www.dreberis.com

Profitability of Renewable Energy Investments in Different Remuneration Systems in the European UnionInfluence of Risk Elements on Capital Costs

Dr. Markus Reichel / Stephan Wegert / Friedrich Czambor

www.dreberis.com

Outline

1. EU targets for renewable energy sources

2. Remuneration schemes for electricity from RES in Germany, Poland, Bulgaria and Romania

3. Comparing wind projects in different countries

4. Variations in capital costs

5. Influence of country and market risk on the necessary minimum average prices

6. Conclusions

www.dreberis.com

EU Targets for Renewable EnergySources

Outline

3

www.dreberis.com

EU Targets for RES

Political aims of the EU:• Increase of energy security• Decrease of greenhouse gas emissions

Power from renewable energy sources has to play a major role

Directive 2001/77/EC: ca. 22% electricity produced from RES to gross electricity consumption by 2010EU 2020 target (draft for directive): 20% share of RES to final energy consumption

Need for promotion of RES in EU member states Support schemes: feed-in tariff vs. quota system

www.dreberis.com

Support Schemes for RES

Feed-in tariffs:• obligations by electricity suppliers to purchase electricity from RES• guaranteed fixed prices over a certain period (e.g. 20 years)• no sales risk for RES power producers • freedom to choose between fixed feed-in tariffs and electricity

market price

Quota system:• a certain share of RES power must be produced or bought by

producers or suppliers or customers• tradable green certificates (TGCs): separation TGC market –

electricity market• control of the compliance with the quota• sales risks for RES power producers

www.dreberis.com

Feed-in Tariffs vs. Quota systems - Questions

• What is the influence of the national approach on the energy prices to be expected?

• How do country risks and market risks influence capital costs and thus production costs?

• When does a promotion system lead to overcompensation and will no be accepted by the EU, which should be interested in creatingcommon conditions throughout the EU?

www.dreberis.com

Support Schemes for RES

Country Support scheme Share of RES in final energy consumption

(2005)

Target 2020

Germany Feed-in tariff 5,8% 18%

Poland Quota system 7,2% 15%

Romania Quota system 17,8% 24%

Bulgaria Feed-in tariff 9,4% 16%

www.dreberis.com

Remuneration Schemes in Germany, Poland, Bulgaria and Romania

Outline

8

www.dreberis.com

Germany – Feed-in Tariff

Technology Range of feed-in tariffs per MWh

Remuneration period (years)

Degression factor (year over year)

Wind power (onshore)

92.00 € 20 1.0 %

Wind power (offshore)

130.00 € 20 5.0 % (from 2015)

Hydropower 126.70 – 35.00 € 20 (over 5 MW: 15) 1.0 %

Biomass 116.70 – 77.90 € 20 1.0 %

Landfill gas, mine gas, sewage gas

90.00 – 41.60 € 20 1.5 %

Geothermal 160.00 – 105.00 € 20 1.0 %

Photovoltaics 430.10 – 250.10 € 20 10 – 8 %

www.dreberis.com

Poland – Quota System

2006 2007 2008 2009

Electricity price (PLN/MWh) 117.49 PLN 119.70 PLN 128.80 PLN n.s.

Max. TGC price (penalty fee) 240.00 PLN 242.40 PLN 248,46 PLN 258,89 PLN

Total (PLN / MWh) 357.49 PLN 362.10 PLN 377,26 PLN n.s.

Exchange rate 3.90 3.78 3.52 4.40

Total (EUR / MWh) 92 EUR ca. 96 EUR ca. 107 EUR n.s.

www.dreberis.com

Development of Quota in Poland

5,1

8,710,4 10,4

11,9 12,4 12,9

7,0

10,911,4

10,4

0

2

4

6

8

10

12

14

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

%

www.dreberis.com

Bulgaria – Feed-in Tariff

• Act on renewable energy sources and biofuels (19.07.2007)

• Mandatory purchase price for wind installations (after 01.01.2006):» effective operation < 2250 hours p. a. 175 Lewa/MWh

(ca.89,38 €/MWh),» effective operation > 2250 hours p.a. 156 Lewa/MWh

(ca. 79,67 €/MWh),» installed capacity up to 10 MW: 120 Lewa/MWh

(ca. 61,29 €/MWh)

• 1 EUR = 1,958 BGN (fixed exchange rate)• These prices are valid only for projects that start energy production

in 2010 at the latest.

