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RISK FACTORS AND THEIR IMPACT ON THE ECONOMIC VIABILITY OF A WIND FARM INVESTMENT IN POLAND

RISK FACTORS AND THEIR IMPACT ON THE ECONOMIC VIABILITY OF A WIND FARM INVESTMENT IN POLAND
Grażyna Wójcik, lecturer

Jakub Woźniak, student

Warsaw University of Life Science, Poland

Championship participant: the National Research Analytics Championship - "Poland";

JEL Classification – G110

 

The authors analyse the profitability of building a wind farm in Poland. The enterprise venture comprises 15 Vestas V-90 turbines with a total capacity of 30 MW. The investment is valued at 192.3 million zloty, of which 20% is own capital and 80% borrowed capital. The authors estimate the wind farm’s annual productivity at 86.6 GW. The analysis was conducted for the period 2013-2039. The article is based on numerous press and scientific articles, as well as reports.

Due to the long payback period on wind farm investments, the authors used only the discount method; they also used derivatives to minimalize risk. The concept of weighted average cost of capital was used to indicate the discount rate, a sensitivity analysis and the value at risk was used to estimate the impact of the price of guarantees of origin and the wind farm productivity, and the Cash Flow at Risk concept was used to estimate the value at risk.

In order to eliminate the impact of risk from interest rates and currency exchange rates, the authors used derivatives; in order to avoid public protest, a noise impact analysis was conducted which showed that noise levels fall within the limits and will not have a negative effect on the surrounding inhabitants.

The authors provide a schedule for the wind farm construction in Poland, a simplified cost estimate of the investment, information regarding income and expenditure in subsequent years as a basis for evaluating the viability of the investment, and estimates of the exploitation costs involved in operating the wind farm. They also estimate the wind farm output based on yearly fluctuations in wind speed.

Keywords: wind energy, risk factors, investment viability, discount method.

 

Introduction

In recent years Poland has emerged from the economic periphery to become a country with a very strong and stable position in Europe. It’s high GDP and legislative stability which was improved in some branch make Poland attractive to foreign investors. Of particular interest is the wind energy sector. The attractiveness of the Polish wind energy sector lies in the fact that a large part of the country (around 66%) has favourable wind conditions which allow wind energy to be harnessed. While in other EU countries there has been continued growth in the number of offshore wind farms, the waters of the Baltic Sea have yet to be developed by this kind of investment. This makes the Polish wind energy sector even more attractive to foreign investors. Many firms treat the Polish market as a priority in the area of wind energy investment.

Literature Review and Hypotheses

The wind energy sector worldwide

From the beginning of the 90s we have witnessed continuous growth in the number of wind energy power stations worldwide (fig. 1).

Fig. 1. Wind farm capacity and capacity growth rate.

Source: own study based on Joint paper. 2012. Wind Energy in Poland. October: 10.

 

The total capacity of wind power stations worldwide at the end of 2011 amounted to 237,76 GW (Joint paper, 2012). The leader in the field is China, with a share of more than 26% in the wind energy market. Detailed data on the capacity of wind energy stations is given in Table 1.

Table 1.

Global wind power production

Source: own study based on Joint paper. 2012. Wind energy in Poland, October: 11.

 

According to forecasts from the Global Wind Energy Council for the period 2011-2016, we will witness systematic growth in the capacity of existing wind power stations at a rate of 15.72% annually (fig. 2).

Fig. 2. Forecasts for global wind power development.

Source: own study based on Annual market update 2011. 2012. Global Wind Energy Council, March: 19.

 

During this period the greatest number of wind farms will be set up in Asia. The annual growth rate in this area of the world is around 20 GW, thus set to reach a capacity of 200 GW by 2016. In Europe, new farms will appear at a rate of around 10 GW annually. The total capacity of farms in Europe will amount to nearly 162 GW in 2016. In South America, Africa and the Middle East, growth is forecast at a level of 1 GW annually (Annual market update 2011, 2012).

Over the last 12 years in Europe, wind energy capacity has increased yearly from 3.2 GW to nearly 12 GW. This trend is shown in Fig. 3.

Fig.3. Wind power investment in the period 2001-2012 in Europe.

