exam notes wind energy economics

7/28/2019 Exam Notes Wind Energy Economics

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AEP= Annual Energy Production, PPA= Power Purchase Agreement, FIT= Feed In Tariff

NPV= Net Present Value, CF= Cash Flow, IRR= Internal Rate of Return, ECF= Equity Cash Flow,

rE= Return on Equity, FCF= Free Cash Flow, WACC= Weighted Average Cost of Capital

DSRA= Debt Service Reserve Account, ARR= Accounting Rate of Return, PI= Profitability index,

PTC= Production Tax Credits, EPC= Engineering Procurement Construction, CAPM= capital asset

pricing model,DSCR= Debt Service Cover Ratio, EBIT= Earnings Before Interest and Taxes.

Leverage= influence/control.Abstinence=moderation/self discip.

1. Wind project value chainFive stagesi) Site Development

Wind Survey: Identifying areas (anemometers), Mapping (land owners), Inspection or Study of

viability of the site (available power transmission)

Site Acquisition: Buying or renting the site for the new wind farm project (Establishing

relationship with landowners)Permitting: The new site needs to be suitable and the most convenient for the developers

(limitations for the wind turbine height), the project needs the approvals (local government,

environmental groups), regulations and authorizations by the government.

Environmental Assessment: Estimation of the environmental impact which will be produced by

the WF.

ii) Financing

Business Planning: Development stage, construction & installation stage and Operation stage.

Financial Engineering: Investment decisions, financial methods and financial risks.

Debt and Equity: Debt (Credits, interest, fixed contracts) & Equity (Investors-risk capital, no fixed

payments and interests)Contract Negotiation: Landowners, Banks, Investors, Equipment warranties, Contractors etc.

iii) Construction

Turbine Purchasing: Chosing the most suitable turbines for the project (equipment warranties,

following regulations of the site)

Cabling: Appropriate cables according to the generated power of WF.

Grid Connection: interconnection and transmission to transmission operators (substations)

Turn-key Installation: Layout of WF, road access, grid connection, fundation works, comissioning.

iv) Operation and Maintainance

SPV: Special Purpose Vehicle (Independent legal entity)Some of the targets of SPV: Operation, Condition-Monitoring and Maintenance. The operation

and maintenance of a WF is often outsourced to a third party. Technical Service Provider

company is in charge of O & M.

v) Wind Farm ownership

Management of Asset Portfolio.- maximising returns from a windfarm investment, minimize risk

for a given level of expected return, by carefully choosing the proportions of various assets.

Administration is set by the ownership and the management has to accomplish desired goals and

objectives using available resources efficiently and effectively.


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2. Feed In Tariff (Advantages, Disadvantages)It is a Promotion system (incentive) for renewable energy generation. It offers a

guarantee of: Payments, /kWh, access to the grid, stable and long-term contract. FIT

rate is classified based on technology type and project size.

Advantages:

Provide investors and developers certainty.

Job creation.

Promote renewable electricity generation.

Renewable energy development.

Diversify energy supply.

GHG, pollution reduction

Disadvantages: Increase the average electricity bill. Lack of cost/price efficiency.

Incompatible with a competitive market.

FIT in Germany: Onshore wind projects highest contributors (36.6%) of renewable

electricity to the grid. But the tariff for wind is the lowest of all renewable technologies,

regardless of size of installation.

FIT design is based on electricity generation costs and avoided external costs (all those

costs that would have occurred if the same power was produced from conventional

plants).

Quota Systems (Advan, Disadvan.) It is a system in which electricity companies are obliged to purchase a proportion (quota)

of the electricity they sell from renewable sources. This proportion will be set up by the

government. The electricity supplier passes the extra cost on to the end consumers. The

system uses green certificates which are tradable.

Electricity supplier has to prove that a certain quota of the sold electricity has been

derived from renewable energy sources. Evidence is provided through a presentation of

green certificates. They are allocated to the supplier for produced green power or

can be purchased at the certificate-market. If this obligation is not fulfilled, the supplier

has to pay a penalty fee. The more adjustments made to a quota system, the more it

looks like a Feed in Tariff (FIT) regime.

Advantages: Policy makers set the target they would like to achieve. -Price and

support determined by market forces.

Disadvantages: -Every subsequent increase in the quota could be subject of intensecontroversy. -Benefit only the most cost-effective technology. -Relatively new

technologies (like PV compared with Wind energy) are left behind because

investment is in the most cost effective technology. -Borrowing of certificates.

Note: From 2002-2010, the FIT system resulted in 3.9 times more installed capacity

Germany than the Quota system did in the UK.

Production Tax Credits (PTC) (Advantages, Disadvantages) lookup further!The production tax credit (PTC) is a per-kilowatt-hour tax credit for electricity generated

from energy resources and sold.

OR An income tax credit of 2.2 cent per kilowatt hour for the production of electricityfrom utility scale turbines


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Advantages: -It is an effective policy tool to help developers to raise capital in the

marketplace complete financing of wind projects and completion of these projects. -

Due to continuity of PTC period from last several years, there is average annual

growth of 35% in wind industry.

