Since 1985 the inhabitants of the Nice 8 residential complex in northwestern Bogotá use the sun to heat the water they use at home. Viviana T., who owns a three-bedroom apartment on the fifth floor of the building, says she has never turned to gas or electricity heaters. The photovoltaic system of solar panels installed on the roof of the building has met your daily needs and has allowed you to save on your electricity bill. In addition, it does not produce greenhouse gas or polluting emissions.
The Nice example illustrates the reliability of photovoltaic systems, which is one of the reasons why photovoltaic energy is positioned as an alternative to conventional energy. However, until a few years ago, it could not compete with traditional sources because of its high costs. Today, this has changed because the components that constitute the facilities have reduced their costs and, in addition, the Colombian government has established tax incentives that make photovoltaics present as an economically feasible technology. We present a hypothetical installation in Bogotá in order to demonstrate a methodology that allows establishing profitability.
The free cash flow of a photovoltaic installation allows to identify the financing that maximizes the economic return –
The methodology serves promoters, investors, individuals, cooperatives and associations that see the attractions of a photovoltaic installation to contribute to the preservation of the environment and as a profitable investment. We start from the assumption that the system has been sized, which allows selecting the components and establishing the installation and commissioning costs.
We present a simple but rigorous procedure that allows establishing the economic feasibility of a project. In addition to providing the financial return, it makes it possible to compare financing options so that people who are considering investing in a project can identify the alternative that maximizes their return.
The methodology, free cash flow, is based on determining revenues and costs throughout the operational life of the facility. This methodology is appropriate in the case of photovoltaic systems because it is possible, based on technical sizing, to accurately determine the cash flow.
The revenues are derived from the forecasts of the electrical production of the installation obtained from the sizing. Once production is determined, it is possible to establish revenue from estimates of the value of electric power. In turn, the costs are obtained from quotes of the suitable components to ensure the expected production. To these costs, it is necessary to add installation costs, previous studies and environmental permits.
Consider an example to illustrate the steps. Take the case of an Estrato 5 housing complex in Bogotá. To meet the electricity demand of the 80 inhabitants, the council of co-owners contemplates the installation of a photovoltaic system on the roof. The template establishes an available area of 360 m2 for the installation of panels. Taking into account solar irradiation at the site, an ideal 55 kW power system consisting of 160 panels and an inverter results from technical modeling. Electricity production is expected in the first year of operation of 68.8 MWh, which would supply a large part of the demand for the property. In order for the return analysis to represent the current operating conditions, in the following years we assume a degradation of the photovoltaic panels of 0.4% per year.
From sizing, cash flow is determined starting with revenue. It is assumed that all the electricity produced is sold at the consumer price of the building. Based on information accessible online, this price for the month of December 2017 is COP $ 521 per k Wh. (Source: www.codensa.com.co/hogar/tarifas). Therefore, assuming the start-up of the system in January 2019 and an inflation of 2.5% per year, the production at the course of 2019 would have a value of COP $ 521 x 1,025 x 68 800 = COP $ 36.8 million .
With regard to costs we obtain estimates of the components and the installation of the system from surveys and quotes from suppliers. From the example given, the investments will be COP $ 296 million. To determine the cash flow, it is necessary to add operational costs throughout the operational life of the facility such as maintenance costs and management costs. A representative value would be 1.5% of the initial investments.
The financial premises presented in the table below allow the calculation of free cash flow, that is, the net movement of funds per year once the installation is commissioned. We point out that the calculations take into account the tax incentives of Decree 2143 of November 4, 2015. In the case presented, own funds are available for 30% of the initial investments. It would be necessary to apply for loans of the remaining 70%.
The analysis results for investors, an internal rate of return (IRR) of 14.4%, a recovery period of 10 years and a net present value (NPV) of COP $ 359 thousand. Taking into account the premises mentioned above, the project is profitable. In principle, this result is encouraging because it indicates that the project would provide a positive return with a debt level of 70%. However, would this analysis convince potential creditors to lend money to carry out the project? We will analyze this in the next section.