www.dreberis.com

Romania – Quota System

• Mandatory quota system established in 2004 • Confirmed by the new law for the promotion of RES, Nov. 2008• But due to flaws in the legal text and fears of overcompensation for

certain technologies, the law is currently under revision. • Share of electricity produced from renewable energy sources in the

final national consumption (E- RES ) for the period 2008-2020:

2008 5,26% 2015 10,8%2009 6,28% 2016 12,0%2010-2012 8,3% 2017 13,2%2013 9,0% 2018 14,4%2014 10,0% 2019 15,6%

2020 16,8%

www.dreberis.com

Romania – Quota System

• Remuneration according to old legislation:» Regulated electricity price for RES: 132 RON/MWh (31,04 EUR)

+ 1 TGC per produced MWh (TGC price: 24 - 42 EUR/MWh)» Total price for wind energy: 55 – 73 EUR/MWh

• Remuneration according to new law (Nov 2008, but not in force yet)» Electricity sale on the market, with balancing risk

Average electr. price on day-ahead market 2008: 51 EUR/MWh» Number of TGC per MWh depending on technology

(1 for Small Hydro, 2 for Wind Energy, 3 for Biomass)» Price of 1 TGC: 28 – 55 EUR/MWh» Total price for wind energy: ca. 107 – 161 EUR/MWh

www.dreberis.com

Comparing wind projects in different countries

Outline

15

www.dreberis.com

Comparing wind projects in different countries

• Wind energy is not yet competitive to usual energy sources. • All promotion systems have in common that the provide electricity

sales prices above market average. • Due to the absence of guaranteed sales prices, investment risks are

much higher for projects in quota systems compared to systems that are based on feed-in tariffs.

• In addition, political risks vary across countries. This is especially the case in the new member states in Central and SoutheasternEurope, compared with countries like Germany.

• However, the European commission will try to ensure, that promotion systems do not distort competition in the Common European Market.

www.dreberis.com

A Standard Wind Power Project

Installed power [MW] 2 MW

Net operating hours 2.200 h

Investment costs [EUR/kW] 1.150 EUR/kW

Maintenance (before and after warranty eripod)

7,5 EUR/MWh14,5 EUR/MWh

Repairs 3%

Administration 10.000 EUR/a

Land 3600 EUR/a

Lifetime 20 years

www.dreberis.com

Variations in Costs of CapitalOutline

18

www.dreberis.com

Costs of Capital

WACC = Share of Equity * Cost of Equity + Share of Debt * Cost of Debt * (1 – Tax rate)

Costs of equity can be estimated on basis of CAPM:

Cost of Equity = Rf + CERP + Equity Beta *(MRP)

» Rf … The Risk free rate is usually set at the rate of long-term US or Euro treasury bonds.

» CERP … The Country Equity Risk Premium reflects the country default risk, adjusted by the volatility of the equity market.

» Equity Beta … estimates the volatility of the company’s shares in compare to the overall equity market.

» MRP … The market risk premium reflects the long-term difference in the yield of equity vs. government bonds.

www.dreberis.com

Costs of Capital

WACC = Share of Equity * Cost of Equity + Share of Debt * Cost of Debt * (1 – Tax rate)

Cost of debt depends on the countries as well as on the company’s default risk.

Cost of debt = Rf + CRP + Company default spread

» Rf … Risk free rate

» CRP … Country risk premium

» The Company default spread will result from the credit rating of the investor. We choose a proxy of 1,00%.

• Due to differences in country risks, equity betas and the tax rates, a standardized investor will face different capital costs in each country.

www.dreberis.com

Costs of Capital

• What are the key drivers of the Equity Beta?

» Debt leverage:Equity Beta = Asset Beta * (1+ [(1-t) * Debt/Equity])

» Following the bottom-up approach, the asset beta should be estimated specifically for each business activity.

» The asset beta is depending on the volatility of revenues and the operational leverage of the company (i.e. share of fixed costs)

Asset Beta = Revenue Beta * (1 + PV(fixed costs)/PV(assets) )

www.dreberis.com

Costs of Capital

• Unfortunately, there is very low information about asset betas in wind energy!

• What would be a comparable industry?

We see that the revenue beta should be very low in a feed-in tariff environment. As prices are definite for each kWh produced, uncertainties in revenues can only result from losses in production and political risks (i.e. the change of legislation).