Disadvantages: not a long term policy, it has not been sufficient in providing

consistency and market certainty.

3. CDM machenism: definition, advantages/disadvantages Lookup further!Definition: It is a mechanism that allow Annex I countries (developed countries) to meet

their GHG emission limitations by purchasing Certified Emission Reductions Credits from

elsewhere, through projects that reduce emissions in non-Annex I countries (developing

countries). It is defined in the Kyoto Protocol as one of the flexibility mechanisms.

Note: In the Kyoto Protocol, all Annex I countries (including the US) collectively agreed to

reduce their greenhouse gas emissions by 5.2% on average for the period 2008-2012.

Concept: It will be cheaper to reduce one unit of GHG in developing country compared to

developed country; therefore developing country will implement cheap GHG emission

reduction projects in developing country and earn the CERs (Certified Emission Reduction

Credits) from CDMs.

Advantages: -Developed countries can get CERs to meet their own CO2 emission target

at home with lower investment. - Developing countries can get foreign investment and

technologies; the clean energy sector will also generate employment.

Three Criterion for a CDM project: i) It must be a Sustainable Development Project.ii)The emission reductions must be real and additional: You must prove the project reduces

emissions more than it would have occurred in the absence of the project. You must

overcome barriers. For example investment and technological barriers. Or without CDM the

project cant be implemented. The baseline emissions are the emissions that are predicted

to occur in the absence of a particular CDM project. So (Baseline of emissions) (Actual

emissions) = you earn credits for this. iii) Methodologies: Any proposed CDM project has to

use a baseline and monitoring methodology approved by CDM Executive Board.


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4. Value creation of a wind farm (Profits, incomes, tax, job creation)

Definition: In the study of municipal value creation from renewable energies, it is the sum

of: Net profits of the enterprises involved + Net income of the employees involved + Taxes

paid to the municipality (municipal share of income tax, business taxes).

i) Value creation in form of profits: The profit is calculated from the proceeds from the

sale of electricity fed into the grid, minus business expenses, interest on loans,

depreciation and other expenditures. The profits are stated in term of Kilowatts

(KW) of the installed output capacity of a facility.

ii) Value creation in form of income: It is a breakdown of the staff into professional

groups at each stage of the value creation. The income effects can be represented in

terms of kilowatts of installed output capacity.

iii) Value creation in form of taxes: Municipalities levy the business tax independtly. It is

one of the most important in order to tax revenue. In the case of the Wind enegysystem, the community where wind farms are located receive normally 70% of

business tax. Municipalities recevie and additional 15% share of the nationally

established income tax.

Stages of value creation: a) Production of facilities and components. B) Planning and

installation. C) Operation and Maintenance. D) Operating company.

The more stages of the broadly diversified value creation chain are located in the

community, the more income, profits and taxes will be generated.

Advantages: -Creation of jobs (construction of roads and foundations, electrical jobs,

operation and maintenance of the wind farm etc.).Tax revenue (tax on income and wages,

trade tax etc.). Regional economic growth, increase in spending power.Generation oflocal economy: Orders for local trade and business companies in construction and operation.

5. Determination of Revenue (R= Q*P) Lookup Further!

Definition: Revenue is the income that a company receives from its normal business

activities. In a monetary unit, it may refer to the amount received during a period of time.

Profit (net income) = Total revenue - Total expenses in a given period

Revenue (R)= Energy yield (Q) * Price (P)

Energy yield calculations are based on: -Topographic, -Meteorological, -Technical Input

Data, -Mathematical Methods Applied.

Estimating Revenues: WAsP (Wind Atlas Analysis and Application Program:

Predicting wind climates, wind resources, and power productions.

Predictions are based on wind data measured at stations in the same region.


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6. Capital budgeting: NPV/ IRR (add individual scripts!!)

Definition: process of planning expenditures on real assets whose cash flows are expected to

extend beyond one year.

Most important step in capital budgeting is estimating the projects cash flows the capital

expenditures and the annual net cash inflows after a project goes into operationMethods:

A) ARR: Accounting Rate of Return>> Financial ratio; it does not take into account the time

value of money. ARR= Average profit/ Average investment

B) Payback period: The time required for the return on an investment to repay the sum of

original investment. It does not take into account time value of money.

C) **Net Present Value (NPV):Sum of the present values of the individual cash flows. It is a

standard method of using time value of money to appraise long time projects. It comparesthe present value of money today to the present value of money in future. The discount rate

is one of the main elements in calculating NPV; it reflects the assets risk (script 5). Other

elements of NPV are -The magnitude and the timing of the capital investment, -The

operating cash flows which will arise in addition to the firms existing cash flows, -Any

decommissioning costs or salvage value when the project is terminated.

D) Profitability index (PI): It allows u to quantify the amount of value created per unit of

investment. PI= PV of future cash flows/ initial investment. If PI>1, then accept the project,

if PI


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3. Net salvage value: is the after tax net cash flow for the termination, liquidation or

sale of an investment.