Source: own study based on Wind in Power 2012 European statistics. 2013. The European Wind Energy Association, February: 10.

 

The report published in 2009 by the European Wind Energy Association outlining the scenario for wind energy development in EU countries predicts a level of 230 GW in 2020. The mid-term target of 103 GW was achieved in 2012 (Wind in Power 2012 European statistics, 2013). Table 2 provides data on wind energy in selected EU member states.

Table 2.

Wind Energy in Selected EU Countries

Source: own study based on Wind in Power 2012 European statistics. 2013. The European Wind Energy Association, February: 13.

 

Poland is a country with favourable climatic conditions for running enterprises connected with the production of wind powered electricity. The most attractive terrain lies in the north-western regions, along the Baltic coast as well as in the Warmińsko-mazurskie voivodship (Fig. 4).

Fig.4. Wind farm capacity in individual voivodships in Poland.

Source: own study based on Joint paper. 2012. Wind Energy in Poland. October: 14.

 

Macro-economic aspects of development in the wind energy sector in Poland

Given that the average investment expenditure per 1 MW capacity in the period 2006-2011 was 6.9 million zloty, while in 2012 – 6.6 million zloty, the value of investments realized up to 2012 amounts to around 16.97 billion zloty. It is estimated that only around 27% of this outlay was invested on Polish territory (Ciżkowicz et al, 2012). This stems from the fact that in Poland there is no producer of wind turbines and it is therefore necessary to import them. In terms of expenditure within Poland, these relate to cable installation, financial services, turbine installation and the construction of internal infrastructure. Assuming the above, it can be said that the amount of money invested in Poland for the establishment of new wind farms stands at around 4.6 billion zloty.

Based on the scenario for wind energy development drawn up by the Institute of Renewable Energy, the authors estimated the level of investment expenditure in wind power in Poland until 2020 (Fig. 5). In their analysis they took the average outlay on an onshore wind farm to be 6.6 million zloty/MW and 13.75 million zloty/MW in the case of offshore wind farms (calculated using a Euro/Zloty exchange rate of 4.154 from the period 01.01.2013-05.04.2013 given by NBP (the National Bank of Poland) (The Foundation for Sustainable Energy, 2012). Furthermore, they assumed that in this period no production plant for wind turbines would be established, and that only 27% of expenditure made by investors would be spent in Poland.

Fig. 5. Forecast of investment expenditure 2013-2020

Source: own study.

 

In forthcoming years, the wind energy sector may become an important branch of the Polish economy. Wind power will not replace energy from fossil fuels, but it may become an excellent supplement, which will not only ensure that Poland meets the limits imposed by the European Union, but which will also contribute to improving national energy security.

Methodology and results

Project description

The proposed wind farm is located in the north-east of Poland. The site planned for the wind park is bordered solely by woodland. There are no residential buildings in the immediate neighbourhood. Farm buildings occur at a distance of about 500m. The site is currently used for agricultural purposes including numerous ponds and is located
at 200-230m above sea level. Due to the stage of the work in progress and the interests of the client, it is not possible to give the exact location of the wind park.

From May 2009 to May 2010, research was conducted at a distance of about 1500m from the planned wind park location in order to establish the suitability of the site for this type of investment. Measuring gauges were placed at altitudes of 30, 40 and 50m. The average wind speed in the given period was 6.13m/s at an altitude of 50m, 5.42m/s at an altitude
of 40m and 5.01m/s at an altitude of 30m (Annex 1).

Annex 1.

Data on wind conditions for the period 05.2009-05.2010

Source: Printout from WindPRO 2.

 

The above analysis was supported by satellite readings of wind strength from the past 20 years, which showed that the average wind speed in the years 1990-2009 was 5.5m/s (Annex 2).

Annex 2.

Historical wind speed data for the period 1990-2009

Source: Printout from WindPRO 2.

 

Based on the above information, a wind report was drawn up in November 2010 for two alternative investment plans:

-          Alternative I: total wind park capacity 30 MW (15 turbines with 2 MW capacity),

-          Alternative II: total wind park capacity 24 MW (8 turbines with 3 MW capacity).

