Before you make any decisions about your community energy project, you need to make sure it is financially viable. A financial model will help you establish the amount of capital you need to raise, your operational costs, and whether the revenue your project will earn is enough to cover those costs.
Main topics covered in this article include:
A financial model is an essential for making business decisions. It helps you focus on the expected costs, benefits, values and risks of your project. As you move through the different stages of your project, you'll need different financial models:
- Pre-feasibility and early stages: Start with a basic model during the pre-feasibility phase of your project, to determine whether the idea is even financially viable. Initially it will be quite rudimentary, as you'll be making broad assumptions about your capital costs, operating costs and revenue.
- Feasibility and development: As you move into the feasibility, assessment and development stages of the project, your model will need to become more detailed and rigorous.
To help you, we intend to put some financial model templates on this website for you to use. You'll be able to copy and adapt these to suit your particular project.
When do you need a financial model?
It’s important to do a preliminary financial assessment at the pre-feasibility stage. You may already have a shortlist of sites and so will need to start looking at costs.
Over time, the information you enter into your model will become more accurate, and the model itself may become more detailed. It’s important to keep going back to your financial model whenever you make a decision that will affect your revenue or expenditure. This could be anything from the corporate structure you decide on, to what proportion of funding you’re prepared to borrow and what price you need to set on your energy output.
A basic financial model
A basic model will require some assumptions about the following key elements:
Expected life of your project
Typically, a wind farm or a solar park will have a lifespan of about 20 to 25 years. Life spans of other types of projects vary but some research into similar projects will probably help you make a good life span assumption.
Amount of energy you'll produce
This will depend on your project capacity and your fuel resource, among other factors. For example, Hepburn Wind in Victoria has two wind turbines, each with two megawatt (MW) capacity, and expects to produce 12,200 megawatt hours (MWh) each year.
This combines the income you expect to get from selling your energy and your Large-scale Generation Certificates (LGCs, formerly known as RECs), as well as the end-of-life value of your wind farm. You'll need to determine the current and future price of electricity and LGCs.
Your capital costs
This includes all the costs you'll incur to get your project up and running – from planning and design through to construction. Don't forget to include:
- feasibility study costs, such as energy resource assessments and environmental impact studies
- the cost of the equipment procurement
- installation and grid connection charges
- legal fees
Some of these costs become assets and some (such as legal negotiations or stakeholder engagement) are one-off capital expenses (CAPEX). Your resource assessment is your first non-cash asset - it's valuable intellectual property, so make sure in any agreement with the landowner, your project owns that data.
As a rule of thumb, the overall capital cost per MW of installed capacity for a community project is approximately:
Cost ($m/MW installed)
2.5 - 3
3 - 3.5
Your operational costs
What will it cost each year to run your project? Management fees, repairs, metering and monitoring, and any rent payments you make to the landowner are all operational costs.
If you're borrowing money to develop your community energy project, remember to include the cost of interest. This can have a major impact on your annual expenses – a half percentage point difference in interest could become a huge budget item over 20 years.
Banks are currently quite cautious in their lending, and will charge more interest where they see a higher level of risk. Your debt to equity ratio (how heavily your project is geared) could make all the difference to its financial viability.
When costs blow out
The Hepburn Community Wind Farm project found estimating some costs before the wind park design was complete was a challenge.
They estimated their grid connection costs to be $210,000, based on expert opinion. By the time all the grid connection requirements were taken care of, it was closer to $1.8 million.
In the NSW Wind Energy Handbook 2002, the Sustainable Energy Development Authority (SEDA) estimates the average cost of grid connection is $600,000. But there are many land-specific variables involved.
For solar projects, costs of connection are very difficult to estimate. Influencing factors may include if all generated power is consumed on site, any potential export and solar penetration in the area.
Keep updating your financial model to check the energy price you negotiate will cover your revised costs.
In the case of a wind farm, the potential to generate electricity grows exponentially with greater wind speeds, so your wind resource assessment will affect your projected income. In the case of a solar park, the potential to generate electricity may be more clearly understood before the project proceeds.
Either way, the exact value of that income is difficult to determine before you enter final negotiations with an energy retailer. You have two options:
- Negotiate a Power Purchase Agreement (PPA) with an energy retailer. This means you sell your energy at a specific price for a fixed period - usually three or five years. However, to appeal to an energy retailer (who already produce their own energy), you need to offer a discounted price.
- Sell your energy on the spot market. This is more complex and pricing is volatile, but ultimately may provide a greater revenue return.
Your choice will ultimately depend on how flexible your credit lender is. Most banks prefer PPAs as they guarantee regular income, so the higher your debt to equity ratio the more likely you’ll need a PPA to satisfy the bank.
Renewable energy systems and some solar water heater installations can also earn revenue from the sale of your Renewable Energy Certificates (LGCs or STCs).
Under the enhanced Renewable Energy Target (RET) Scheme, you can create a Large-scale Generation Certificate (LGC) or a Small-scale Technology Certificate (STC) for every MWh of electricity you generate. The price of an LGC or an STC is determined by the market, and recent prices have varied from $10 to $50. Visit the Office of the Renewable Energy Regulator (http:/www.orer.gov.au) for more information on LGCs and STCs and how you can become an accredited renewable energy power station.
Is the project viable?
There are two key variables for any community project — capital, and return on investment. The bigger your capital requirements, the more funding you'll need. The bigger your return on investment, the better your chance of success in attracting that funding.
If you can produce energy for less than the expected revenue, you have a viable project. Your financial model will calculate the payback period — how long it will take for the project to pay off the costs associated with its development and operation.
Once you have your financial model, you'll know exactly what level of revenue you need to make the project viable. Will the cost of your project make it feasible? Work backwards from your revenue and check off your input costs. If the cost of producing is higher than the revenue, you can’t be competitive.
Your financial model shows you how much money you need for your project and a cashflow analysis outlines when you'll need it. The two go hand in hand, and it’s vital to check your income and expenses at each stage of the project.
When do you need to draw down on your credit facility to keep the project moving? Can you afford to pay the deposit to the wind turbine supplier – and prove you have the remaining payment available in a trust account or guarantee? A good projected cashflow will help you plan for these issues.
Before you start developing your financial model, you need to make assumptions about:
- energy capacity and output
- capital costs
- operating costs
- energy prices
- LGC or STC price
- interest rates
During the feasibility and planning phases, you’ll start to get more accurate information on all of these variables. Continue to update your financial model, checking your energy pricing will always cover your projected input costs. This ultimately determines the financial viability of your project, and how successful you'll be.
Hepburn Community Wind Park Co-operative case study
OSEA Community Power Financing Guidebook
Energy4all's financial models
Guide to Developing a Community Renewable Energy project in North America
Bankable Models which Enable Local Community Wind Farm Ownership
Funding the early stages of projects
Building the business case
Raising Debt - what banks look for
Developing the offer document, prospectus or PDS
Marketing to raise capital
Grants and government funding options