To move forward, it would be necessary to show potential creditors that the risk of losing their capital is minimal. As long as the operation generates a free cash flow that exceeds the debt commitments. The index that measures the ability to assume debt, the debt coverage rate (TCD), is the relationship between net income and debt costs. A TCD equal to one indicates that the operation will generate the funds to pay the debt. As a safety margin, creditors typically require a TCD greater than one during all periods of the plant’s operational life. A value of 1.5 is typical.
The relationship between the net flow and the debt commitments, the debt coverage rate (TCD), discloses the ability to assume debt. A TCD is greater than one demonstrates that the net income of the period exceeds the costs of the debt, therefore, the operation generates sufficient capital to cover the costs. Therefore, the operation meets the requirements of the creditors. In practice, a TCD greater than one is required as a safety margin. A value of 1.5 is typical.
In order to identify the optimal level of indebtedness, we consider the impact of the evolution of the debt on the IRR and the TCD. The graph reveals the impact for the contemplated project. The profitability of the project increases with indebtedness, however, in parallel, the ability to pay it is reduced.
Si un acreedor solamente concede capital cuando la TCD mínima supera 1,5, podríamos obtener un préstamo hasta 50% del valor de las inversiones iniciales y no los 70% inicialmente planteado. Es decir, tendremos que aportarle al proyecto fondos propios de COP$ 148 millones, lo que generaría una TIR de 13%.
If investors do not have 50% to inject into the project, it is necessary to consider the types of financing offered in order to identify a financial model that is profitable.
In the event that the capital is insufficient, one option would be to use other sources to start the project. This implies finding investors willing to inject their capital. Some would be entities that contribute venture capital or user associations where members gather their capital.
Once the capital and the system in place have been invested, all profits, including tax incentives, are paid to the owners. However, it is necessary to keep in mind that the benefits for those who contribute capital are reduced as the number of participants increases. On the other hand, financing with own funds avoids commitments with creditors.
The use of own funds is an impulse for the creation of associations or cooperatives where groups of individuals make up a legal entity for the realization and operation of the installation. With this financing modality, users ensure the sizing, issuance of authorizations, purchase of equipment, construction and operation. Normally, a company specialized in the branch is hired to start the system.
Obviously, if capital is missing, it is necessary to consider other types of financing.
In this form of financing, users do not buy the components of the installation, instead, they lease them through a fixed-term contract with a financial institution where fees are paid at an agreed frequency, usually monthly. The entity that grants the capital for the acquisition retains the title deed. From the point of view of the users, the advantages of the lease are:
When assessing the lease, it is necessary to take into account the bond required by the financial institution. Normally for the rental of equipment, the market value is considered as a guarantee. In the case of photovoltaic components, because facilities in the country are still not widely distributed, it may be assigned a low value, which would discourage this modality.
In this financing modality, a third-party company is responsible for conceptualizing, installing, maintaining and operating the installation. A sales contract is agreed with consumers of electricity through which users agree to buy electricity for a term, usually 15 to 30 years.
During this period, the supplier retains the title to the installation. To make this type of contract attractive, users are offered electricity at a lower rate than the grid.
The main advantage for users is a reduction in their energy costs without needing to invest their capital. In addition, all operational expenses are left to the provider. On the other hand, it is important, before signing a purchase and sale contract, to ensure that the company has the technical skills and financial support to keep the system running.
A loan is probably the most common means of obtaining financing. Among the financial entities that finance renewable projects, the following stand out:
However, investments in renewables in Colombia is new land. Obtaining a loan requires a financial analysis anchored in reliable forecasts.
The example shows that the cash flow analysis allows you to calculate the return and indicate the level of indebtedness possible for a project. In this way it points to the possible types of financing to structure the project in a way that maximizes the return.
Article written on January 6, 2018.
By: David E Tipping
About the author
David Tipping is a project engineer, M.Sc. Management of Technology, Imperial College of the United Kingdom and Master of Renewable Energies of the European University of Spain. He has worked 28 years as an engineer in Europe, Africa, Russia and Latin America. It is currently dedicated to promoting the implementation of renewables for power generation.