4. Depreciation: the decrease in value of assets.

8. Repowering/ offshore: contribution to the future, and challenges,potential (Lookup further for offshore!)

Definition: Repowering is the process of replacing older power stations with newer ones

that either have a greater nameplate capacity or more efficiency which results in a net

increase of power generated.

Replacement of existing (old) wind turbines before end of lifetime by new (more

efficient/more powerful) turbines>> More electricity from wind energy with fewer turbines!

Advantages: -Generation of more wind power from the same area of land (electrical output

increases). -In most cases, replacing an old wind turbine with a larger more powerful one is

economically profitable. -Possible decrease in terms of visual and noise effects. -The quality

of the landscape improves. -Operation and maintenance (O&M) cost is reduced. -Takingthe incentives into consideration, in the long run it will make more profits>> one incentive

being that EEG assures additional bonus on tariff of 0,5ct/kWh (2009) under certain

conditions.

Challenges: -Financial investment and more government incentives. -Turbine Height

restrictions. -Spacing restrictions. -Grid expansion problems. -Relatively long planning

period. -Turbines of 2001-2003 are in focus currently

Challenges for offshore wind farms: -High noise levels can affect the marine life surrounding

the site.Collisions: Ships may only sail in certain areas and in general the closer to the

coast, the denser the vessel routes get, so a detailed analysis must be carried before

beginning of installation.The Scour phenomenon: Scour is the result of the interaction

between a fluid flow field, an obstruction to this flow field (marine foundation) and the

sediment bed. -Installation, transportation and maintenance: The demands of ships for

transportation are very high.For the operations and maintenance, the weather plays an

essential role.Bird mortality: Wind turbines can affect the bird migration paths.

9. Contracts: PPA, EPC, O&M. What kind of contracts do we have?

Power Purchase Agreement (PPA): Is a contract to buy electricity generated by a power

plant; long-term agreement between the seller of wind energy and the purchaser.

Things to consider with a power purchaser:

A) Length of the agreement: 15 to 25 years. The end date of the PPA is measured in the # of

years from the commercial operation date. PPA can be terminated early if: -Federal

production tax is not available. -Permits for construction and operation not obtained. ----------Transmission access has not been secured.


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B) Commissioning process: In this section there are steps aimed to ensure that the facility

will be able to reliably deliver wind energy to the purchaser.

C) Sale and Purchase (SPA):Price terms vary depending on the project financing, quality of the

wind resource, available transmission resources and other issues. Price terms may remain flat,

escalate or deescalate over the life of the project. For example (Minnesotas communitybased energy development) requires a tariff with higher rate during the first 10 years and a

lower rate in the later 10 years.

D) Curtailment: TSO may mandatorily curtail the production of wind energy because of

constrains of the system, emergency and other reasons. Many PPAs are structured as Take

or Pay.

E) Transmission issues:Seller is often responsible for the costs of all transmission upgrades

necessary to deliver the wind energy to the point of delivery. Purchaser assumes the risk of loss

beyond that point.

F) Milestones and defaults: Are intended to allow the purchaser and seller to track the

projects development progress. Includes acquisition of permits for construction, execution

of a construction contract and evidence of sellers purchase of wind turbines.

G) Credit:Many Purchasers require sellers to provide some form of credit enhancement to cover

expected damages to the purchaser if the project does not meet construction milestones. Sellers

require purchasers to provide a security fund or letter to assure payment for electricity

produced by the project.

H) Insurance: PPA requires that the seller maintain specific insurance policies: -Commercial

general liability insurance. -Workers compensation insurance for sellers employees. -

Automobile liability insurance. -Builders risk insurance. -All-risk property insurance. -

Business interruption and extra expense insurance.

Engineering Procurement Construction (EPC):Its a common form of contracting

arrangement within the construction industry. Under an EPC, the contractor will design the

installation, procure the necessary materials (except the power equipment) and construct it,

through own labor or by subcontracting part of the work. The contractor carries the project

risk for schedule as well as budget in return for a fixed price. EPC Contractor is responsiblefor the final project commissioning.

In an EPC contract the sponsor and the contractor define the following: -Scope and

specifications of the project.Quality. -Project duration. -Cost.

Advantages for sponsor: -Puts in minimum efforts for the project. -EPC gives the owner one

point contact. It is easy to monitor and coordinate. -It is easy for the owner to get post-

commissioning services. -EPC way ensures quality and reduces practical issues faced in other

ways. -Sponsor is not affected by the market rise. -Investment figure is known at the start of

the project.


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10.Special Purpose Vehicle (SPV)

Definition: A special purpose vehicle or a special purpose entity is a legal entity usually a

limited company of some type or, sometimes, a limited partnership created to fulfill narrow,

specific or temporary objectives.

Functions: SPEs are typically used by companies to isolate the firm from financial risk. They

are also commonly used to hide debt, hide ownership, and obscure relationships between

different entities which are in fact related to each other. Normally a company will transfer

assets to the SPE for management or use the SPE to finance a large project thereby achieving

a narrow set of goals without putting the entire firm at risk. SPEs are also commonly used in

complex financings to separate different layers of equity infusion.

