Financing costs change energy prices

The title of this post shouldn't really be a surprising statement!


Nevertheless, I'm 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 mean higher energy prices.


As so often with charts like this, my recommendation is not to worry about the specific numbers - after all, they are only relevant to the specific set of assumptions used. Instead focus on the range of outcomes.


These illustrate just how much impact different financing costs can have on the energy costs from power projects, when other key aspects such as installed costs and energy resource are identical.



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