Furthermore, the share of variable costs is very low.

A similar industry would be water utilities with strong regulation regarding prices, low volatility in demand and a very high share of fixed cost.

www.dreberis.com

Costs of Capital

• The Asset Beta for systems based on feed-in tariff is set at 0,33 (same value as for water utilities in Europe, see Damodaran)

• In quota systems, revenues depend on the demand for green certificates on the market. Besides established max. or min. prices and a mandatory demand, revenues are still much more uncertain in comparison to feed-in tariffs

• We assume that the revenue beta in quota system is twice the revenue beta as in systems with feed-in tariff

• Thus, the Asset Beta for quota systems is set at 0,66.

www.dreberis.com

Germany Poland Bulgaria Romania

Cost of Equity - feed-in tariff 8,39% 12,25% 14,73% 14,58%Cost of Equity - quota system 11,79% 15,91% 18,61% 18,31%

Risk free rate 5,00% 5,00% 5,00% 5,00%Country risk premium (CRP)[1] 0,00% 2,40% 3,90% 3,90%Country equity risk premium 0,00% 3,60% 5,85% 5,85%Market risk premium 5,00% 5,00% 5,00% 5,00%Asset Beta for Industry -feed-in tariff [2] 0,33 0,33 0,33 0,33Asset Beta for Industry -quota system[3] 0,66 0,66 0,66 0,66Equity Beta (levered with debt) - feed-in tariff 0,68 0,73 0,78 0,75Equity Beta (levered with debt)- quota system 1,36 1,46 1,55 1,49

www.dreberis.com

Germany Poland Bulgaria Romania

Cost of debt (adjusted with CRP) 6,00% 8,40% 9,90% 9,90%

Risk free rate 5,00% 5,00% 5,00% 5,00%Country default risk 0,00% 2,40% 3,90% 3,90%Company default risk 1,00% 1,00% 1,00% 1,00%

Share of equity 40% 40% 40% 40%Share of debt 60% 60% 60% 60%Marginal tax rate 29,51% 19% 10% 16%

WACC after tax - feed-in tariff 5,90% 8,98% 11,24% 10,82%WACC before tax - feed-in tariff 9,87% 12,27% 13,15% 14,01%WACC after tax - quota system 7,25% 10,45% 12,79% 12,31%WACC before tax- quota system 11,80% 14,08% 14,87% 15,79%

www.dreberis.com

Influence of country and market risk on the necessary minimum average prices

Outline

26

www.dreberis.com

Approach

• Standard DCF model• Standard assumptions of investment and operational

costs• Implementation of market and country specific WACCs• Calculation of minimum average price, which is

necessary to create an NPV>0• Details of promotion schemes cannot be considered at

this stage

www.dreberis.com

Average Minimum Energy Prices

Country Germany Poland Bulgaria Romania WACC after tax - quota system 7,25% 10,45% 12,79% 12,31% Price [€/MWh] - quota system 83,32 95,56 105,00 104,35 WACC after tax - feed-in tariff 5,90% 8,98% 11,24% 10,82% Price [€/MWh] - feed-in tariff 77,81 88,62 97,03 96,59

Source: own calculations

www.dreberis.com

Average Minimum Energy Prices

www.dreberis.com

ConclusionsOutline

30

www.dreberis.com

Conclusions

• In certificate schemes prices, all other conditions fixed, have to be higher to attract investors.

• Not only do countries with a higher country risk have to face higher prices, but the spread between the feed-in and the certificate scheme is even bigger, the higher the country risk is.

• The question, if a specific promotion scheme leads to overcompensation, not only needs to be discussed in dependence of the technology, but also of the country and market approach.

www.dreberis.com

Conclusions

• It is a reasonable question to be asked, if a society is willing to pay in general higher prices in order to have on the other hand the advantage of the implementation of market oriented promotion systems (i.e. certificate schemes).

• It furthermore shows, that poorer countries have (in comparison with countries like Germany) a bigger burden in reaching the same share of RES in electricity production.

www.dreberis.com 33

Gern beantworten wir Ihre Fragen

» Bitte kontaktieren Sie uns!

Contact Details

DREBERIS GmbHGostritzer Str. 61-6301217 Dresden

Tel. +49 351 871 8344Fax +49 351 871 8448E-Mail office@dreberis.com