A Decision Support Tool for the Risk Management of Offshore Wind Energy Projects

A Decision Support Tool for the Risk Management of Offshore Wind Energy Projects, Michael H. Breitner Leibniz Universität Hannover

Outline for presentation Motivation and relevance Research questions Characteristics and methods of the DST Case study: Offshore wind park in Germany Conclusion and outlook # 2

Motivation and relevance Motivation Recent studies analyzed offshore projects in the context of corporate finance Many studies refer to obsolete general conditions Gap: There is a need for a study that focuses on both project developers and lenders under current general conditions Relevance Offshore wind energy represents a major part Institut of energy für Wirtschaftsinformatik production from renewable energy sources in some regions Due to high costs of offshore wind parks a majority of future offshore projects will be realized in the framework of project financing # 3

Research questions Question 1 Does an offshore wind park provides adequate returns for investors? Question 2 Do the project returns provide sufficient debt service coverage? # 4

Decision support tool (DST) Discounted cash-flow model # 5

DST Adjusted present value (APV) method Project value = T t=1 FCF t (1 + r U ) t + T t=1 τ [r D,t D t 1 ] (1 + r D,t ) t (1) r U = r E E V + r D D V (2) r E = r f + r M r f β (3) Advantage if the debt to equity ratio is not constant in time # 6

DST Financial key figures Debt service cover ratio DSCR t = CFADS t DS t Loan life cover ratio LLCR t = L l=t CFADS l (1 + r D,l ) l D t 1 Project life cover ratio PLCR t = P p=t CFADS p (1 + r D,p ) p D t 1 # 7

DST Monte Carlo simulation (1/4) Allows to take risk into consideration Value-at-risk (VaR) quantifies the influence of risk Applied on the project value it expresses the minimum value of a project that is not undercut by a certain confidence level Four steps are necessary: 1. Identification of risk components 2. Setting up probability distributions for each risk component 3. Specification of target key figures 4. Performing the simulation # 8

DST Monte Carlo simulation (2/4) 1. Identification of risk components 2. Setting up probability distributions for each risk component 3. Specification of target key figures 4. Performing the simulation All components within the Investment cash-flow Operating cash-flow Additional other components Construction period Inflation rate # 9

DST Monte Carlo simulation (3/4) 1. Identification of risk components 2. Setting up probability distributions for each risk component 3. Specification of target key figures 4. Performing the simulation BetaPert distributions require only a minimum, a maximum and a likeliest value to be completely described # 10

DST Monte Carlo simulation (4/4) 1. Identification of risk components 2. Setting up probability distributions for each risk component 3. Specification of target key figures 4. Performing the simulation Target key figures Project value DSCR LLCR PLCR 100,000 simulation runs # 11

Case study: OWP in Germany (1/2) Key parameters Wind energy plants 80 Distance to cost 90 km Nominal output 5000 kw Depth of water 40 m Expected annual energy output 1540 GWh Tax rate 35 % Total investment costs 1440 M Debt 864 M Discount factor / interest rates Cost of debt 6.66 % Return on equity 16.4 % Discount factor 10.56 % Parameters with an influence on multiple factors Parameter Expected Value Discount / surcharge Annual inflation rate 2 % - 25 % / + 50 % Annual increase of electricity market price (5 ct/ kwh today) 2 % - 20 % / + 20 % Net full load hours 3850-20 % / + 10 % Construction period 30 months - 6.7 % / + 20 % # 12

Case study: OWP in Germany (2/2) Investment costs Component Expected costs Discount / surcharge Wind turbine 682.4 M - 5 % / + 5 % Foundation 340.6 M - 10% / + 10 % Internal power connection 238.0 M - 5 % / + 5 % Design / Insurance / Expertise 67.5 M - 10 % / + 15 % Other costs 111.5 M - 25 % / + 25 % Total investment costs 1440.0 M Operating costs (per year) Component Expected costs Discount / surcharge Maintenance 22.5 Institut M für Wirtschaftsinformatik - 25 % / + 25 % Insurance 18.8 M - 5 % / + 25 % Transportation 3.0 M - 25 % / + 25 % Monitoring 1.0 M - 5 % / + 5 % Other costs 0.9 M - 5 % / + 5 % Total operating costs 46.2 M Sources: BMU 2011, EWEA 2009, KPMG 2010, Madlener et al. 2009 # 13

Results (1/4): expected project value millions of 2013 2014 2015 2016 2017 2035 1. Investment cash-flow -145.0-575.0-720.0 2. Operating cash-flow 123.2 245.5 244.5-89.1 2.1 Earnings 146.3 292.6 292.6 59.5 2.2 Expenditures -23.1-47.1-48.1-148.7 3. Taxes -21.2 Free cash-flow -145.0-575.0-596.8 245.5 239.0-89.1 Tax-shield 6.7 20.6 21.1 19.8 Discounted free cash-flow -49.8-131.2-470.4-441.7 164.3 135.2-8.9 Discounted tax shield 121.9 6.3 18.1 17.4 15.3 Project value 72.1-131.2-464.2-423.6 181.7 150.5-8.9 Cumulative project value -131.2-595.3-1018.9-837.2-686.7 72.1 Project value > 0 return on equity > 16.4 % IRR = 12.29 % Positive investment after 13 years # 14

Results (2/4): distribution of the project value 100,000 simulations in millions of With a certainty of 95 % the project value is at least -60 M IRR for this project value is 9.26% # 15

Value Results (3/4): DSCR for various confidence levels 2,25 2,00 1,75 1,50 1,25 1,00 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 confidence level 25% 50% 75% 90% 95% 99% # 16

Value Results (4/4): Key figures at a 95% confidence level 2,25 2,00 1,75 1,50 1,25 1,00 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 Debt service cover ratio (DSCR) Loan life cover ratio (LLCR) Project life cover ratio (PLCR) DSCR is most of the time between 1.35 and 1.45 Minimum DSCR > 1 LLCR > 1.2 PLCR > 1.5 # 17

Conclusion and outlook (1/2) Conclusions An investment into an offshore project in the German North Sea is in the average profitable for project developers and lenders. It is obvious that the DST provides an aggregated representation of important financial key figures The DST gives an answer about the economic efficiency of offshore wind projects which are constructed and operated within the context of project finance. # 18

Conclusion and outlook (2/2) Future work Extend the model to consider a more complex tax system Add the technical availability as an independent key figure to take improvements of this ratio in the long term of the project operation into consideration Use more realistic probability assumptions to realize a better consideration of individual risk factors # 19

Thank you for your attention! Contact Leibniz Universität Hannover Königsworther Platz 1 30167 Hannover E-Mail: koukal@iwi.uni-hannover.de

References BMU (2011). Vorbereitung und Begleitung der Erstellung des Erfahrungsberichtes 2011 gemäß 65 EEG. Vorhabe IIe Windenergie. EWEA (2009). The Economics of Wind Energy. Madlener, R., Siegers, L., Bendig, S. (2009). Risikomanagement und -controlling bei Offshore-Windenergieanlagen. Zeitschrift für Energiewirtschaft 33, 135 146. KPMG (2010). Offshore Wind in Europe. 2010 Market Report. # 21