Risk, return and valuation of wind farms through the project - - PowerPoint PPT Presentation

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Risk, return and valuation of wind farms through the project lifecycle

Megan Raynal All Energy Conference,11 October 2017

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Risks, Returns and Valuation

Over the last two years there has been a surge in interest and investment in the renewable energy sector due to the 2020 RET target, forecast high energy prices for the next few years and innovative funding provided by organisations such as the Clean energy finance corporation. More investors are interested in renewable energy. There are now many small scale investors, as well as large investors. In addition, existing investors are moving into different stages in the project lifecycle. For example, institutional investors are moving into construction stage projects, whereas historically they more commonly focused on brownfields projects. As investment increases, margins and IRRs are getting tighter across many assets. It is therefore important to understand drivers of risk and return across the project lifecycle. This presentation will look at three stages in the project lifecycle: 1. greenfields/development 2. construction/seasoning 3. brownfields/operational

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Types of Value

Market Value International Valuation Standards Council (“IVSC”) definition: “Market Value is the estimated amount for which an asset or liability should exchange on the valuation date between a willing buyer and a willing seller in an arm’s length transaction, after proper marketing and where the parties had each acted knowledgeably, prudently and without compulsion.” Special Value Special value does take into account the specific circumstances of the buyer or seller, and may include a strategic premium or discount.

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There are two kinds of value – market value and special value. The concept of market value does not consider the circumstances of any specific buyer or seller, and does not include any strategic premium that may be placed

• n the business or asset by a particular buyer or seller. Special value on the other hand, does take into account the specific circumstances of the buyer or seller,

and may include a strategic premium or discount. The difference between market value and special value is important to know because some wind farm transactions represent special value, not market value,. For example, buyers want to obtain certainty of power supply, or they want to test or showcase new technology, and so they may be prepared to pay more than market value. The concepts of market and special value are relevant when we look at the different stages of the project, because at each stage there may be different investors with different goals. Bearing this in mind, lets have a look at who invests at each stage.

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Contracts and counterparties impact risk and reward

Greenfields & Construction

On many projects, the Engineering Procurement and Construction (“EPC”) Contractor is often the equity investor at the greenfields and construction

• stages. EPC Contractors typically sell down once construction is complete so they don’t tie up capital.

In addition to EPC contractors, institutions such as super funds are becoming increasingly involved in equity investment at the construction stage. At the greenfields stage, equity investors, particularly EPC contractors, may have specific strategic reasons to invest, outside of financial returns, so the value paid may reflect special value, not market value.

Equity investors Lenders Connection Agreement EPC Contractor O&M Contractor Offtaker Tripartite Agreements Network Distributor Operation & Maintenance ("O&M") Power Purchase Agreement ("PPA")/ Offtake Agreement Engineer, Procure & Construct Project Company Equity Agreement Finance Agreements

Source: Construction, operation, regulatory and bankability issues for utility scale renewable energy projects, PwC, Feb 2016

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Contracts and counterparties impact risk and reward

Brownfields/operations

At the brownfields stage, equity investors are more commonly institutional investors who are looking for financial reward and focus on market value. The operations and maintenance contractor and/or offtaker may also be an equity investor, particularly if their main business is operating energy generation facilities. For most equity investors and lenders, long term Purchase Price Agreements (“PPAs”) make the investment more attractive. It is mainly operators that prefer merchant risk. Now we have looked at contracts and counterparties, lets have a look at the key valuation considerations at each stage.

Source: Construction, operation, regulatory and bankability issues for utility scale renewable energy projects, PwC, Feb 2016

Equity investors Lenders Connection Agreement EPC Contractor O&M Contractor Offtaker Tripartite Agreements Network Distributor Operation & Maintenance ("O&M") Power Purchase Agreement ("PPA")/ Offtake Agreement Engineer, Procure & Construct Project Company Equity Agreement Finance Agreements

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Greenfields/Development stage

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The greenfields/development stage involves feasibility studies, design, environmental impact assessment, agreements and applications, wind studies, establishment of procurement and contracts, a business case, and culminates in a final investment decision. Valuation approaches include discounted cash flows and multiples-based approaches.

• For discounted cash flows we look at different scenarios for pricing, demand or

capacity factor, regulation/politics or some other variable, and see what the effect

• n value is, because there is so much uncertainty at this stage.
• For multiples-based approaches we typically consider the enterprise value per

megawatt (i.e. debt plus equity per megawatt), although EBITDA multiples are also sometimes used. In general, we prefer to use the discounted cash flow approach as the primary valuation approach, with the multiples approach as a cross check. This is because each wind farm transaction is highly idiosyncratic: some may have full PPAs; some may be entirely merchant; PPAs vary in length and have different prices; there are different technologies used in construction, etc. This makes it very difficult to compare like for like when using multiples. In addition, there is often limited publicly available data on transactions (the primary source of determining multiples), which makes the comparison more difficult.