Commonly created and registered in tax havens, SPE's allow tax avoidance strategies

unavailable in the home district. Round-tripping is one such strategy. In addition, they are

commonly used to own a single asset and associated permits and contract rights (such as an

apartment building or a power plant), to allow for easier transfer of that asset.

Major functions (add-on to the SPV printout)>>

Asset transfer: Many permits required to operate certain assets (such as power plants) are

either non-transferable or difficult to transfer. By having an SPE own the asset and all the

permits, the SPE can be sold as a self-contained package, rather than attempting to assign

over numerous permits.

For competitive reasons: For example, when Intel and Hewlett-Packard started

developing IA-64 (Itanium) processor architecture, they created a special purpose entity

which owned the intellectual technology behind the processor. This was done to prevent

competitors like AMD accessing the technology through pre-existing licensing deals.Financial engineering: SPEs are often used in financial engineering schemes which have, as

their main goal, the avoidance of tax or the manipulation of financial statements.

The Enron case is possibly the most famous example of a company using SPEs to achieve the

latter goal.

Regulatory reasons: A special purpose entity can sometimes be set up within an orphan

structure to circumvent regulatory restrictions, such as regulations relating to nationality of

ownership of specific assets.

Property investing: Some countries have different tax rates for capital gains and gains from

property sales. For tax reasons, letting each property be owned by a separate company can

be a good thing. These companies can then be sold and bought instead of the actualproperties, effectively converting property sale gains into capital gains for tax purposes

11.Uncertainties: what kind of uncertainties do we have in wind farms,

how to analyze (3 Analysis) (Lookup further!!)

Uncertainties regarding AEP, technical availability of the turbines, prices, demand,

technological development, competitors behavior, political development affect

investment facts (Cash Flows are affected due to higher risk)


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Types of analysis:

i) Static analysis: a) Sensitivity analysis: examines the sensitivity/ stabilityof an optimal

solution. It identifies the factors that influence the project economics the most by varying

these key variables: AEP, Prices, Availability, Costs.

b) Scenario analysis: commonly focuses on estimating what a portfolio's value would

decrease to if an unfavorable event, e.g. the "worst-case scenario", were realized. Several

variables are changed simultaneously.

3 different p-Values : -p(50) Base Case/Trend Scenario, -p(75) Conservative Case, -----

-p(90) Pessimistic Case

A common method is the standard deviation of factors (in our case: AEP): -Varying

the probability or p-values, -Depict the future

ii) Dynamic analysis: Risk analysis: Uses the computer aided Monte Carlo Simulation:

Produces (a lot of) random scenarios which are consistent with the analyst's assumptions of

risk incorporated in the key variables. The computer generates random numbers which are

selected for each uncertain parameter from a multi- value probability distribution. -Usually

10,000 iterations.

Investor gets a risk/return profile (not a single value but a histogram). Garbage-in

garbage-out problem if you dont consider correlations between variables

12.Cost of wind energy: key elements

Capital costs for wind energy:

A) Price of wind turbine: Constitutes the major part of the capital costs, including cost for

transportation and Installation of the WT.

B) Grid connection: -Cables required for connection. -Grid Infrastructure (Transmission

towers in case of grid expansion). -Substation that connects the Wind farm with the grid.

C) Civil work costs: -Civil works for the foundation of the wind turbine. -Civil Construction of

Roads. -Required buildings.D) Other fixed costs: Required Licenses, Consulting services and monitoring systems such as

SCADA.

Cost of wind energy vs conventional technologies


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Note: As the WT increases in size O&M costs decrease.

The largest share of cost is taken by wind turbine, followed by foundation cost and grid

connection. For offshore WT (lifetime 25 years), the costs for foundation and grid connection

are higher compared to onshore (lifetime 20 years). The total cost per KW of installed wind

power capacity differs from Country to Country. For Onshore WT: The range is 1000 /kW to

1350 /kW. ForOffshore WT: The range is 1800 /kW to 2500 /kW. Offshore wind power is

more expensive than onshore wind power due to more difficult installation and logistics

solutions, distance from the shore as well as grid connection.

13.Nature of interest: Abstinence Theory, 3 components (Lookup further!!)

Definition: The price paid for the services of capital. Interest may be reserved by the terms

of a contract between the parties, and is then called conventional interest, or it may be

awarded by the law as damages though no agreement for interest has been made by the

parties.

Definition: The interest rate is the price of earlier availability of goods and services; it is the

premium that borrowers must pay to lenders in order to acquire purchasing power (funds)

now rather than later; these funds may be used for either consumption or investment.

Types of interests:

a) Original interest: is the ratio of the value assigned to want-satisfaction in the immediate

future and the value assigned to want-satisfaction in remoter periods of the future. It shows


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itself clearly in the market economy in the discount of future goods as against present

goods.

It is a ratio of commodity prices, but not a price in itself, nor a price determined on the

market by the interplay of the demand for and the supply of capital or capital goods.

