05-00: Economics of Bioenergy

05-00-01 Components of Bioenergy Projects

Bioenergy projects can be considered to be different to many other renewable energy projects as careful consideration has to be given to the entire energy system (fuel supply, fuel processing, energy conversion, residue management etc) to ensure that the project is financial viable. In the majority of cases the fuel or raw material has to be harvested or gathered, transported and processed before being converted into energy. In addition, there are typically end products which have to be disposed of or utilised in another way e.g. ash from a combustion process. It is therefore important that a systems approach is taken when considering the financial viability of bioenergy system.

The approach taken in the following chapters therefore will be to consider the elements to be considered in the fuel/raw material component of the system and then the cost for the bioenergy plant. Where relevant, case studies will be presented. It is important to note that costs for labour, taxes, land etc will vary considerably from country to country with Europe and therefore an approach of presenting percentage breakdowns of the relevant components will be taken.

Firstly however the basics of financial appraisal will be introduced.

05-00-02 Financial Appraisal – the theory

Financial appraisal of a potential project is an important skill to develop. The more thorough your own appraisal of your project, the more likely you are to convince a lender or funder to give you money. To produce a cash flow statement for the proposed project you will require information on Initial Costs, including Capital Expenditure, Annual Costs and Debt Payments, Periodic Costs, Savings or Income and Funding Sources. Producing a cash flow statement (section 05-00-02d) is vital to allow completion of Financial Appraisal tools such as simple payback (05-00-03a), Internal Rate of Return (IRR, 05-00-03c) and Net Present Value (NPV, 05-00-03b).

05-00-02a: Income and Expenditure

Initial and Capital Expenditure Costs could include the following:
•  Feasibility studies
•  Development costs (e.g. Power Purchase Agreement (PPA) & planning permissions)
•  Engineering costs (e.g. design)
•  Development contributions
•  Renewable energy equipment
•  Balance of plant (e.g. civil works, grid)
•  Miscellaneous (including contingencies).
For most renewable energy systems the capital costs are significant and are the most important component in any calculation.

05-00-02b: Annual Costs

Annual Costs can be divided into operation & maintenance (O&M) costs, fuel and electricity costs and debt payments. In many cases these costs have to be spread over the life time of the project e.g. 25 years and the costs need to be covered every year from the annual income.
•  O&M costs include land lease, insurance, operation, maintenance (parts & labour), community contribution and administrative costs. O&M costs are spread over the length of the project lifetime.
•  Fuel and electricity costs for some renewable energy projects can be significant. For bioenergy projects, the cost of fuel can be a major component of the annual costs (e.g. purchase of wood chips) and a bioenergy plant may have a significant electricity demand (e.g. for operation of augers, pumps).
•  Debt Payments will reflect your decision as to what percentage of initial costs will be funded by equity and what percentage by debt. Your debt payments will depend on the debt interest rate and the term of the debt.

Periodic costs are costs that recur on a predictable cycle, for example fire bricks for a wood-fuelled heating system (refractory insulation).

05-00-02c: Determining Savings Or Income

Savings or Income include both the avoided costs of energy purchase where heat / electricity / fuel are used to self-supply, and income earned from selling heat / electricity / fuel to a third party. In most cases you will be comparing the savings from using a bioenergy system to that of the existing system or a default system e.g. wood heating being compared to oil heating or AD CHP to oil heating and electricity supply from the grid. It is important therefore to have a good knowledge of the baseline system which you are comparing against so that your results are valid.

Income for a bioenergy project can come from a number of sources. Examples include:
•  Sale of heat from a biomass plant to a client or via district heating system
•  Sale of electricity from power plant. This is typically sale of electricity into the National Grid. In many countries the sale of electricity is done via a Power Purchase Agreement (PPA). The PPA is made with a utility and normally guarantees the price per kWh of electricity sold for a particular period. The range of prices paid for electricity from a biomass plant varies considerably from country to country and you will need to check the national policy in this regard.
•  Sale of electricity and heat from a Combined Heat and Power plant
•  Sale of biofuels for transportation
•  Sale of by-products e.g. digestate from an Anaerobic Digestion (AD) Plant
•  Income from gate fees charged for raw materials e.g. fish waste into an AD Plant
•  Carbon Credits generated from avoided CO₂ emissions. In some countries projects can generate sell the carbon savings from the project into the Carbon Trading system. Carbon is traded on the markets with considerable ranges in prices (€1 to €30/Tonne CO₂)

Examples of savings could include:
•  Avoided cost of fossil fuel purchases as heat is now supplied from biomass plant
•  Avoided cost of waste disposal as waste is now used as raw material in biofuel production
•  Avoided cost of artificial fertiliser which is now replaced with disgestate from AD plant
•  Avoided cost of electricity purchase from the grid as CHP plant supplies on site demand.

