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Economic & Financial Aspects of

Renewable Energy Systems


Chayun Budiono
PT Gerbang Multindo Nusantara
Institut Teknologi Sepuluh Nopember (ITS), Surabaya
Outline

1. Objectives of Economic Analysis

2. Difference between Economic and Financial


Analysis

3. Financial & Economic Viability of RE Systems

4. Methodology and Methods in Economic Analysis

5. Sensitivity Analysis and Switching Value

6. Deficiencies in Economic Analysis


1. Objectives of the economic analysis

To compare costs with benefits of a project


during its service life, and to determine which
among alternative projects (e.g. hydro versus
diesel options) have an acceptable return on
investment, or which one is the least cost
option to supply electricity to an area or a
station.
Economics as criteria of project selection
Note: The economic analysis is only one among several criteria
of project selection or rejection applied by lending agencies,
donors or Governments. Other objectives may play a role in the
appraisal of (hydro) power projects, e.g.:
 Contribution to economic growth or other socio-economic
issues of a particular area;
 Substitution of imported fossil fuels by indigenous
renewable energy sources;
 Reduction of CO2 emissions in the energy sector;
 Demonstration value of a project in the context of
promotional activities of the Government and development
agencies; etc.
Intangible benefits
Such objectives are, however, difficult to quantify in
monetary terms. The benefits with respect to these
objectives are therefore called intangible benefits.
Intangible costs on the other hand may include
environmental degradation, unemployment, disease etc.
These intangible costs often come in the form of external
costs or externalities of a project, because these
negative effects have to be borne by somebody other
than the project participants - usually the society as a
whole - in the form of reduced quality of life, higher costs
for medical services etc.
2. Economic vs Financial Analysis

 The economic analysis estimates returns to society


/ the national economy as a whole.
 The financial analysis estimates returns to an
individual project participant, usually the developer.

Note: The term ‘economic analysis’ is often used in a


general context to mean the performance of both
calculations, economic and financial.
Economic analysis
For the society as a whole taxes and duties paid by the project
developer are not lost since these payments are still available to
the National economy and must therefore be deducted from the
turbine price in the economic analysis.
Similarly, subsidies by the Government to reduce prices of goods
or services must be added to market prices to reflect the true cost
of these goods to society.
Adjustment to market prices in economic analysis is called
shadow pricing and can be a very important but also difficult
aspect of analyzing power projects.
Financial analysis

In the financial analysis market prices are used when estimating


project costs. The price of a turbine for example may include
sales tax, value-added tax, import duties on imported
components, etc. These are all costs payable by the project
developer and must therefore be included in the financial
analysis.
Kompetisi ET vs Konvensional
PLTD Sistem Energi Terbarukan (ET)

- PLTS Terpusat untuk aplikasi terpencil


Luar Jawa
- Biomassa
- Paket PLTS Skala Kecil
PLN - SKEA Skala Kecil
JAMALI

PLTM dan
PLTMH

a/o: 2016
Financing Possibilities
In-kind community participation
to aim for sustainable operation

Level 1
Public and Level 2 Level 3
government PPP
funding Private investment
4. Economic Analysis Methodology

The economic analysis compares project costs with benefits.


Net benefit = Benefit - Cost

 It has become usual practice to use life-cycle costing,


i.e., all costs and benefits of a project over its estimated
service life are taken into account and not any shorter
period such as loan periods, etc.
Costs for RE Systems
During project preparation and construction:
 capital investment for civil works, equipment, etc. (incl. transport,
installation and commissioning costs);
 cost for project preparation, supervision and administration
 land acquisition and compensation
 costs for licenses, water rights, land usage, environmental permits
and other regulatory requirements.
During project operation:
 operation and maintenance costs of equipment
 administrative costs and overheads of power distribution company
including taxes
 replacement costs
 debt servicing of borrowed capital (only for financial analysis).
Benefits of RE Project

 Revenue from electricity sales


 Revenue from capacity sales
 Avoided cost of energy generation substituted by the new
project
 Subsidies from Government for providing electricity
services to a specific area or consumer group(s)
 Liquidation yield of replaced equipment (scrap value).
Economic Analysis Methodology
The methodology used for analyzing the economic and financial
merit of power projects comprises a comparison of the net benefit
for a scenario with and for another without the project:

 incremental net benefit = - net benefit with project


- net benefit without project

The project with the highest incremental net benefit is the preferred
option from the economics point of view.
Time Value of Money

