10/20/2014

Financial Aspects
of Micro Hydro Power (MHP)

Outline
1.Economic & Financial Viability of RE
Systems
2.Objectives of Economic Analysis
3.Methodology and Methods in Economic
Analysis
4.Sensitivity Analysis and Switching Value
5.Business model, bankability and fund-
mobilization
6.Case Studies

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1. Econom1. Economic & Financial Viability of RES1.

1. Economic & Financial
Economic Viability
& Financial Viabil of RES
Diesel Generating Set (DGS) Renewable Energy System (RES)
2500
Generating Cost (IDR/kWh)

Competition at non-subsidized oil price - Rural and remote PV

2000
Island Grid
1500 - Biomass
Competition at subsidized oil price - Small package PV
1000
- Small wind

MV Jawa-Bali Grid
500

Mini- and
0
micro-hydro
Subsidized Oil Market Oil Price Level 1 RES Level 2 RES Level 3 RES

Competitivenes Category of Generating Plant

Financial Comparison Economic Comparison

1 USD 9,000 IDR

Financing Possibilities
In-kind community
participation to aim for
sustainable operation

Level 1 Level 3
Public and Private
Level 2
governmen investment (e.g.
PPP* community,
t funding
cooperative,
individual, etc)
*Public & Private
Partnership

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2. 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.

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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.
The type of economic analysis presented here
does not include such intangible costs and
benefits and externalities.

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.

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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.

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3. 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 small hydro power

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 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).

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Benefits of small hydro power

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.

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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.

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)

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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.

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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.
(i +1)
real interest /discount rate i* = 1
(a + i)
, where
i = nominal interest or 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.

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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.

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, 50 to 200 USD/kW
grid connection
Project planning and design, site 50 to 500 USD/kW
supervision, project management
Total: 1 500 to 5 000 USD/kW

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Cost estimating: Bill of

Quantities

Operation and maintenance cost

Cost item Description Annual O&M costs in
% of capital cost
a) Personnel Operators, linesmen, according to local
revenue collectors (if salary 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, 0.2 to 1 % of capital
works (incl. access cement, etc.) and local costs of the civil works
roads, powerhouse, manpower
fuel tanks etc. of
diesel power
stations)

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Operation and maintenance cost..

Cost item Description Annual O&M costs
in % of capital cost
d) Maintenance of spare-parts and salaries of 1 to 3 % of capital costs
E/M equipment local fitters, electricians of E/M equipment of
MHP
e) Maintenance of spare parts and repairs of 1 to 3 % of capital costs
electrical gear of switch gear, control of diesel switch gear,
diesel generators panels, transformers transformers etc.
f) Maintenance of bush cutting, fuses, 1 to 3 % of capital costs
transmission & insulators, cross-arms, of T&D
distribution works poles
g) Overheads of communications, postage, according to local
electricity utility staff housing, head office conditions
or local operator charges, management
costs

Variable operation and maintenance cost

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
generators fuel 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 /
generators (filters, belts, gaskets, kWh
spare parts and manpower for
overhauls)
SHP plants no energy-related /
variable costs

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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 years 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 Cash-flow Method

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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.

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.

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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.

4. 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.

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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

12
Electricity Cost (US/kWh)

10

0
2,000 2,500 3,000 3,500 4,000
Specific Investment Cost [USD/kW]

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Ex: Sensitivity of O&M cost

12

Electricity Cost (US/kWh) 10

0
1 2 3 4 5
Annual O&M Cost [% of Investment]

Ex: Sensitivity of plant capacity factor

12
Electricity Cost (US/kWh)

10

0
55 60 65 70 75
Plant Capacity Factor [%]

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Ex: Sensitivity of Plant Availability

12

Electricity Cost (US/kWh) 10

0
90 91 92 93 94 95 96 97 98 99 100
Plant Availability [%]

