and so on) provided by banks or bonds It has priority of repayment over other funding sources Sensitivity The flexing of key assumptions and evaluating the effect upon key output measures 186 Glossary Special purpose company (SPC) or vehicle (SPV) A company especially established to carry out the contract, owned by its shareholders, the providers of equity finance for the scheme Subordinated debt (or sub-debt) See Loan stock Can also be a form of debt that has lower priority for repayment than the senior debt – alternatively called junior debt (Note: junior debt is not the same as loan stock, but loan stock may be called subordinated debt.) Sustainable energy These are sources of energy that are from renewable energy sources and technologies that seek to improve energy efficiency Steam turbines This is equipment that extracts thermal energy from steam which is used to rotate an output shaft Transmission This is the transfer of electrical power from the generating plants to electrical substations to the point close to demand Terawatts The terawatt is equal to one trillion watts, that is, 10^12 UK GAAP The overall body of regulation establishing how company accounts must be prepared in the UK This includes not only accounting standards, but also UK company law WACC (weighted average cost of capital) The weighted average cost of capital is a method of calculating the required rate of return based upon a company’s capital structure and the cost of capital for both debt and equity is weighted in order to find a discount rate for capital investment purposes Watt This is a unit of power named after the Scottish engineer, James 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www.euromoneybooks.com Email: books@euromoneyplc.com Telephone: +44 20 7779 8999 ... shall now look at the important variables and drivers involved in power plant economics or financial analysis Power Generation Financial Modelling & Analysis: A Practical Guide Installed capacity.. .Power Generation Financial Modelling & Analysis: A Practical Guide Power Generation Financial Modelling & Analysis: A Practical Guide David Whittaker E U R O M O N E Y... Source: Author’s own 13 Power Generation Financial Modelling & Analysis: A Practical Guide A structured approach which should ideally be adopted is often referred to as financial modelling best practice’