Interest rates are determined by the supply and demand for loan able funds. The demand

for loan able funds comes from: Productivity of capital resources investment demand

Positive rate of time preference consumers desire for earlier availability

Since original interest is a ratio of commodity prices and there prevails a tendency toward

the equalization of this ratio for all commodities. In the imaginary construction of the evenly

rotating economy, the rate of original interest is the same for all commodities.

According to the figure, when the interest rate rises, the

interest payments will become more expensive. The borrowers will therefore, demand fewer

loan able funds. On the other hand, higher interest rates stimulate lenders to supplyadditional funds to the market.

B) Nominal interest: In finance and economics, nominal interest rate or nominal rate of

interest refers to the rate of interest before adjustment for inflation (in contrast with the

real interest rate); or, for interest rates "as stated" without adjustment for the full effect of

compounding (also referred to as the nominal annual rate). An interest rate is called nominal

if the frequency of compounding (e.g. a month) is not identical to the basic time unit

(normally a year).

C) Real interest rate: is the rate of interest an investor expects to receive after allowing for

inflation. It can be described more formally by the Fisher equation, which states that the realinterest rate is approximately the nominal interest rate minus the inflation rate. During the

inflation, the nominal interest rate will be a misleading indicator of the true cost of

borrowing. The better measure of the true cost of borrowing will be the real interest rate.

14.ECF/re method and FCF/WACC method, which one is better? (Lookup

further!!)

ECF Definition: Equity cash flow represents funds a company receives from investors. While

the most common form of equity financing is from common and preferred stock sales,

companies can also receive direct investment from other companies and large privateinvestors.


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(Formula) ECF = total income (revenues) - total operating costs (O&M costs, land leases,management, taxes other than on incomes auditing, decommissioning reserve ) - taxes

(trade tax, income tax) interest + redemption - debt service reserve account (DSRA)

Business owners and managers will measure the performance of this financing through a

few common metrics. These metrics include return on equity, free cash flow to equity and

the debt to equity ratio. Financial performance management is important because investors

desire a return on their capital.

Return on Equity: is a basic financial performance metric that measures how well the

company generates profits from equity cash flow. The basic formula is net income divided by

total shareholders equity. Investors look at this metric to determine how well the company

can take invested funds and generate more revenue through normal business operations. A

negative return on equity means the company is losing money from invested capital, i.e.

shareholders are losing a portion of their invested capital.

The equity beta (E) is a function of the projects asset or unlevered beta (A) and itsleverage (V/ E). That means that the risk measure beta changes with the degree of

leverage employed in the company. Equity beta is essential for calculating return on

equity (see formula sheet), which is computed by the CAPM equation.

The capital asset pricing model (CAPM) is a theory of the relationship between the risk of a

security or a portfolio of securities and the expected rate of return that is commensurate

with that risk. The theory is based on the assumption that security markets are efficient and

dominated by risk averse investors. In other words, the CAPM argues that investors are

willing to take on more risk only if they can reasonably expect a higher return.

Using this equity cash flow, the derived cost of equity, and the initial equity investment one

can easily calculate projects net present value.

FCF/WACC methodCost of Debt: Interest Rate % charged to your company

Cost of Equity: Expected % return of Investor (usually higher). -Can use CAPM (Capital asset

Pricing Management) to compute it.

Definition (WACC): The WACC is the minimum return that a company must earn on an

existing asset base to satisfy its creditors, owners, and other providers of capital.

15.Financial ratios: 3 types. How to define which value they should be?The most common ratios (risk metrics) used in project finace. Financial Ratios used by banks

to estimate the ability of the project to meet the loan requirements.

i) Debt Service Cover Ratio (DSCR): Debt sizing>>Measure of a projects ability to produce

enough cash to cover its debt. DSCR >1.15 1.20 on P75.


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ii) Loan Life Cover Ratio (LLCR): Number of times the cash flow (discounted basis) can repay

the outstanding debt balance over the scheduled life of the loan. LLCR > 1.30 on P75

iii) Project Life Cover Ratio (PLCR):Shows how oftenoutstanding debt can be repaid over

the remaining life of the project on a discounted basis. PLCR > 1.50 on P75

16.Risks: solutions

Definition: Risk (Event) = Probability (Event) * Consequence (Event)

Risk management is the detection, analysis, evaluation, monitoring and control of risks. Risks

can be divided into external or internal risks.

Financial: change of interest, credit, bank, equity risk, insolvencies.

Legal: legal actions of partners or citizens, penalties, judgements.

Political: Changes in feed-in-tariffs a.o., requirements.

Technical: other renewable energies are more profitable; networks, emergency shutdowns.

Environmental: weather, climate changes, earthquakes, corrosion.

Ways to evaluating risks: -needing of effective risk management in a project management. -

using network plans, risk matrix, risk graphs, Tools like MS Project. -define costs structures

check them permanently. -find countermeasures for your project risks and evaluate them. -

improve your risk management and communicate it to partners

The following are post completion risks for WF:i) Resource risk:Its the Input Factor Risk Availability of Inputs. Examples: -Independent

Reserve Certification, -Firm Supply Contracts, -Ready Spot Market

ii) Production risks or operation risks: The Operating difficulties lead to insufficient cash

flow team. Examples: -Proven Technology, -Experienced Operator, and/or Experienced

Management, -Performance warranties on equipment

iii) Market risk: Volume (Cannot sell entire output). Examples:

Long Term Contract with creditworthy buyers: A creditors measure of a companys

ability to meet debt obligations.