Costs and benefits can have very different values for society
or for the developer depending on when they occur.
Present values are better than the same values in the future,
and early returns are better than later returns.
In other words, we need less money in our pocket today if the
investment is due next year as compared with the same
investment payable now.
In order to take account of these facts in our economic and
financial analysis the concept of discounting project worth is
used.
Contoh Compound Interest
Tahun (n) Deskripsi IDR
1 Modal awal (Principal – P) 1.000.000
Bunga (i) di tahun ke 1: @ 5% 50.000
Nominal pada akhir tahun ke 1 1.050.000
2 Bunga di tahun ke 2: @ 5% 52.500
Nominal pada akhir tahun ke 2 1.102.500
3 Bunga di tahun ke 3: @ 5% 55125
xx Jumlah Nominal (S) pada akhir tahun ke 3 1.157.625

Secara Matematis: 𝑆 = 𝑃(1 + 𝑖)𝑛

S= jumlah nominal pada akhir tahun (atau periode) ke n


P= modal awal atau Principal (P)
i = suku bunga per-tahun (atau per-periode)
Discount Factor

1
Discount Factor 
(1 i)n

where:
i discount rate, must be absolute, not in %
 (i.e.: 10% 0.1)
n number of periods (years) from the present (year 0) to
year n when the value occurs (end of that year)
Pengaruh Faktor Diskon
Discount rate : 10 %
Contoh investasi PLTD : 5 kW
Jam operasi : 10 jam/hari
Ketersediaan : 300 hari/tahun
Jam kerja : 3,000 jam/tahun
Produksi listrik tahunan : 15,000 kWh
Harga Solar (BBM) : 10,000 IDR/liter
Nilai kalor BBM : 10 kWh/liter
Opsi 1 Opsi 2
Harga per-kW USD 300 150
Efisiensi 30% 28%
Harga Unit USD 1,500 750
Kurs IDR/USD 13,500 13,500
Harga Unit IDR 20,250,000 10,125,000
Contoh: Pengadaan Disel
Tahun ke Pengeluaran
Opsi 1 Opsi 2
IDR IDR
0 20,250,000 10,125,000
1 52,437,500 54,968,750
2 52,437,500 54,968,750
3 52,437,500 54,968,750
4 52,437,500 54,968,750
Total cash-flow 230,000,000 230,000,000

- Tahun ke 0 adalah pengeluaran untuk pembelian & pembangunan


- Tahun berikutnya adalah untuk O&M (operation & maintenance)
- Laju Discount (discount rate):10%/th
Tahun ke Current Faktor Diskon Present
IDR IDR
0 20,250,000 1.000 20,250,000
Opsi 1 1 52,437,500 0.909 47,670,455
2 52,437,500 0.826 43,336,777
3 52,437,500 0.751 39,397,070
4 52,437,500 0.683 35,815,518
230,000,000 186,469,819

Tahun ke Current Faktor Diskon Present


IDR IDR
0 10,125,000 1.000 10,125,000
1 54,968,750 0.909 49,971,591
Opsi 2 2 54,968,750 0.826 45,428,719
3 54,968,750 0.751 41,298,835
4 54,968,750 0.683 37,544,396
230,000,000 184,368,541
Capital Recovery Factor
R R R
𝑃 = ෍ 𝑅(𝑃𝑉)

0 1 2 n periode

𝑅
𝑃1 =
(1 + 𝑖)

𝑅
𝑃2 =
(1 + 𝑖)2

𝑃𝑛 =
𝑅 𝑖(1 + 𝑖)𝑛
(1 + 𝑖)𝑛 𝑅=𝑃
(1 + 𝑖)𝑛 −1

Capital Recovery Factor


Methods of Economic Analysis
Static methods look at a project and the associated costs and
benefits independent of time; they do not consider the time
value of money.
Dynamic methods on the other hand treat costs and benefits
which occur at different points in time of a project with different
values.

