Solar thermal, solar hot water, solar hot air, solar heating, solar cooling

## Finance 101 for Solar Thermal Pros

In this article, I’ll go through the basic step-by-step process of how to evaluate, understand and communicate the financial benefits of investing in a solar thermal system. The analysis will be on the client side, but obviously it’s critical for sales as well.

Before you read: get familiar with financial terms and analysis, you should read the first article in the series “Finance 101 for Renewable Energy Pros”. Also, it’s important to note that I’m using the word “finance” as a way to build financial models, understand the economic drivers and benefits of specific technology – not finance as in ‘we financed our car instead of paying cash’.

Here are the other articles in this series:

Finance 101 for RE Pros

Finance 101 for PV Pros

Finance 101 for Geo Pros

We’ll be going through the same drill that I did with solar PV and geothermal in terms of the outline but the specific content will be tailored to the technology that we’re looking at, solar thermal.

Here’s the outline

What makes SHW special and a little different then analyzing other technologies

Step 1. Estimating solar thermal load, array size and power production

Step 2. Gross and net installed costs

Step 3. Determine the value of a SHW BTU

Step 4. Estimating operations and maintenance costs

Step 5. A few examples IRRs and sensitivity analysis for residential and commercial projects based on 1) load 2) fuel source 3) site characteristics

Marketing Implications

What I did not address that could be investigated.

A few issues around the difficulties and issues with determining the exact NPV of a SHW system.

On residential applications, it’s too costly to figure out exactly how much hot water is being used. Thus, we use assumptions that frankly, are not very accurate. See the Canadian study that found out the average of 65 gallons used per day, was actually around 44.

Unless the hot water generator is the only fuel source of that specific kind, it’s difficult to estimate on residential applications and mainly based on assumptions, which can be very wrong.

On commercial applications, it is common to use ultrasonic BTU meters for a week or so to understand exactly how much water is being used. However, it’s still key to understand daily and yearly usage patterns. For example, if a laundromat is used heavily in the morning or a college dormitory is not used during the summer that will have implications for the value of the heat the solar thermal system is creating. See point 2.

Production and usage of solar thermal energy are not equal. A property owner only gets the value of a solar BTU when they’re using water that is getting preheated by a solar thermal system. If they’re not using water, and the solar thermal system is producing that energy gets lost. Not all of it is lost, because the storage tank is able to hold a lot of water but they can’t hold it forever. The reason this is important for financial modeling is because, UNLIKE SOLAR PV, just because the solar thermal modules produce power doesn’t mean it was used and thus doesn’t mean the financial benefit was realized. The classic example is a family that goes on vacation for 2 weeks, if it’s a pressurized solar thermal system (we’re not going to get into pressurized vs drawback in this article and the design and financial implications of each) the pump will likely still cycle and energy will be produced, but nothing will be used. From a finance perspective, nothing is gained, only lost in the power the pump needed to run.

Quoted prices for solar thermal systems can vary widely from site to site and between geographic regions. The main drivers between sites will likely be 1) structural support needed. All else equal pitched shingle roofs are cheaper then flat roofs. 2) If a storage tank is required. For buildings that have a constant load 365, storage is typically not required. Pool heating is a good example. This will decrease installed costs. Between geographic regions that main drivers of costs tend to be the training of the crew. Almost all of the parts are off the shelf, or close to it, so it’s difficult to get better pricing on equipment, however a crew’s ability to executive and their level of training will be different between regions.

Module output is based on more factors then in solar PV. In a solar PV product output is mainly based on 1) the solar resource available 2) orientation of the module 3) efficiency of the module 4) temperature. With solar thermal, all of those factors also apply IN ADDITION to the load profile of the building. Why? The higher the load of the building the colder the water will tend to be, all else equal, when entering the solar therm module. This will increase heat exchange. So for example, if the modules were 180 degrees, the water passing through them will collect more BTUs if it enter the modules at 50, then if it entered the modules at 100. What this means is that if we installed 10 modules on a building with a load of X, if the same number of modules were installed on a building and the load was 2X, the production of the modules would be much higher. For this reason, it’s a good idea to keep the solar fraction low in a design, to maximize the BTU production of each module. How low? Dr. Ben suggestions between around 30% and 60%, see his great explanation of the subject here.

Maintenance costs can vary widely based on the type of system, equipment used, equipment warranties, and what the type of system is connected to. Also, because the solar thermal industry is relatively small, I haven’t been able to find large data sets of warranty information that I can be confident in.

[…]

## Detailed 2012 SREC Market Update: NJ, MA, PA, CT, IL, DC, MD

7 Months ago we did an SREC 101 Episode for HeatSpring TV. The goal of the first interview was simple: to provide basic information on what SRECs are, the state of the current market, and what installers should know about SRECs to sell projects to their clients.

We’ve decided to provide a regular update with SRECTrade on the status and the development of the SREC markets. We’ll discuss policy updates, events that are impacting the supply and demand of existing markets, and expectations for upcoming markets. For example, last week Maryland changed their RPS requirements.

