Note to Reader: This valuation article is over 15 months old. The cost of equipment has trended downward. The methodology is correct, but the numbers are high. If you would like to discuss, please contact Ka-Ming Lin at the information to the right.
Valuation of a Rooftop Solar Project in Ontario:
Valuation of a rooftop solar project, participating in the Ontario Power Authority’s (OPA) Feed-in Tariff (FIT) program is a very dynamic and fluid process. The OPA goal was an internal rate of return (IRR) levered ranging between 10-12%. The pricing of a commissioned solar project has dropped considerably over the last 2 years but the IRR has essentially remained the same.
In determining the value of a project, two other factors must be considered. One, the type of contract, in this case, FIT 2 and FIT 3. ORTECH assumes most of the FIT 1 projects are either built or in the process of being built. The other factor is where the project lies in the lifecycle. Two notable phases, Pre-NTP (financial close) and Commissioned. It is ORTECH’s experience that most term sheets on the equity side use these two timeframes in the lifecycle as acquisition points.
A significant fraction of FIT 2 and FIT 3 contracts are currently in the control of developers that are associated with EPC providers or owned directly by EPC contractors. These projects are often developed as turnkey applications where the developer’s upside is in securing the EPC contract and thus are unlikely to be “flipped” pre-NTP. Arrangements between the EPC-developer and the building owner may be for the building owner to acquire the project(s) post commissioning or may be a roof lease arrangement where the EPC-developer retains ownership. Acquiring these projects from either the EPC-developer or the building owner should come at a cost similar to the EPC turnkey cost for the project.
The price ORTECH previously quoted at $0.50-.75 per watt for the contract only is out of date. The sale of these contracts has actually slowed and the rules set out by the OPA prohibit the sale. The only way, prior to commercial operation, to buy into projects is as a new partial equity investor.
The value of operational rooftop solar projects is in their FIT contracts. These contracts are with the OPA and backed by the Ontario government. They are paid out through the Global Adjustment meaning that they automatically get funding from the rate base without any input from OEB. This is because OPA is authorized to do so directly through provincial legislation. As a result, the revenue stream is generally considered reliable.
Determination of the actual value of a project will depend on the evaluator and their perspective on the risks associated with these assets. Since the value is in the contract and the revenues from it, the approach ORTECH often uses in determining a project’s value is to look at the cash flows and determine the net present value (NPV). NPV calculations are a method of discounting future revenues and require a discount rate. For a developer evaluating the NPV of a solar project, the discount rate would be their required rate of return which will depend on their assessment of the risk associated with the cash flow. Again, since the counterparty to the FIT contract has legislative authority to acquire funds from the rate base, the risk associated with not getting paid for energy delivered is considered low. The main risks are associated with the project’s ability to deliver energy, operating costs, and the potential for failing to meet the obligations of the FIT contract. These are the key factors ORTECH considers when executing technical due diligence engagements.
For reference, OPA prices FIT contracts based on what it expects the installed costs to be and allows for an investor rate of return in the neighbourhood of 10%. That rate of return is offered to also offset development costs for some projects which never reach commercial operations. OPA recognizes that there is the cost of developing a project even if it fails prior to construction (i.e. no EPC funds are spent) and that the EPC-developer entities which make up most of the industry need to recoup those lost resources with their successful projects.
The current market has matured and the predominate model is an EPC turnkey solution. The EPC quotes an all in price per watt. The current turnkey cost of projects, commissioned for FIT 2 expected to be projected is in the range of $3.25-$4.00 a watt. For FIT 3, the range is lower at $3.05-3.75 a watt. The changes in domestic content requirements and improvements in manufacturing efficiencies account for the downward pressure on pricing. This is expected to change as the market matures.
The key question remains; what is the value?, to answer the real question; “How much?” There is no general answer here. The question is akin to "how long is a piece of string?" it is all about risk and discount rate. The discount rate is determined on a case by case assessment.
- FIT 2.0 (53.6 cents per kWh) – 20 years of contract remaining – 250 kW rooftop with 20% overbuild
- At 1200 kWh per kW (this will vary by location by up to +/- 20% or more) with a total O&M cost of 10 cents per installed Watt DC (which is also highly variable)
- A discount rate of 12% yields an NPV of $897K
- A 50% equity stake would be valued at $449K ($1.79 per watt)
- FIT 3.0 (32.9 cents per kWh) – 20 years of contract remaining – 250 kW rooftop
- With the same operating conditions as previous.
- A discount rate of 10% yields an NPV of $522K
- A 50% equity stake would be valued at $260K ($1.04 per watt)
Changing any one factor will impact everything and by different amounts depending on conditions. For example, dropping O&M to 7 cents changes the FIT 2.0 project NPV from $897K to $958K (up $61K). The FIT 3.0 goes from $522K to $599K (up $77K)
Some other factors may affect the valuation of these projects are as follows:
- Individual equity investor’s discount rate and risk assessment of each project.
- Equity Investor with low cost of capital, especially on the Debt side. A number of Local distribution companies (LDCs) have access to low-cost debt from Infrastructure Ontario.
- New players wanting to build a portfolio of projects quickly, especially from Germany and US, is putting pressure on the prices.
- Tax benefits: Some Canadian firms are using tax credits allowing a high acquisition price in bidding situations.
- Specific circumstances related to individual contracts such as the extent of required roof repairs.
Disclaimer: The above information is a static description of what in reality is a dynamic environment. This document remains the property of ORTECH Consulting Inc. (ORTECH) and may not be used in whole or in part by any person for any purpose other than that specified without the express written consent of ORTECH. ORTECH will not assume any liability to any Third Party that makes use of this document and the potential client and any Third Party will indemnify and hold ORTECH harmless for any loss, damage or expense from any such use.
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