Static methods should not be used to analyze the economics of


a power project. Thanks to computer models (spread sheets),
economic analysis using dynamic methods is no longer a time
consuming affair.
Terminology

Payback period: Time in years from the beginning of the project until the time
when the sum of the revenues from electricity sales (and other income) equals
the capital invested for the project.
Break-even point: The break-even point is usually taken as the minimum
tariff level required at which annual revenues from electricity sales exceed the
cost of production. For a given tariff, the break-even point can also mean the
year when due to increasing electricity sales the annual revenue exceeds
annual costs.
Annuity: An annuity is an amount paid or received annually. With the annuity
method, all costs and revenues (benefits) are expressed in equal annual
amounts. This allows quick calculation of unit production costs, pay-back
period and break-even point.
Terminology (cont.)
Inflation: In order to simplify economic analysis, inflation-free
values should be used, i.e., costs and benefits should be stated at
current prices and interest / discount rates should be inflation
corrected.
Inflation corrected interest rates are called real as opposed to
nominal rates which include inflation.

(1  i)
real interest / discount rate i 
*
1
(1  a )
where
i = discount rate (absolute, not in %)
a = inflation rate (absolute, not in %)
Inflation rate
Note: This simplification does not do away with the need to
make an estimate of the expected inflation rate over the project
period.
 Historical trends may be extrapolated as a first
approximation
 Predictions by the World Bank or other lending institutes
for a particular country may be consulted
Note: Different cost / benefit items of a project may have very
different escalation rates, e.g. the price of fuel may increase
faster as the salary cost of operators.
Simple Payback Method

• This method is categorized as a static method and does not look at benefits, it
only compares costs of the project and its alternatives.
• Divide the total cost of the investment by the projected annual cash inflow.
• If we predict different annual inflows during the payback period Take the
average of the cash inflows.

𝑇𝑜𝑡𝑎𝑙 𝐼𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡
𝑃𝑎𝑦𝑏𝑎𝑐𝑘 𝑃𝑒𝑟𝑖𝑜𝑑 𝑠𝑖𝑚𝑝𝑙𝑒 =
𝐴𝑛𝑛𝑢𝑎𝑙 𝐶𝑎𝑠ℎ 𝑖𝑛𝑓𝑙𝑜𝑤𝑠

For example, if the total investment for a small MHP project is


$100,000 and the average annual cash inflows of electricity sale are
$20,000, the payback period is five years.
Simplified Annuity Method
This method does not look at benefits, it only compares costs of
the project and its alternatives.
With this method unit production costs can be calculated by
dividing cost annuities by annual energy generation or sales
figures.
Annuity of Investment Cost + Annual O & M Cost
Energy Production Cost 
Annual Energy Production

The simplified annuity method presented gives good results if


generation figures and annual operating costs are fairly constant
over the whole project duration, which is usually the case for grid-
connected hydro power projects.
Simplified Annuity Method
Case: Wangan Aji MHP
A. Cost Fixed to Capital
Components Investments Technical Annual Maintenance Sum Fixed
Life Costs factor Cost Costs
000 IDR a 000 IDR/a % 000 IDR/a 000 IDR/a
Civil Works 386,452.40 20.00 51,737.78 2.00 1,034.76 52,772.53
Electro-Mechanical Equipment 1,175,000.00 5.00 325,956.44 2.00 6,519.13 332,475.56
Transmission/distribution line 44,640.00 30.00 5,541.77 2.00 110.84 5,652.61
Land Acquisition 72,000.00 20.00 9,639.27 2.00 192.79 9,832.06
Survey, Feasibility Study & DED 25,000.00 20.00 3,346.97 0.00 0.00 3,346.97
Contingencies 56,410.00 10.00 9,983.68 0.00 0.00 9,983.68

Average Life Cycle (n) 9.92


Total Investment 1,759,502.40 406,205.90 7857.505
Cost Fixed to Capital (A) 414,063.41

B. Cost Fixed to Operation


Input Costs Price Price Price Consumption Sum of
Factor (fc) Extrapolated Operating Cost
at (n) Against fc 000 IDR/a
Electricity 650 IDR/kWh 1.11 724.51 0 kWh/a 0.00
Lubricants 9,000 IDR/lt 1.25 11,220.15 438 lt/a 4,914.43