By using the WindPRO 2 programme the authors calculated the productivity of the wind park using the wind turbines presented in Table 3.

Table 3.

Alternatives for the planned investment

Source: own study based on wind audit (Annex 3).

Annex 3.

Wind farm productivity

Source: Printout from WindPRO 2.

 

Using the simple payback method the authors chose one of the above alternatives. In estimating the simple payback period, they made the following assumptions:

-          Investment outlay – 6.6 million zloty/MW,

-          Operation costs – 83 zloty/MW (Ciżkowicz et al., 2012: 30-33),

-          Price of electricity – 198.90 zloty/MW, adjusted each year according to inflation – for the purposes of calculation the authors took inflation rates to be 2.5% year on year (Joint paper, 2013: 71,72),

-          Average value of guarantees of origin - 241.98 zloty/MW (set for the period 01.2012-01.2013) (Polish Power Exchange, 2013: 9),

-          External financing costs and depreciation were not taken into account.

The calculations made by the authors showed that the shortest payback period is obtained using the Vestas V-90 wind turbine. The period in which outlay balances with income from wind farm operations is 8 years and 2 months. Fig. 6 gives the calculations for different types of turbine.

Fig. 6.Simple payback period for different types of wind turbine.

Source: own study.

 

The authors made further calculations for the second wind park alternative consisting of 15 Vesta 90 turbines spread over an area of 345 Ares (3.45 hectares). Using this type of wind turbine it is possible to generate 86,561 MW of electricity. The average wind speed for which the calculation was made was 6.89 m/s (at an altitude of 105m above sea level) (Annex 3). The productivity of each turbine in the given layout is shown in Table 4.

Table 4.

Productivity of individual wind turbines

Source: own study based on wind audit (Annex 3).

 

The authors went on to analyse the noise levels generated by the wind turbines. This showed that in the immediate vicinity of the wind turbines, the noise level reaches around 104 dB at a wind speed of 7m/s. At a distance of 500m from the wind park, the noise level reaches around 44 dB. In view of the fact that there are no residential buildings directly neighbouring the wind park, the investment should not be objected to by local communities, whose protest could prevent the project from going ahead.

Project schedule

The average time-scale for completing wind farm investments in Poland is 4-7 years. The formalities involved in project preparation (including obtaining planning permission and environmental decisions) until the commencement of building works can take as long as 5 years. The above project will be analysed from the moment of obtaining all the necessary permits, from which time the predicted duration of all construction work is 2 years. The authors assumed that construction of the wind farm will commence at the beginning of 2013, and thus the start of operations in January 2015. Table 5 gives details of the investment schedule.

Table 5.

Investment Schedule

Source: own study.

 

Investment Expenditure

Wind farm investment projects typically involve high initial costs. Despite a significant drop in wind farm construction costs over recent years, the average construction cost remains high at around 6.6 million zloty per 1MW capacity. Depending on the location of the wind farm and the technology used, the cost may vary between 4.4 million zloty/MW and 8 million zloty/MW. In the case of the investment in question, the total construction cost is estimated at 192.27 million zloty. The unit cost per 1MW amounts to 6.409 million zloty. Table 6 gives a simplified cost estimate of the investment.

Table 6.

Simplified investment cost estimate

Source: own study.

 

When it comes to the purchase of wind turbines, as well as part of the transport and instalment costs, payment is made in a foreign currency such as Euros. For their calculations the authors used the average Euro/Zloty exchange rate of 4.154 from the period 01.01.2013 to 05.04.2013 as given by the National Bank of Poland (http://nbp.pl/home.aspx?c=/ascx/archa.ascx). The percentage breakdown of costs is given in Fig. 7.

Fig. 7.Percentage breakdown of expenses

Source: own study.

 

The greatest outlay in the planned investment is incurred by the purchase of turbines. Moreover, this expenditure is vulnerable to currency exchange rate fluctuations which can affect the value of the investment. In order to eliminate this type of risk, the authors used futures contracts. In this way, irrespective of the situation on currency markets, the level of expenditure remains stable. The costs involved in building internal infrastructure also pose a serious burden. The remaining investment costs run at about 9.3 – 10.3 million zloty. A reserve was created to cover unforeseen costs which may arise, such as in the case of delays in building works due to unfavourable atmospheric conditions.