Take-or-pay: An agreement between two parties where one agrees to buy certain goods

or services from the other and has to pay for them even if not need them.

Take-and-pay: An agreement that obligates the purchaser to take any product that is

offered, and also pay a penalty if the product is not taken.


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Take-if-delivered: An agreement between two parties to the sale and purchase of a

particular commodity at a specific future time.

Price (Cannot sell output at profit).

iv) Force Majeure Risks: The risk that there will be a prolonged interruption of operations

for a project finance enterprise due to fires, floods, storms, earthquakes, or some other

factor beyond the control of the project's sponsors.

Examples: -Insurance, -Debt Service Reserve Fund, -Reserve established to service interest

and principal payments on short- and long-term debt.

v) Political risks: Any political change that alters the expected outcome and value of a given

economic action by changing the probability of achieving business objectives. It covers a

great range of issues. For example, nationalization or expropriation, changes in tax, currency

inconvertibility, etc.

Examples: -Assurances against a hostile government>> explain to the government how the

companys policies are consistent with these priorities.

vi) Abandonment risk:Its when the Sponsors walk away from the project.Examples:

Abandonment test for banks to run from a project based on historical and projected costs

and revenues.

vii) Other risks:

Syndication Risk>>Examples: Secure Strong lead financial institution.

Currency Risk>>Examples: Currency Swaps.

Interest rate exposure>>Examples: Interest rate swaps.

17.Power curve/ available warranty, definitionDefinition: Power curve is the power output according to the wind speed (or) operation

performance of the wind turbine.

Power curve for 1500kw wind turbine

Cut-in speed: The speed at which the turbine first starts to rotate and generate power is

called the cut-in speed and is typically between 3 and 4 meters per second.

0

200

400

600

800

1000

1200

1400

1600

0 5 10 15 20 25 30

ElectricalPow

er(kW)

Wind Speed (m/s)

Cut In(4m/s)

Rated Power OutputCut Out(25 m/s)

Rated Wind Speed


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Rate output wind speed: The power output reaches the limit that the electrical generator is

capable of. This limit to the generator output is called the rated power output.

Cut-out speed: As the speed increases above the rate output wind speed, the forces on the

turbine structure continue to rise and, at some point, there is a risk of damage to the rotor.

As a result, a braking system is employed to bring the rotor to a standstill. This is called the

cut-out speed and is usually around 25 meters per second

Definition>> Power curve warranty: is aimed at ensuring the efficiency of the turbines.

Warranty indirect via AEP; assumptions about wind speed distribution and/or air density;

uncertainty depending on real situation on site and nature of difference in power curve

values. Difference is not measurable for all WTGs after installation (roughness, barriers,

turbulences). Site calibration prior to installation is necessary. Damage payments in case of

proven non-compliance will be based on relative generation yield losses.

Power curve warranty usually 95% of AEP (annual energy production) referenced to the

theoretical / warranted power curve.

Decision making process>>ensuring power warranty: Collecting the historic Data; wind

shear, wind veer, turbulence, wake effects and icing. blade condition, turbine suitability,

control algorithm, wind farm layout, maintenance and downtime, and error and alarm

states,,, All the Present error Data's which are Recorded By the SCADA is analyzed. Once a

detailed understanding of present performance has been attained, using the techniques

described above, it is possible to project forward to predict long-term energy production.

Improvement Points: Subtle improvements in energy production; understanding any

deviations from expectations; if appropriate, revaluation of project with a low uncertaintyprediction.

Power curve deviations: expected performance, unexpected performance

Corrective steps>> identification of constrained power performance; removal of constrained power

performance.


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Definition>> Availability: it is the proportion of time; a system is in a functioning condition.

No system can guarantee 100.000% reliability; no system can assure 100.000% availability.Reliability involves processes designed to optimize availability under a set of constraints,

such as: -time, -cost, -and efficiency.

The availability of a power plant varies greatly depending on the type of fuel, the design of

the plant and how the plant is operated. For example P.P availability (in ideal fuel or

recourses existence). -Thermal, Coal and Nuclear P.P. availability (70-90) %, -Gas Turbine

station (80-96)% ,peaking PP, -Wind &Solar 98%.

Availability Warranty is aim at ensuring the reliability of the wind turbine. Availability

defined as a timely relation of WTG when it is not available due to manufacture faults.

Availability Warranty put the responsibility on the manufacture or the supplier according tothe contract.

Availability warranty estimation>> F (availability functional unit) = N (actual numbers of

hours in operation)/ T (numbers of hours in one contract year)The WTG owners paying a lot for a satisfied Availability Warranty!!

The availability warranty depends on the manufactures and differs from one to another

therefore the period of the Availability Warranty is an important issue for the investors. For

Example SEIMENS allows turbines owners to choose availability warranty up to 20 years and

extended component defect warranties for up to 12 years.