Wages
Engineer 42,000,000 Rp/th 1.35 56,519,221.42 2 % 1,130.38
Technician 21,000,000 Rp/th 1.35 28,259,610.71 25 % 7,064.90
Helper 12,000,000 Rp/th 1.35 16,148,348.98 100 % 16,148.35
Cost Fixed to Operation (B) 29,258.06

C. Recapitulation
Electricity Cost Breakdown
Total Cost (A+B) 443,321,469 Rp/a Capital 491.73 Rp/kWh 91.63 %
Energy Generated 826,080 kWh/a Maintenance 9.51 Rp/kWh 1.77 %
Operational 35.42 Rp/kWh 6.60 %
Average Electricity Cost 536.66 IDR/kWh ----------- ---------- ---------- ---
6.26 US₡/kWh Total 536.66 Rp/kWh 100.00 %

Levelized Electricity Cost 5.62 US₡/kWh

28
Case MHP 30kW
Case MHP 30kW
Cost-Benefit Analysis
 All cash expenditure and revenues are tabulated during the
chosen period separately for each year.
 A net benefit for each year can be calculated by subtracting
expenditure from revenue.
 Each year’s net benefit is then discounted to the present
and cumulatively added to a single sum, the so-called net
present value (NPV) of the project.
 This NPV is then compared with the NPV of alternatives.
The project with the highest NPV is the preferred option.
Discounted Cashflow Method

➢ All cash expenditure and revenues are tabulated during


the chosen period separately for each year.
➢ A net benefit for each year can be calculated by
subtracting expenditure from revenue.
➢ Each year’s net benefit is then discounted to the present
and cumulatively added to a single sum, the so-called
net present value (NPV) of the project.
➢ This NPV is then compared with the NPV of
alternatives. The project with the highest NPV is the
preferred option.
Internal Rate of Return

The net present value does not say anything about the
value of the project as compared to other infrastructure
projects (e.g. a road or a school). For this we can calculate
the internal rate of return (IRR) of a project.

Funding agencies or Governments use the IRR as a


selection criterion. They could accept all projects with an
IRR greater than the cut-off rate, which is usually taken as
the opportunity cost of capital, or the rate at which a
developer can borrow money.
Discounted Cash-flow Method
Discounted Cash-flow: Case MHP Wanganaji

Total hydro capital cost 1,759,502,400 IDR Selling Conditions


Hydro capital cost per kW installed capacity 1,656 US$ Tariff 443.46 IDR/kWh
Hydro capital cost per kW installed capacity
14,076,019 IDR Annual tariff increase 3% per annum
1 US$ = 8,500 IDR Transmission losses 4.00%
Plant capacity hydro 125 kW Grid Availability 95.00%
Annual generation 971,598 kWh/a
Discount rate (nominal) 12.00% Results:
Discount rate (real) 12.00% NPV 1,567,378,230 IDR (at end year 0)
Inflation rate 0.00% FIRR 23.1% % (nominal)
Service life 25 years Payback period 4 years
O&M hydro 39,957,293 IDR/a

Annual Energy
Operation & Total Energy Sell Gross Investment
Production Investment Net Cash-Flow
Maintenance Payback
Year total PLN Selling Tariff PLN Revenue
kWh/a IDR IDR/a kWh/a IDR/kWh IDR/a IDR/a IDR/a IDR/a
2004 0 -1,759,502,400 -1,759,502,400 -1,759,502,400 -1,759,502,400
2005 1 971,598 -39,957,293 886,098 443.46 392,948,830 392,948,830 352,991,537 -1,406,510,863
2006 2 971,598 -39,957,293 886,098 456.76 404,737,295 404,737,295 364,780,002 -1,041,730,861
2007 3 971,598 -39,957,293 886,098 470.47 416,879,414 416,879,414 376,922,121 -664,808,741
2008 4 971,598 -39,957,293 886,098 484.58 429,385,796 429,385,796 389,428,503 -275,380,238
2009 5 971,598 -39,957,293 886,098 499.12 442,267,370 442,267,370 402,310,077 126,929,839
2010 6 971,598 -39,957,293 886,098 514.09 455,535,391 455,535,391 415,578,098 542,507,937
2011 7 971,598 -39,957,293 886,098 529.51 469,201,453 469,201,453 429,244,160 971,752,097
2012 8 971,598 -39,957,293 886,098 545.40 483,277,496 483,277,496 443,320,203 1,415,072,300
2013 9 971,598 -39,957,293 886,098 561.76 497,775,821 497,775,821 457,818,528 1,872,890,828
2014 10 971,598 -39,957,293 886,098 578.61 512,709,096 512,709,096 472,751,803 2,345,642,631
2015 11 971,598 -39,957,293 886,098 595.97 528,090,369 528,090,369 488,133,076 2,833,775,706
Depreciation
Depreciation or the writing down of project assets need not be
taken into account when using the discounted cash-flow
method, because all costs and benefits throughout the service
life of the project are already included.
Exception: In the financial cash-flow analysis depreciation of
project assests can have an impact on profit taxes to be paid on
income generated by the project.
Remarks on discounted cash-flow
 In the discounted cash-flow method the same period of years
must be used for each alternative project. For small-scale
hydropower schemes an analysis period of 20 to 25 years is
usually applied.
 The alternatives must be able to supply the same demand
profile (both energy and peak power).
 If the period of analysis is shorter than the service life of the
equipment then the discounted salvage value must be
deducted from expenditure.
Investment cost
Estimated investment costs for grid-connected small-scale
hydropower plants (example):