SRECs are extremely important in specific markets because they impact a contractor’s or developer’s ability to sell projects. However, they are changing rapidly and sometimes it’s difficult to get clear answers.

For this update, I spoke with Steven Eisenberg who is the VP of Business Development with SRECTrade. He manages the relationships between all the buyers of SRECs and the sellers of projects that are larger then 250kW. Because he is at the intersection of clients that are buying and those that are selling SRECs, he has great insights into the dynamics of the SREC market.

(Please note: The interview was filmed on Friday, March 30th and some SREC policies have changed since filming)

Here is the full agenda of what we talked about:

Question: What is happening in each market regarding legislation that will impact SREC prices, supply and demand, in the next couple months?

NJ: Coming from 2011 and prior periods there was an under-supply leading to high prices and this lead to a huge build up and now the market is oversupplied. The market has hit a point that through February 2012, 689MW of capacity can is eligible for SRECS .40MW was installed in February 2012.

There is huge oversupply. NJ state only needs 370MW operational throughout the 2012 compliance year to supply the needed SRECs required by the RPS. The requirement for 2013 and 2014 is LESS THAN what has been installed through February 2012.

There have been a variety of different policy groups looking to increase the RPS requirements to take up some of that supply, but it is uncertain this will happen in the near term.

In our March NJ spot auction, SRECs were traded at $145 per MWh and traded at $135 per MWh in the April auciton. Other transactions have since traded below the $135 level.

Without any legislative change, NJ will be oversupplied for the next few compliance periods.

Question: In some ways, is this news good for the NJ industry? It will drive out unprofitable solar EPC companies?

Answer: Surely the most competitive financiers, developers, EPC contractors, and customers with high energy costs will be in the best position.

The decline in equipment cost is also really helping.

Projects now need to be really competitive to pencil out.

[…]

## Finance 101 for Renewable Energy Professionals

Understanding finance is required to sell renewable energy projects. It’s needed to communicate the value of both residential and commercial projects, and for all types of technologies: solar PV, solar hot water, and geothermal heat pumps.

The reason financial metrics are important is that all of these technologies are financial investments. Thus, you must be able to communicate the financial value of the system to the client and ‘payback period’ does not do this. I repeat, don’t use ‘payback period’, and we’ll talk about why later.

The key to understanding financial analysis is a small contradiction. The actual financial calculations are not difficult once you have all the numbers. The challenging aspect of financial analysis is that many of the numbers the model depends on are assumptions and projections — things you can’t always nail down. Thus, it’s important to perform sensitivity analysis to see how a few critical variables will impact a project’s returns.

Another challenge is communicating exactly what these numbers mean to a consumer, so they understand it. In order to do this, you need to understand what each term represents and how to explain it in plain language.

I’ve noticed that the information and educational resources on basic financial analysis for the renewable energy industry is lacking. While many PV installers can derate conductors easily, they may not know what the NPV of an array is. Most geothermal contractors can size of a heat pump, but few know that the typical IRR of a system is when it’s replacing an oil boiler. We need to change this.

Let’s Start With the Basic Terms

Below are the basic financial terms you will need to understand to perform financial analysis on any renewable energy project. I’m simply going to discuss what each variable is and how to calculate it, with an example from excel. At the bottom of the article you’ll be able to download the excel file, so you can play with it yourself.

It’s critical to remember that the variables that impact these metrics will change based upon technology and incentives, but the underlying cash flows that create the financial returns will remain the same. NPV is NPV.

Here are the terms will will discuss

Net Present Value (NPV)

Present Value

Future Value

Discount Rate

Internal Rate of Return (IRR)

Sensitivity Analysis

Net Present Value (NPV)

NPV is the most recognized metric used to analyze capital projects. NPV takes every known cash flow in a period, negative and positive, and discounts back to today to see if the project is profitable or not. If a profit has a negative NPV, it should not be completed. If it’s zero, it doesn’t matter if a project is completed or not, from a pure financial perspective. If it’s positive, all else equal, it means the project should be completed.

Unlike ‘payback period’, NPV provides a specific dollar amount that you can use to determine if a project is profitable or not. HOWEVER, NPV analysis can vary widely because it is extremely dependent on the discount rate used. On residential sales in particular, an acceptable discount rate can change greatly depending on the customer.

The analysis can also vary widely due to the confidence one has in the financial assumptions used to create the model. It is key to perform a sensitivity analysis when performing NPV analysis because most times the cash values being used are projections and it cannot be said with 100% confidence the numbers will be exact.

The equation to calculate NPV is to add together the present values of each cash flow for each period for a project. Here is the formula to calculate present value for a single period.

Present Value = Net Cash Flow / (1 + i)^t

i = discount rate

t = time period.

**Note, I’m using “^” meaning to the power of X, or in replacement of a supercript because our publishing software does not allow superscript. This is also the same script that excel will use if you want to raise a integer to a power of X**

If we had 5 periods, we could calculate the present value for each period, then add those numbers together.

What is the net present value of $500 investment, with 5 unequal cash flows, 50, 200, 200, 300, and 300 at a 5% discount rate?