Estimated income

The level of income from wind-generated electricity sales depends on the value of substitute payments as well as on the average energy prices determined by the Chairman of the Energy Regulatory Office. The value of the substitute payments which came into force in 2013, were set at a level of 297.35 zloty/MW (Information from the Energy Regulatory Office, 2013), while the average price of energy amounts to 201.36 zloty/MW ((Information on average electricity prices, 2013). For the purposes of analysing the received income from energy generation, the authors took the base price of electricity, which is subject to inflation, as 198.9 zloty/MW for 2012. Inflation was taken to run at the level of the inflation target set by the National Bank of Poland, amounting to 2.5% (+/-1%) annually. The price of green certificates at a sum of 241.98 zloty/MW was calculated on the basis of the weighted average index OZEX_A for the period February 2012 to January 2013 (Polish Power Exchange, 2013: 9). The price of property rights depends on the substitute payments set by the Chairman of the Energy Regulatory Office, which is also subject to inflation. It can therefore by expected that their price will rise each year. For the purposes of their analysis, the authors assumed a stable OZEX_A index value for the whole period, due to the fact that it is not possible to reasonably estimate future OZEX_A index values, as they are dependent on transactions made by Polish Power Exchange.

The anticipated economic lifetime of the wind park without the necessity for major renovation expenditure is 25 years. In the opinion of the authors the first revenues will not be received until the first quarter of 2015. An income forecast is given in Table 7.

Table 7.

Income forecast for the period 2015-2040

Source: own study.

 

Wind park operational costs

In addition the basic costs of running a wind farm, it is necessary to add those ensuing from: ground rent, property tax, service charges, grid integration, supervision and management, energy used for own needs, insurance, renovation and maintenance. To the above operational costs we should also add the costs relating to servicing debts as well as expenses incurred by depreciation of capital assets. Part of the costs involved in operating the wind farm are susceptible to the risk of interest rate and exchange rate fluctuations. All servicing work is performed by the turbine providers, which means that payment is made in a foreign currency. Expenditure on servicing debt is particularly vulnerable to changes in interest rates. In terms of the project in question, the general debt indicator is 0.8%, which indicates a significant degree of risk for the venture.

According to research conducted among wind farm owners, the average running costs in 2011 came to 83 zloty per 1MW electricity generated (Ciżkowicz et al, 2012: 33). This figure provided the authors with the basis for estimating the annual operational costs of the project in question. These costs are subject to inflation, which the authors took to be 2.5%. Due to the fact that operations are due to commence in January 2015, the average operational costs for that year amount to 91.62 zloty/MW (allowing for inflation in the period preceding). Table 8 contains a breakdown of basic running costs for 2015 and 2016.

Table 8.

Wind farm operational costs 2015-2016

Source: own study.

 

In accordance with the Cabinet ruling (Cabinet ruling, 2010) wind turbines are classified as a capital asset with the symbol 346. The ruling acknowledges two methods of depreciating capital assets of this type: the declining balance method – at a rate of 14% and the straight-line method – at a rate of 7%. In the project in question, the depreciation rate is deducted using the straight-line method. The capital asset will start operation in the second half of 2015 and therefore, in line with the Accountancy Act (Accountancy Act, 1994), it is from this moment that depreciation should be deducted. A schedule of depreciation deductions is given in Table 9.

Table 9.

Deductions due to devaluation of capital assets

 

Source: own study.

 

Profitability analysis

Here are many methods of estimating the profitability of a given venture (Table 10).

Table 10.

Methods of evaluating investment profitability

Source: own study.

 

Due to the fact that investment in wind farm construction is characterized by a long payback period, the authors used only the discount method to evaluate its profitability. The net present value of the project analysed is presented in Table 11.

 

Table 11.

Net present value of the project

Source: own study.

 

The net present value of the project in question amounts to 78,799,501.78 zloty. The NPV≥ condition was met and thus the project should be allowed to go ahead. Using the calculated NPV value, the authors estimated the profitability index. The total discounted positive cash flow equals 117,693,602.12 zloty, while negative cash flow equals 38,894,100.34.87 zloty.