Civil works 1 000 to 3 000 USD/kW


Electro-mechanical equipment 400 to 1 300 USD/kW
Transmission lines, transformation, grid 50 to 200 USD/kW
connection
Project planning and design, site 50 to 500 USD/kW
supervision, project management
Total: 1 500 to 5 000 USD/kW
Cost estimating: Unit Price Analysis

Unit Price Analysis October 29, 2003

Unit Price Total


No. Position Quantity Unit
IDR IDR
1 1 M3 SOIL EXCAVATION 9,875
workers 0.75 day 12,500 9,375
foreman 0.025 day 20,000 500
pos 10% 10,863
2 1 M3 CORAL/STONE EXCAVATION 60,000
workers 4 day 12,500 50,000
foreman 0.5 day 20,000 10,000
pos 10% 66,000
3 1 M3 ROCK/STONE MASONRY 1:3 293,988
rock/stone 1.2 m3 58,000 69,600
portland cement 5.16 bag 23,000 118,680
sand 0.4644 m3 70,000 32,508
workers 3.6 day 12,500 45,000
mason 1.2 day 18,500 22,200
rock/stone foreman 0.12 day 20,000 2,400
foreman 0.18 day 20,000 3,600
pos 10% 323,387
4 1 M3 ROCK/STONE MASONRY 1:4 272,337
rock/stone 1.2 m3 58,000 69,600
portland cement 4.124 bag 23,000 94,852
sand 0.4955 m3 70,000 34,685
workers 3.6 day 12,500 45,000
mason 1.2 day 18,500 22,200
rock/stone foreman 0.12 day 20,000 2,400
foreman 0.18 day 20,000 3,600
Cost estimating: Bill of Quantities

Mini Hydropower Scheme Wangan Aji, Wonosobo, Central Java


Cost Estimate (Qd = 1420 l/s, P = 125kW) Date: October 29, 2003
No. Item / Specification Unit Quantity Rate Total
Summary
A Civil Works 386,452,400
B Electro-Mechanical Equipment 1,175,000,000
C Transmission and Distribution Lines 44,640,000
D Land Acquisition 72,000,000
E Survey, Feasibility Study & Detailed Design 25,000,000
F Contingencies 56,410,000
Total Project Cost (Rupiah) 1,759,502,400

Approx USD 1700 per-kW


A Civil Works
Section 1: Preliminary and General
Total Section 1 (carried forward to summary Part A) Rupiah 18,000,000