Figure 1: Adding together the present values of 5 future cash flows to determine NPV

A few notes: The cell in C13 is simply summing the values of C6:C11. Each of the values in C6:C11 is calculating the present value of a single cash flow. Notice how $200 in 2 years, is worth more then $200 in year 3? This is because it’s getting discounted by 5% every year.

Present Value (PV):

Present value is the present value, today, of a future cash amount discounted back to today. Net present value is thus, a series of cash flows all discounted back to today’s terms. For example, what is $50 worth today? It’s worth $50. However, if you wanted to find out what $100 in 5 years would be worth today at a 5% interest rate, you’d need to calculate the present value. Here is the equation.

The equation to find present value of a future cash flow is:

PV = FV / (1 + i) ^ n

i = interest rate

n = number of period.

So, what is the present value of $100 payment in 5 years at a discount rate of 5%

PV = $100 / (1 + .05) ^ 5

PV = $100 / 1.28

PV = $78.15

This means that is someone gave you $100 in 5 years, and you have a bank account with a yield of 5%, it would have been the same value of money if they would have given you $78.15 today and you put the money into the bank for 5 years.

Future Value: (FV)

The future value is asking what the future value is of a present day cash amount, given it is accumulating at a specific interest rate. The best way of describing future value is a typical savings accounts.

If you put $50 dollars into a savings account with a 5% interest rate and take it out in 10 years, how much will it be worth?

The equation to calculate future value is

FV = PV (1+i)^n.

FV = the value of a future cash flow today, given x % interest rate.

PV = the present value of the investment

i = the interest rate of the investment

n = number of periods of the investment

FV = $50 (1+.05) ^ 10

(1.05)^10 = 1.63

$50 * 1.63 = $81.44

In other words, $50 today at 5% interest is EQUAL TO be given $81.44 in 10 years

How about a 10% interest rate?

FV = $50 (1 + .10) ^10

FV = $129.69

As you can see, the interest rate used over the term has a huge impact on the value of the investment.

Discount Rate / Interest Rate:

In the calculations of NPV, PV, and FV, you’ve noticed that we’ve been using an interest rate to calculate the value of money in different parts of time. This value is called the discount rate. Sometimes, it’s referred to as the interest rate (for future value), or minimal attractive rate of return (MARR), which we’ll discuss below.

The discount rate can be somewhat confusing to some. There are critical pieces to understand about the discount rate. First, what it does. Second, how you determine it.

In the above examples of calculating PV and FV you noticed I used an interest rate to calculate the value of cash between a certain period in time and another period in time. So, to define it very simply the discount rate is an interest rate that is the difference between a present value and future value of the same dollar amount. The difference between $100 today and in five years is the discount rate.

How one should select the discount rate is a little more difficult. Many times the discount rate is selected based on a few characteristics. None of these is wrong, it simply depends on the circumstances.

A comparable investment or savings rate. If a homeowner could invest the same money in a CD at risk free interest rate of 5.6%, they will likely use 5.6% as a discount rate for other investments. Also, keep in mind that many times a homeowner might add a few percentage points to a different investment that is not risk free to cover the additional risk.

The inflation rate. If I had $100 in cash and stuffed it in a safe (a place that is not getting interest), and took it out in 5 years, it would have lower purchasing power. To understand how the purchasing power changes, we would calculate the FV of $100 in 5 years with the discount rate being the expected rate of inflation.

Risk tolerance. The more risky the investment, the higher discount rate you’d need to satisfy the level or risk. Having a higher discount rate will decrease the time it takes for you re-coup your investment, given the NPV is still positive. When risk tolerance is being used to determine need returns, it’s sometimes referred to as “Minimum Attractive Rate of Return” (MARR), or the “hurdle rate”.

The thing to remember about discount rate is that while it’s use in the financial analysis is extremely clear, determining what exactly to use as a discount rate is extremely subjective or will vary widely between homeowners.

The impact of a different discount rate can be huge when talking about renewable energy projects because an acceptable discount rate between different homeowners can vary widely. Let’s walk through some examples to demonstrate.

CASE STUDY: A Sample Solar Hot Water Customer in Greenfield, MA.

Net Installed Cost After Incentives: $4,000

Displaced Oil : 130 Gallons with 3 Full Time Occupants

Value of Displaced Oil @ 3.00 Gallon = $390

The life of the system will be 20 years.

Maintenance costs are $200 at year 10.

All other equipment failures will be paid by the manufacturer

Here’s the T*Sol estimation for the system production and load.

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## “If you can’t install solar at $3.45/watt, you’re going out of business.” Straight Talk on Solar with Jigar Shah at NESEA 2012

Jigar Shah was my favorite presenter at this year’s Building Energy Conference. Mr. Shah founded SunEdison in 2003 and sold it five years later for $200 million. Here are some quotes he offered up in the “Energy Subsidies and the Future of Solar: Where Do We Go From Here?” session:

He outlined a 25kw project in […]

## [Video] How to Select Solar Hot Water Components and System Types

In this video, author and ISPQ Certified Master Trainer Bob Ramlow provides a detailed outline of common components found in solar thermal systems, and the four most common types of systems.