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Greenfields/Development stage

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Source of Global Multiples: Deloitte “A Market Approach for Valuing Wind Farm Assets, April 2016 for Global Multiples in Euro millions, converted to AUD millions at April 2016 exchange rates.

Uncertainty Risks Returns Cost Equity Global Multiples (m/MW) Low 1 2 3 High 9%-14% 0.3-0.4 The graph below provides an overview of risk, return and uncertainty at different stages. The graph is simplistic because at each stage there are wide variations in risk, return and uncertainty for different assets. However, in general the logic of this graph holds for a single wind farm across its life. At the greenfields/development stage risks are high and returns outcomes are variable. Returns can be high if construction is efficient, the right pricing is obtained and a high capacity factor is achieved. One of the key characteristics of this stage is a high level of uncertainty. For example there may be uncertainty related to capacity factor, technology (depending on what is being installed), wind history, regulation, off-take agreements and pricing, amongst other things. The cost of equity is therefore typically higher at this stage than in later stages. Deloitte published research on global wind farm transaction multiples in April 2016 across the different stages. They reported in Euros, which I have converted to Australian dollars at the April 2016 exchange rate (1.4887). According to the Deloitte report, late greenfields development stage multiples for onshore wind farms are typically $0.3m/MW to $0.4m/MW globally. One of the reasons multiples are low at this stage is that the price paid is only the initial outlay.

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Greenfields/Development stage

Key valuation considerations at this stage include (but are not limited to):

• grid access,
• site location and access,
• approvals,
• technology,
• construction schedule,
• EPC experience,
• PPAs (if any),
• pricing forecasts,
• generation forecasts,
• Regulation/politics.

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Construction/Seasoning

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The construction stage involves construction, an updated business case, and commissioning. Buyers at this stage tend to be wind farm operators or financial investors. Over the last few years there have been more institutional investors involved at this stage. Common valuation approaches include discounted cash flows and multiples. The scenarios considered at this stage under the discounted cash flow approach typically relate to capacity factor and yield. As discussed before, it is important to adjust multiples for the specific characteristics of the wind farm For example, one construction wind farm I valued had a high value per megawatt compared to similar wind farms. This was because its forecast capacity factor was higher than comparables and, more importantly, it had a very high offtake price locked in for 15 years. It is also important to understand where the uncertainties lie and how robust your data is when valuing a wind farm. In the greenfields wind farm I mentioned, the long term PPA price was certain, which provided most of the justification for a high

• multiple. The wind farm also had a high forecast capacity factor, but this was

much less certain. However, this capacity factor forecast was based on 5 years

• f data by a leading independent wind consultancy and was in a location where
• perational wind farms typically had high capacity factors. Some wind farms have

data that is less robust. Construction cost based multiples may differ from transaction cost multiples at the construction stage for a range of reasons, e.g. buyers often have to continue to fund construction after the transaction, and energy pricing forecasts may affect value. This is a good reason why a discounted cash flow approach is better at determining value.

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Construction/Seasoning

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Source Australian Multiples: Clean Energy Council for 2016/17 construction data, Maven Libera research for other Australian data. Australian multiples cover: 20 construction projects since 2009; 12 brownfields transactions. Global Multiples: Deloitte “A Market Approach for Valuing Wind Farm Assets, April 2016 for Global Multiples in Euro millions, converted to AUD millions at April 2016 exchange rates.

Uncertainty Risks Returns Cost Equity Global Multiples (m/MW) Australian Multiples (m/MW) Low 1 2 3 High 8%-14% 1.0-1.3 2.2-2.3 At the construction/seasoning phase risks, uncertainty and rewards in general have moderated. The cost of equity range is around 8% to 14%, and tends to be lower than at the greenfields/development stages (before financing). According to the Deloitte report, global multiples for onshore wind farms have increased from an average of $0.3m/MW to $0.4m/MW at the development stage to an average of $1.0m/MW to 1.3m/MW at the construction stage. The report states that multiples have reduced over the last few years as construction costs have reduced. Maven Libera compared this to Australian wind farm construction multiples. We looked at total construction costs or transaction enterprise value (debt plus equity) costs for 21 wind projects from 2009 to 2017. The median multiples are $2.2m/MW to $2.3m/MW, with a range of $1.5m/MW to $4.5m/MW. We found that multiples have reduced over time. The multiples for Stockyard Hill and Coopers Gap transactions (not construction costs) were $1.5m/MW and $1.9m/MW respectively, but both have offtake agreements with a locked in price of $60/MWh. Some of the most recent transactions (e.g. Taralga, Silverton, Stockyard Hill and Coopers Gap) have PPAs of around 10 years (often 5 years plus an option on a further 5 years). This is shorter than many historical PPAs. In our discussions with wind industry participants, there is a general view that multiples are likely to go down further over time in Australia as construction costs and wholesale prices reduce.

