Calculating the the un-levered (no debt), internal rate of return (IRR) of a commercial solar PV project is key to selling the project to the property owner, or gain investors on board for financing. If you’re still using the term “payback” or “return on investment” to sell commercial projects, you’re behind the ball.
This is going to be short article on a very specific subject around how just changing the assumptions for one critical value, the effective value of an SREC, can widely change the economics of a project. Before we get started, there are a few resources I wanted to provide because I can’t get into definitions in a two page article.
- If you need background reading on finance basics; NPV, IRR, discount rates, time value of money, why not to use payback period. Read this: http://blog.heatspring.com/renewable-energy-financing-101/
- If you need solar PV specific finance review; how to calculate MACRS, SRECs vs FITs, etc, read and download an IRR tool here: http://blog.heatspring.com/solar-project-financing/
- Are SREC Taxable? Read this article: http://blog.heatspring.com/are-solar-renewable-energy-credits-taxable/
- If you need in-depth commercial solar PV model, download this commercial solar model.
For this article, I’m going to establish a very simple commercial solar PV client, and then we’ll discuss how different assumptions of SREC value can impact the projects IRR and the strategy you should employ when selling a project. We’re going to be looking for the IRR over 20 years, because the length of bankable solar projects with equipment warranties.
Baseline Project Assumptions
- Customer Sentiment: The customer a distribution of paper products on the North Shore of Massachusetts. It’s a family owned business, they own the property and plan to for the next 30 years. They business is profitable, so they are going to buy the system cash, and they have a tax appetite to accept all of the tax credits. The business is paying a corporate tax rate of 30%. This will be critical for calculating MACRS depreciation value, and effective SREC value.
- System Size: 200kW
- Gross Installed Costs: $4.50 per watt
- O+M: .05% of the gross installed costs per year for 20 years.
- Derating: We assumed 20% loss of power going from DC and AC
- Production: We assume 1.3 MWh of production per 1kW installed per year.
- Value of Power: $.12kWh. Again, remember that commercial properties tend to spend more cash on demand chargers rather than usage charges. We can’t assume solar will reduce demand charges because timing and clouds can’t be controlled.
- Tax Credits: 30% Investment Tax Credits and 5 Year 50% Bonus MACRS Depreciation
- We assume the electrical inflation rate will be 3% per year.
How will we value our SRECs? Let’s look at a few common scenarios.
Take the nominal value of the last closing price. In this case, it would be $210/MWh from Q3 of 2013.
20 Year IRR = 12.67%
Option 2 – Take the nominal SREC price, assume that it will never go lower than this, and reduce it by the effective corporate tax, rate in this case 30% to calculate it’s effective value = $147/MWh
20 Year IRR = 10.11%
Option 3 – Ask around and get 3 year long term contract. currently around $175/MWh currently (source anecdotal from Jason Gifford at Sustainable Energy Advantage). Although this is only three years, assume this will be the lowest price over a 10 year period, i.e. after the 3 year guaranteed contract you can sell it on the spot market for more.
20 Year IRR = 11.25%
Option 4 – Take the the $175/MWh and reduce by 30% for taxes = $122/MWh
20 Year IRR = 9.11%
Key Learnings from a Simple Sensitivity Analysis
- You’re assumptions on the effective value of an SREC have huge impacts on the economics of the project. The difference between 9.11% and 12.67% is almost 40%.
- Remember you need to pay taxes on SREC income. Thus, clients tax rates are critical to understand.
- In sales, you need to model the worst case scenario to build trust with the client. If the client asks an accountant something and he points out an issue that you did not address, you’re credibility has been lost.