Revenue from the solar plant is computed by multiplying the units generated by the plant over a year with the tariff applicable in the location of the plant. The units generated for a year can be found out as below
Annual Generation (kWh) = CUF x Capacity (kW) x 24 x 365
CUF can be ascertained by studying the performance of other plants in the region from data periodically published by MNRE. It is important to consider 0.5% degradation of output from the solar plant after a year. So while considering revenue from the solar plant for a projection of 20 yrs., it is essential to consider this degradation factor.
Summarizing utility scale solar cost, we have:
Cash flow (Net Returns) = Revenue – Costs
- Revenue = Generation x Tariff
- Costs = Initial costs + Recurring costs + Financing costs
- Initial costs = Land, components, installation, preliminary and preoperative expenses
- Recurring costs = O&M, insurance, inverter replacement
- Financing costs = Debt service, taxes, tax savings from accelerated depreciation and interest.
On what basis can returns be quantified?
When we discuss the return on investment for solar power systems, we should be specific about what we are referring to. Because returns could be one of the following
- Annual returns over the project duration (as an absolute number): Here the returns can be calculated based on the above illustration of revenues.
- Internal Rate of Return:
Internal rate of return is a financial measure used for cash flow analysis and is often used to predict the health of an investment. Using this metric, the magnitude and time value of returns are compared against the costs associated with a project. Before going into Internal Rate of Return of a utility scale solar power plant, we need to understand the concept of Net Present Value (NPV).NPV brings the future cash flow to its value today (present value) by estimating how much value money loses over time.
The IRR is defined as the discount factor that makes the NPV of cash flows as zero. It is always expressed in percentage.
When a project is financed by means of equity as well as debt, we have to take into consideration equity IRR as well as project IRR.
- Project IRR: Calculation of the internal rate of return considering only the project cash flows (excluding the financing cash flows) gives us the project IRR whereas calculation of the internal rate of return considering the cash flows net of financing gives us the equity IRR.
- Equity IRR: represents the degree of returns of a project to the providers of equity capital. For profitable investments, equity IRR is always higher than project IRR. Equity IRR will reduce if equity portion is increased as leverage provided by debt reduces. If there is no debt, then equity IRR is same as project IRR.
- Equity Payback period (in number of years): Equity Payback period is also computed to have an idea about the financial viability of a project. The lower the pay back, the more attractive a project will be. It is computed by dividing the initial investments costs for a project by the annual cash flow from the project. But this may not always be the case. If the cash flows are uneven we accumulate the annual cash flows till we get the payback period.
Payback period denotes the time taken to recover the investments made in a project from the revenues generated from it. Let’s consider a 1 MW solar plant. A 1 MW plant would require a capital cost of 6.5-7 Crores in India. The system would generate anywhere between 4000-4500 units of electricity daily. The electricity generated could fetch up to 25000-30000 rupees a day, and about Rs 1 crore in a year after the minor O&M expenses. This means that the payback period can be achieved in about 7 years.
A solar power plant has a life of around 20-25 years. Thus, even though it takes 7 years to recover the initial investments, it can be considered attractive as the project lifetime extends almost 20 years after this payback period.
Please note however that the Payback Period concept is not utilized significantly by finance professionals for large projects such as the MW scale solar projects. The financial metrics used for these are the IRRs or the internal rate of returns. The two main IRRs that are used as metrics are the Project IRR and the Equity IRR.
What are the factors that affect the returns on the solar project?
Several factors affect the returns that can be expected from a solar power project. The main factors are:
- Tariff rates: Higher the tariff rates, higher will be the returns from the project. The tariff rates depends on the PPAs won by the plant owner and is dependent on the policy under which the solar plant is registered. Most state solar policies differ from one another and hence the tariff rates at which you can sell the produced energy also differs. Sometimes going for a 3rd party PPA might ensure higher tariff rates but it comes with a risk factor that most 3rd party PPAs are signed for a shorter period of time than the usual 25 year period for PPAs signed with government agencies.
- Annual Generation: The returns from a solar project is directly proportional to the generation (in units) derived from it. This can be ensured by not compromising on the quality of components associated with the plants. Moreover there maybe penalty clauses mentioned in the signed PPAs for shortfall or excess in expected generation from the plant. Hence the plant owner has to ensure optimal generation from the plant in order to optimize generation.
- Investments: An optimal debt: equity ratio can be a determinant factor in ensuring high returns from a solar project. A project entirely funded by equity (self-financed or with investor funding) can bring in higher returns since there are no interests on loan to be paid. But this involves a high risk factor and is seldom employed in the case of MW scale projects.
- Incentives from the Government: Obviously, the incentives from respective governments can impact returns associated with a solar plant positively. Projects with Accelerated Depreciation have a higher Internal Rate of Return than those without it. Also, projects which are eligible for capital subsidies and tax holidays recover the investments made sooner than those without it.
Apart from the main factors that affect the returns from the project there are other factors such as:
- Evacuation capacity of nearby substation: Evacuation is the ability of the nearest substation(s) to accept the power generated by the plant and transmit it to the grid. If the substation doesn’t have sufficient capacity at all times, the power generated by the plant will not be evacuated whenever there is insufficient capacity. This un-evacuated power will not earn any revenue.
- Equipment efficiency: Ensuring the quality of components used for the project, be it the inverters, modules, electrical infrastructure and other parts can play a significant role in the returns generated in the solar power plant.
- Proper Operations and Maintenance of the plant: Attention must be given to adhere to the standard operations and periodic maintenance practices of the plant in order to maximize its generation.
As of 2015, Solar Mango estimates based on trends worldwide that solar farm projects have project and equity IRRs in the range 15-20% for 25 years, and project IRRs in the range 10-15%. The equity payback period ranges from 7-10 years for most projects. For projects where incentives are much more than average, the IRRs will be tending towards the upper end of the range and the payback periods towards the lower end of the range.
- What is the Internal Rate of Return and Break-Even Point of Utility Scale Solar in India?
- What are the Financing Options Available for MW Solar Plants in India?
- What are the Initial Investment and O&M Costs Required for a MW Solar Plant in India? What Kind of Financial Returns can We Expect from It?
- What Do Financial Investors Look for When Funding Solar Projects?