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Construction/Seasoning

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Key valuation considerations at the construction stage include (but are not limited to):

• construction handover,
• generation forecasts,
• PPAs (if any),
• pricing forecasts,
• O&M forecasts,
• Regulation/politics.

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Brownfields/Operational

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The brownfields stage involves ongoing operation and maintenance, technical and commercial management, investment evaluation, and repowering or decommissioning at the end of the project life. Investors at this stage are often long term financial investors looking for yield, such as super funds as well as wind farm operators. Many financial investors have limited or no involvement in the day to day wind farm operations.

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Brownfields/Operational

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Uncertainty Risks Returns Cost Equity Global Multiples (m/MW) Australian Multiples (m/MW) Low 1 2 3 High 7%-13% 2.4-2.5 2.5-2.7

Source Australian Multiples: Maven Libera research for other Australian data. 12 brownfields transactions. Global Multiples: Deloitte “A Market Approach for Valuing Wind Farm Assets, April 2016 for Global Multiples in Euro millions, converted to AUD millions at April 2016 exchange rates.

At the brownfields stage risks, returns and uncertainty are generally lower than in prior stages, however there is a wide variation depending on whether the wind farm is highly contracted, or it is a merchant wind farm bearing wind and price risk. Risk can be very low (bond- like to investors) if there is no wind and price risk at all because operators, rather than key investors, bear wind risk (e.g. the Hallett series of wind farms). For very highly contracted projects, above average returns are mainly possible through refinancing structures and the terminal value. For merchant wind farms price and generation are what drive above average returns. The cost of equity tends to be lowest at this stage (before financing). While the graph shows average costs of equity across a broad spectrum of assets, for a single wind farm costs of equity typically reduce by 2% or more at this stage. For highly contracted assets leverage can be very high. We typically see gearing around 40-50% for merchant assets, and around 55% to 75% for highly contracted assets. Deloitte found average installed multiples to be $2.4m/MW to $2.5m/MW at the brownfields stage. They found that multiples decline as the wind farm gets older. They calculated a new wind farm has an average value globally of around $2.7m/MW and that the installed capacity multiple declines by around $0.11m/MW per year. This means the average life of a wind farm is 23.5 years. When we looked at Australian multiples, the median range was $2.5m/MW to $2.7m/MW.

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Brownfields/Operational

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Key valuation considerations at the operational stage include (but are not limited to):

• PPAs (if any) and contracts,
• generation forecasts,
• pricing forecasts,
• O&M forecasts,
• Debt and gearing,
• Regulation/politics,
• Post contract period,
• Post design life period.

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Optionality can be a key driver of both market value and special value. Wind farms that are able to provide some firming through battery storage or other technology such as pumped storage, are likely to be significantly more valuable. Some wind farms have the option to add solar or additional turbines, increasing energy yield. There is often optionality around land leases. In one wind farm I valued the investors had the option to renew the leases for an extended period. Because the wind farm was located in an area with excellent wind resources, there was significant value potential in the post design life period. Other examples of options could be related to demand, e.g. locating the wind farm in an area where demand is likely to grow or where a corporate PPA could be signed in future.

Optionality

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Conclusion

In conclusion, Renewable assets across the project lifecycle have widely varying risk characteristics, from Greenfields developments with no long term contracts in place and uncertain network access, to operational assets with long term purchase price agreements and bond like cash flows. To determine the value at each stage it is important to consider what contracts and counterparties are involved, the risks, returns and uncertainties at each stage, and whether the wind farm value reflects market .or special value.

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Megan Raynal MAVEN LIBERA

P / +61 3 9653 6456 E / info@mavenlibera.com.au A / Level 27, 101 Collins Street Melbourne, VIC, Australia, 3000 www.mavenlibera.com.au megan.r@mavenlibera.com.au

Disclaimer: The information contained in this document is of a general nature and is not intended to address the

• bjectives, financial situation or needs of any particular individual or entity. It is provided for information purposes only and

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