When compared to other asset classes, renewable energy investments (wind parks, photovoltaic power plants, hydro power assets, etc.) are in certain ways more complex. The monetization of for example wind parks is directly driven by the production volumes (which are simple driven by how windy it is) and electricity prices (market prices – or feed-in tariffs, PPAs…).  Both of these inputs have to be handled properly – you can have a very good financial model, but if you do not get the underlying inputs right – you will get “garbage in, garbage out” type of model. The situation is especially complex when the wind park is in the merchant regime (i.e. no feed-in tariff and the energy is being sold on the market). Renewable energy investors often enter in PPAs (Power Purchase Agreements) to hedge the market prices and to stabilize the cash flows.

But practically – how does such valuation look like? Pretty much everybody uses DCF models (discounted cash flows). Investors also use multiples – but rather as sanity check and to make sure the DCF value is in a range of other transactions on the market. The DCF is usually an Excel based model and it can be structured as an extended income statement (where free cash flows to the firm or free cash flows to the equity are calculated) or fully fledged three statement model (including income statement, balance sheet and cash flow statement).

The construction of the financial model is quite straight-forward (and compared to other asset classes – the business mechanics of renewable energy projects is quite simple – to generate and to sell electricity). However, the optimization of the model inputs and the assumptions is the tricky part – especially the decisions regarding how to hedge the electricity production (i.e. how to structure the PPA) and how much debt to take. Such decisions are not trivial. In the upcoming articles we will try to shed some light on what the best valuation practice is and how to decide on PPA and capital structure of the project. On Blue Yellow we also want to provide financial model examples which should be helpful to e.g. renewable energy developers preparing documentation of renewable energy projects for sale.