Financing costs significantly change energy prices



I’m often surprised how little attention is often paid to the costs of finance for renewable power projects; in particular how these costs impact the price of energy that a project needs to secure in order to make its business case work. 

The chart below runs some simple calculations for a hypothetical solar PV project, where most variables (capex, opex, energy production, tax on profits, inflation, analysis period and so on) are kept the same.

The ones that have been changed are the costs of debt (the interest rate) and the required internal rate of return for equity investors. The debt/equity ratio has been constrained by two things: a minimum debt service coverage ratio requirement (1.2) and a maximum debt/equity ratio of 4:1 (i.e. 80% debt). The sale price of each MWh generated by the project has then been calculated, sufficient to achieve the required equity IRR .

Not surprisingly, higher interest rates and higher equity investor expectations means higher energy prices. As so often with charts like this, my recommendation is not to focus on the specific numbers, but instead on the range of outcomes. They illustrate just how much impact differing financing costs can have on the energy costs from power projects.


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