18.Debt capacity

Definition: Debt capacity is the ability to borrow. It refers to the amount of funding that an

organization can borrow up to the point where its corporate value no longer increases. Debt

capacity involves the assessment of the amount of debt that the organization can repay in a

timely manner without forfeiting its financial viability.

Determination of debt capacity>> done by one of the financial ratios mentioned earlier:

Debt Service Cover Ratio: Ratio of 'Cash flow Available to Pay Debt' or 'Earnings before

Interest, Taxes, Depreciation to debt payments due during that period.


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Static risk metric which banks use for debt sizing. Min

Range: Greater than 1.15-1.2

Interest Coverage Ratio: The ratio is calculated by dividing a company's Debt capacity = NetPresent Value of all CEDSs (EBIT) by the company's interest expenses for the same period.

The lower the ratio, the more the company is burdened by debt expense.

High risk vs low risk cash flows>> High Risk Project has higher margin, shorter-term and

declining debt service; higher volatility of cash flow. Low risk has flat debt service, and longer

term and higher IRR on equity.

Cash Flow Available for Debt Service (CADs) = Electricity Revenue (Quantity x Price) + other

Revenues (CO2, interest income etc.) - variable Costs (O&M Costs, Trade Tax) - fixed Costs

Cash Flow Eligible for Debt Service (CEDs):CADs has to fulfill the DSCR-requirements of the

bank. thats why only a part of CADs can be levered: we call it CEDs.

CEDs = CADs/DSCR

Debt capacity = Net Present Value of all CEDs

19.Forward and future contracts: differenceFuture contract: is a standardized contract between two parties to buy or sell a specified

asset of standardized quantity and quality for a price agreed today (the futures

price or strike price) with delivery and payment occurring at a specified future date,

the delivery date. The contracts are negotiated at a futures exchange, which acts as an

intermediary between the two parties.

First used to fix the price of olives, the first exchange was the Dojima Rice Exchange in Japan

in the 1730s. Modern futures contract were originally created asforward contracts and

traded at the Chicago Board of Trade (CBOT).

Forward contract: is a non-standardized contract between two parties to buy or sell an asset

at a specified future time at a price agreed upon today.

Long position. Short position. Forward price. Eg. A wheat farmer planting a crop of 5000

bushels

Functions: Fundamentally, forward and futures contracts have the same function, by

defining: -specific type of asset, -specific time, -given price. The Goal is to protect buyer or

seller against the price fluctuations (especially against the exchange-rate changes), to have

security in locking in estimated profit, to have a guaranteed quality and quantity

In the absence of any transactions or storage cost the price of the forward contract is simply

the future value of the current spot price.


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Electricity forward contracts are the primary instruments used in electricity price risk

management. Electricity forwards are essentially custom-tailored supply contracts.

Electricity futures have the same payoff structure as forwards. Electricity futures, like other

futures, are highly standardized in contract specifications: -trading locations, -transaction

requirements, -settlement procedures

When hedging against electricity spot price movements, we will consider using futurescontracts as oppose to forward contracts because: i) they are more reflective of higher

market consensus and transparency than the forward price. ii) They are more relevant to the

issue of hedging because the majority of electricity futures are settled by financial payments

rather than physical delivery.

>Comparison Forward Contract Futures Contract

Transaction

method:

Negotiated directly by the buyer

and seller

Quoted and traded on

the Exchange

Contract size: Depending on the transaction

and the requirements of

the contracting parties.

Standardized

Expiry date: Depending on the transaction Standardized

Institutional

guarantee:

The contracting parties Clearing House

Risk: High counterparty risk Low counterparty risk

Market

regulation:

Not regulated Government regulated market

Method of pre-

termination:

Opposite contract with same or

different counterparty.

Counterparty risk remains while

terminating with different

counterparty.

Opposite contract on

the exchange.

Structure: Customized to customers need.

Usually no initial payment

required.

Standardized. Initial margin

payment required.

Contract Maturity: Forward contract mostly mature

by delivering the commodity

Future contracts may not

necessarily mature by delivery of

commodity


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Guarantees: No guranantee of settlement

until the date of maturity only

the forward price, based on the

spot price of the underlying

asset is paid

Both parties must deposit an

initial guarantee (margin). The

value of the operation is marked

to market rates with daily

settlement of profits and losses.

20.M & M proposition 1 and 2: definition (with tax, without tax)

Modigliani-Miller Theorem: forms the basis for modern thinking on capital structure. In a

market, without taxes, bankruptcy costs, agency costs, value of a firm is unaffected by how

that firm is financed. It does not matter if the firm's capital is raised by issuing stock or

selling debt. There are two types of propositions: with tax and w/o tax.

Assumptions: -Capital structure does not affect cash flows. -No taxes. -No bankruptcy costs. -

-No effect on management incentives. -For firms in same risk class.

With taxes: The first (Firm U) is unlevered: that is, it is financed by equity only. The other

(Firm L) is levered: it is financed partly by equity, and partly by debt. >>> VL=VU+TCD

Without taxes: VL=VU where VU is the value of an unlevered firm = price of buying a firm

composed only of equity, and VL is the value of a levered firm = price of buying a firm that is

composed of some mix of debt and equity.