Section 2: Intake Works


Total Section 2 (carried forward to summary) Rp. 14,557,566

Section 3: Forebay
Total Section 3 (carried forward to summary Part A) Rp. 23,942,479
Operation and maintenance cost
Cost item Description Annual O&M costs in
% of capital cost
a) Personnel Operators, linesmen, according to local salary
revenue collectors (if levels
applicable)
b) Administration Insurance, customer according to local rules
service costs, land rent, and regulations
taxes, water fees, other
duties
c) Maintenance of civil materials (paint, cement, 0.2 to 1 % of capital costs
works (incl. access etc.) and local manpower of the civil works
roads, powerhouse,
fuel tanks etc. of diesel
power stations)
Operation and maintenance cost..
Cost item Description Annual O&M costs
in % of capital cost
d) Maintenance of E/M spare-parts and salaries of 1 to 3 % of capital costs of
equipment local fitters, electricians E/M equipment of MHP
e) Maintenance of spare parts and repairs of 1 to 3 % of capital costs of
electrical gear of switch gear, control panels, diesel switch gear,
diesel generators transformers transformers etc.
f) Maintenance of bush cutting, fuses, 1 to 3 % of capital costs of
transmission & insulators, cross-arms, poles T&D
distribution works
g) Overheads of communications, postage, according to local
electricity utility or staff housing, head office conditions
local operator charges, management costs
Specific O&M Variable Costs
Cost item Description Specific costs
High-speed a) Fuel consumption of high-speed 0.28 - 0.40 l/kWh of
diesel diesel generators diesel fuel (costs for fuel
generators transport, storage and
handling to be included)

b) Lubricants of high speed diesel 1 % of fuel costs


generators
c) Maintenance of high speed diesel US$ 0.03 to 0.10 / kWh
generators (filters, belts, gaskets,
spare parts and manpower for
overhauls)
SHP plants no energy-related /
variable costs
5. Sensitivity analysis
All projects should be subjected to sensitivity analysis as
it is the most effective tool for analyzing the risks and
uncertainties of projects.

For the sensitivity analysis the economic or financial analysis is


simply recomputed using the new estimates of project costs,
discount rates, energy sales, etc., one after the other for both the
‘with-project’ as well as the ‘without-project’ situation.

Note: only one parameter in the analysis can be changed at a


time.
Example: sensitivity analysis, base scenario
Installed Capacity 1 000 kW
Specific Investment Cost MHP Scheme 3 000 USD/kW
Total Investment Cost MHP Scheme 3 000 000 USD
Average Annual Inflation rate 0 %
Average Interest/Discount Rate 10 %
Inflation Corrected Interest Rate 10 %
Service Life MHP Scheme 25 years
Annuity of Investment 330 504 USD
Annual Cost Operation & Maintenance 3.0 % of Investment
Annual Cost Operation & Maintenance 90 000 USD
Plant Availability 95 %
Average Plant Factor 65 %
Average Annual Energy Production 5 409 300 kWh
Average Energy Production Cost 7.77 US¢/kWh
Ex: Sensitivity vs specific investment cost

Average Energy Production Cost 12


Cost (US₡/kWh)
10

8
[USc/kWh]]

6
Electricity

0
2,000 2,500 3,000 3,500 4,000
Specific Investment Cost [USD/kW]
Ex: Sensitivity of O&M cost

Cost
(US₡/kWh) 12

10
Production

8
[USc/kWh]]
Cost

6
Energy
Electricity

4
Average

0
1 2 3 4 5
Annual O&M Cost [% of Investment]
Ex: Sensitivity of plant capacity factor
12

(US₡/kWh)
CostProduction Cost 10

8
[USc/kWh]]

6
Energy
Electricity

4
Average

0
55 60 65 70 75
Plant Capacity Factor [%]
Ex: Sensitivity of Plant Availability
12
Average Energy Production Cost
Cost (US₡/kWh)
10

8
[USc/kWh]]

6
Electricity

0
90 91 92 93 94 95 96 97 98 99 100
Plant Availability [%]
Ex: sensitivity of interest rate

Average Energy Production Cost 12


Cost (US₡/kWh)
10

8
[USc/kWh]]

6
Electricity

0
6 8 10 12 14
Discount Rate [%]
Ex: Sensitivity of Service Life
12

Average Energy Production


Electricity Cost (US₡/kWh) 10
Cost [USc/kWh]]
8

0
0 10 20 30 40 50
Service Life [years]
6. Common deficiencies in E&F analyses

 Cost estimates incomplete – missing items such as land


acquisition, interconnection equipment, transportation and
installation of equipment, and environmental mitigation.
 Interest during construction not taken into account
 Escalation of project costs not considered
 Absence of rationale used to select key parameters, such as
interest rates or term of loans
 No discussion of “negative cash flow” and its impact on the
financial feasibility of a project
Thank you