The condition PI≥1 is met. This means that the project should go ahead.

The internal return rate of the venture is estimated by the authors at a level of 22.439%. The IRR value exceeds the discount rate, which further supports the decision to proceed with the venture. Using the IRR indicator, the authors defined the margins of safety at 12.508%.

A detailed description of the research, basic risk factors, instruments used to eliminate or minimalize these risks and the methods of estimating the impact of risk on the profitability of the venture are described by the authors in the monograph which is due to be published at the end of 2013. This article presents merely the research objectives as well as basic information concerning the profitability of the venture analysed.

Discussion

A few notes to conclude

Poland is a country worth investing in, especially in the wind power sector, which is developing much faster than expected. This sector may have a crucial impact on the Polish economy in the coming years, due partly to improved energy security and the creation of new jobs. Investment in wind farm construction is a viable undertaking, although associated with considerable risk. In analysing the economic viability of such a project, the authors also allowed for aspects which are not possible to measure. However, there remain factors of which the impact is impossible to predict.

Given the fact that wind farm investment is characterized by a long payback period, the authors used only the discount method. To determine the discount rate they used the concept of weighted average capital cost. Using this method, the discount rate was estimated at 9.931%. Onto this value must be added the level of interest on loans (9.597%) and the value of dividends on shares of Polish Energy Partners (18.56%). The net present value (NPV) of the venture amounts to 78.8 million, while the profitability index (PI) is 3.06. The internal return rate (IRR) and modified internal return rate (MIRR) is estimated by the authors as 22.439% and 11.836%. Thus all the indicators used for evaluating the profitability of the investment show that the venture in question is viable.

 

References:

  1. Annual market update 2011. 2012. Global Wind Energy Council. March: 19, 20.
  2. Agnolucci, P. (n.d.). Wind electricity in Denmark: A survey of policies, their effectiveness and factors motivating their introduction. Renewable and Sustainable Energy Reviews, 11 (5), 951-963. doi:10.1016/j.rser.2005.07.004.
  3. Ciżkowicz P., Gabryś A., Baj K., Bawół M.. 2012. The impact of wind power on economic growth in Poland. Ernst & Young, March: 40.
  4. The Foundation for Sustainable Energy – Advisory Group SMDI 2012. Analysis of the required level of support for offshore wind farms in Poland until 2025. Warsaw: 30.
  5. Information from the Chairman of the Energy Regulatory Office No. 3/2013 regarding substitute payments, in compliance with Article 9a of the Energy Regulation Act 2013, Warsaw 26.02.2013: 1.
  6. Information regarding the average market price of electricity for 2012. No. 8/2013. Warsaw 28.03.2013: 1.
  7. Letter of issue no. 44/2012 from the Minister of Finance October 2012 regarding the issue of bonds with fixed interest and date of maturing 25 October 2023: 1, 2.
  8. Joint paper. 2012. Wind energy in Poland. October: 9-11.
  9. Cabinet ruling of 10 December 2010 regarding the Classification of Capital Assets (Journal of Laws No. 242, item 1622).
  10. Polish Power Exchange, monthly report, January 2013: 9.
  11. The Accountancy Act of 29 September 1994 (Journal of Laws No. 121, item 591, as amended).
  12. Wind in Power 2012 European statistics. 2013. The European Wind Energy Association, February: 10.
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Your rating: None Average: 7.5 (2 votes)
Comments: 2

Grażyna Wójcik

Dear Elena Nikołajewna, Thank you very much for the constructive comments. Best regards Grażyna Wójcik

Elena Artamonova

Respected Grażyna Paulina! The article interesting and relevant: as a result, the capital costs and environmental impacts of implementation would be much greater, because a greater capacity of wind turbines and transmission systems would be required to generate the same quantity of energy.
Comments: 2

Grażyna Wójcik

Dear Elena Nikołajewna, Thank you very much for the constructive comments. Best regards Grażyna Wójcik

Elena Artamonova

Respected Grażyna Paulina! The article interesting and relevant: as a result, the capital costs and environmental impacts of implementation would be much greater, because a greater capacity of wind turbines and transmission systems would be required to generate the same quantity of energy.
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