Ex: Sensitivity of interest rate

12
Electricity Cost (US/kWh)

10

0
6 8 10 12 14
Discount Rate [%]

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Ex: Sensitivity of Service Life

12
Electricity Cost (US/kWh)
10

0
0 10 20 30 40 50
Service Life [years]

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

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5. Business Model , bankability etc

Typical performance:

Capacity factors:
Off-grid Sale - Off-grid 25-30%
- On-grid 60-70%

Electricity Sale:
On-grid Sale - Off-grid 40%
- On-grid 60%

Revenue
- Off-grid 25%
- On-grid 75%
Typical Profile MHP Kalimaron

Business Model
In-kind community
participation to aim for
sustainable operation

Level 1 Level 3
Public and Level 2 Private
governmen investment
PPP*
t funding (e.g. community,
cooperative,
individual, etc)
*Public & Private
Partnership

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Business Model
There are several business model that can be developed in the electrification
sector depending on the existing policies and regulations.

Energy Service Company (ESCO)

ESCO scheme basically generates and sells electricity directly to consumer through
local grid. If the national utility grid available, electricity surplus can be exported
through the utility grid provided that the regulation allows.
Independent Power Producer (IPP)
IPP mainly generates electricity and sells it to the utility grid (common practice).
Franchise
In some countries electricity distribution within the country is divided into several
region or area. Each area are considered as the Franchise Area - FA. The
distribution of electricity in certain area will be carried out by the franchisee which
is normally a community base organization like cooperative.

Bankability
Acceptable for processing by a bank; has minimum risks and
considered powerful enough to ensure profitability.
Guarantees:
Project guarantees: not sensitive to parameter changes,
acceptable IRR and short-term pay-back period (preferably 5
years)
Fixed-asset guarantee, such as: marketable land.
State Guarantee (mostly in connection with PPP program) to
ensure: e.g. public sector policy, financial and project risk
drivers. Type of State Guarantee among others: Finance
Guarantees (like: loan guarantee) and Contract Provision.

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6. Case Study, MHP Wanganaji

Jawar (WA-1)
11.3 m; 1.4 m3/s; 125 kW
Argopeni (WA-2)
50.0 m; 1.0 m3/s; 260 kW
Mangli (WA-3)
37.0 m; 2.0 m3/s; 500 kW
Kalitulang (WA-4)
26.0 m; 1.0 m3/s; 180 kW
Geblok 1 (WA-5)
30.0 m; 4.0 m3/s; 900 kW
Geblok 2 (WA-6)
30.0 m; 4.0 m3/s; 900 kW
Total 2,855 kW

PPP & Community Base MHP

Wanganaji
WA-1:
Investment Cost : USD 250,000
NPV : USD 150,000
FIRR : 22.1%
EIRR : 26.5%
Payback Period : 4-5 years

Financing
Public (Central & local govt) : USD 187,500 (75%)
Community (Cooperatives) : USD 62,500 (25%)

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Projected Revenue

Sensitivity of Investment

Purchase tariff decrease of 10%

decreases FIRR by 3%
Increase of O&M by 10% reduces
the FIRR by 0.35%
Reduction of electricity sales by 10%
reduces the FIRR by 2.3%

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PPP Scheme on MHP Wanganaji

Public Funds
Financial Institutions, e.g.
Pilot Intervention Banks
Energy Coop.

Revolving fund
75%

25%
Local Coop 1 WA-1

Local Coop 2 WA-2

Local Coop 3 WA-3

WA is an Operating Unit of Local Cooperative

Sustainable Scheme
Managerial
Capacity
Dedicated Human
Resources

Willingness and ability to pay Sufficient fund for O&M

Transparent management Trained local operator
Well maintenance and
Management operating procedure
Sufficient spare parts

Security of Reliable, financially

Consumer Technical viable and
sufficient System
income environmentally
Sound

Satisfies the electricity

demand of the consumer
Guarantees quality and
continuous supply of
electricity

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