M&M theorem (script 2): A financial theory stating that the market value of a firm is

determined by its earning power and the risk of its underlying assets, and it makes no

difference whether a firm finances itself with debt or equity. Capital structre does not

matter. Remember that a firm can choose between three methods of financing: issuing

shares, borrowing or spending profits (as opposed to dispersing them to shareholders in

dividends).

M&M Proposition II: states that the value of the firm depends on three things: 1) Required

rate of return on the firm's assets (Ra). 2) Cost of debt of the firm (Rd). 3) Debt/Equity ratio


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of the firm (D/E).

Without Taxes: A higher debt-to-equity ratio leads to a higher required return on equity,

because of the higher risk involved for equity-holders in a company with debt.

Ke =Ko+ D/E( Ko - Kd }

Ke = Required rate of return on equity, or cost of equity.

Ko = Company unlevered cost of capital (ie assume no leverage).Kd = Required rate of return on borrowings, or cost of debt.

D/E = Debt-to-equity ratio.

With taxes: The same relationship stating that the cost of equity rises with leverage, because

the risk to equity rises, still holds. The formula however has implications for the difference

with the WACC (Weighted average cost of capital).

The weighted average cost of capital (WACC) is the minimum return that a company must

earn on an existing asset base to satisfy its creditors, owners, and other providers of capital,

or they will invest elsewhere.

Use of M&M proposition: These propositions are true assuming the following assumptions: no transaction costs exist, and

individuals and corporations borrow at the same rates.

These results might seem irrelevant, but the theorem is still taught and studied because it

tells something very important. That is, capital structure (ways to finance assets) matters

precisely because one or more of these assumptions is violated.

21.Options for financingFinancing is the second stage in the wind project value chain.

Funding options: Developers equity, Private equity (investors), Closed-end Equity Funds,Mezzanine Capital, Project Finance.

Closed-end Equity Fund (CEF):

limited number of shares

predetermined amount of fund

new shares are rarely issued once the fund has launched

an investor can acquire shares by buying in the stock market

fixed duration

Mezzanine Capital:

subordinated debt (= debt which ranks after other debts should a company fall into bankruptcy

or liquidation) higher riskmore expensive financing source

often used by smaller companies mezzanine debt holders require a higher return for their investment than secured lenders, due

to higher risk

often in the form of: participation certificates, silent partnerships

Project Finance:

project loan from bank, based upon the projected cash flows of the project (off-balance sheet)

several equity investors as well as a syndicate of banks or other lending institutions provide

loans

risk identification and allocation is a key component (risk sharing)

e.g. foundation of a fond (several investors bring in equity which is supplemented by a bank

loan)

most commonly used option

Debt financing (3 options):

Financing on the sponsors balance sheet (on-balance sheet)


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utilities / sponsors with strong financing capacity

provide all necessary financing (use their own cash resources)

Financing using capital market products

stock market

bond market

Project Finance without / with limited recourse to the sponsor mostly used by large and risky projects

debt is provided by banks and other financial institutions

project equity is paid-in by the sponsors or external investors

22.Currency swap/ interest rate swapDefinition: Swaps: Swaps are agreements between two parties that decide to exchange cash

flows, liabilities or one type of asset at certain due dates. Swaps are one of the most original

financial tools negotiated on financial markets. Swaps belong to the group of derivative

instruments.

Definition: Derivatives: are financial contracts derived from but independent of other

contracts. They involve a party that is not associated with the original, underlying contract.

The value of nearly all derivatives is based on an underlying asset (Stock; Bond; Currency;

Index).

Interest rate swaps are agreements between two parties (counterparties) that exchange

interest payments on an imaginary principal (notional principal) for a certain period. Interest

rate swaps are based on an exchange of cash flows generated from a fix interest rate for

those derived from a floating interest rate.

The underlying asset of interest rate swaps is the notional principal, which is not exchanged

in the transaction, but it is used to calculate the interest cash flows. Example:A company

that earns a steady stream of income may prefer one which matches the market interest

rates. It may agree to exchange its interest income on a certain sum for a certain period withanother company which earns a fluctuating interest income but prefers a steady one.

Currency swaps are financial agreements between two parties to exchange the principal of

two different currencies immediately and to make interest payments on that principal during

the contract term. When the contract ends the parties re-exchange the principal amount of

the swap. Example: A U.S.-based company needs to acquire Swiss francs and a Swiss-based

company needs to acquire U.S. dollars. These two companies could arrange to swap

currencies. They could establish an interest rate, an agreed upon amount and a common

maturity date for the exchange.

Advantages of Currency swaps and interest rate swaps: Both interest rate and currency

swaps have the same benefits: they help to limit or manage exposure to fluctuations in

interest rates or to acquire a lower interest rate than a company would otherwise be able to

obtain. Furthermore, currency swaps are used to enter new capital markets or to provide

predictable revenue streams in another currency.

exam notes wind energy economics

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