05-00-02d: Cash Flow Statement

Knowing your income and expenditure, it is possible to produce a cash flow statement that brings all of the above information together. This summarises the figures over the length of the project lifetime e.g 25 years. A simple cashflow statement might look like this:

Example of a Cash Flow calculation

05-00-03: Financial Appraisal methods: Tools (Payback, NPV, IRR)

Financial Appraisal tools such as Payback, Net Present Value (NPV) and Internal Rate of Return (IRR) will facilitate decision making and provide an assessment of whether an investment is worthwhile. These figures are important to be able to present to decision makers e.g. local authorities, funding agencies, banks etc so that they can be assured that the project is viable and worthwhile supporting or investing in. Appraisals can be done in 'real' terms (inflation not included) and in 'nominal' terms (inflation included).

05-00-03a: Payback Period

Payback period is the simplest appraisal approach, but it has disadvantages. It calculates the number of years to recover the initial cost. The payback period equals initial costs divided by net annual savings, calculated below.

Payback = Initial Costs / Net Annual Savings

05-00-03b: Net Present Value

In practice, using Payback Period as an appraisal tool can be too simplistic. For example, Payback Period does not consider cashflows after the end of the simple payback time. It also ignores the differences in the value of money over time. These differences in value can be due to a number of factors including inflation, the level of risks in a project and society's 'time preference' for receiving money, goods and services now rather than later.

Net Present Value (NPV) applies an appropriate discount rate to a series of future payments (negative values) and income (positive values) with the starting investment designated in the 'zero year'. Applying the discount rate converts all costs and benefits to 'present values'.

Choosing the discount rate is important as it is a significant variable in the analysis. Some firms will have a weighted average cost of capital (after tax). This can be increased to allow take account of risk into the future. A variable discount rate with higher rates applied to cash flows occurring further along the time span might be used to reflect the yield curve premium for long-term debt.

Another approach to choosing the discount rate factor is to decide the rate which the capital needed for the project could return if invested in an alternative venture. If, for example, the capital required for Project A can earn five percent elsewhere, use this discount rate in the NPV calculation to allow a direct comparison to be made between Project A and the alternative.

This NPV figure should then be compared to that of other investment options to help decide on a particular course of action. Sensitivity analysis is advisable to determine which parameters have the greatest impact on the NPV. The selection of the appropriate discount rate is complex and expert advice should be sought.

05-00-03c: Internal Rate of Return

Internal Rate of Return (IRR) is closely related to NPV in that IRR is the discount rate that meets the condition NPV=0. In other words IRR is the discount rate with which the discounted net income of the project is equal to the starting investment. Options with higher IRRs are generally better but NPV and other analyses should also be used to supplement the IRR approach.

An advantage of IRR as an appraisal tool is that (unlike in NPV analysis) a specific discount rate does not have to be chosen. A disadvantage of IRR is that analysis of a project whose cashflow changes from negative to positive more than once over the project's lifetime can return multiple IRR values, thus hindering decision making.

05-00-03d: Costs and Pricing Strategies

The range of scenarios in which a bioenergy project can be developed is significant. Some projects will be stand alone development on a green field site where costs or income do not have to be apportioned out to different areas or business units.

However, there are many cases where a bioenergy project is an additional business development for an existing enterprise or business. A farmer decides to start producing straw briquettes using his existing material, a biomass DH plant develops into a biomass CHP plant or a sawmill develops a wood pelleting plant. Where such a situation occurs consideration needs to be given to how the costs and income are split between the different units of the business.

Taking the example of the sawmill starting to produce wood pellets. It is likely that the pellet production plant will be designed provide heat to the sawmill for timber drying and the plant will avoid costs associated with disposing of waste which is now converted into pellets. The costs associated with the development of the pellet plant could be split to reflect the portion of the costs relevant to the 'core' sawmill business and the 'new' pellet business. Similarly the farmer or farmers cooperative which invest in new harvesting machinery to maximise straw harvesting should consider whether the full cost of the new equipment should be applied to the briquettes enterprise or some applied to the farming enterprise.

For initial analysis splitting cost or income can be ignored but as the project proceeds further into financial analysis this issue should be considered.

05-00-04: Financial Appraisal tools

There are a wide variety of tools available which can be used for assessing bioenergy projects. One which has international appeal is the RETScreen model developed by Natural Resources Canada and can be used to complete a pre-feasibility analysis of a particular project.

Other tools may be available in your own country. Check your National Energy Agency or National Bioenergy Association.

05-00-05: The Bankers View

The following are key points extracted from a presentation by Tom Bruton, Bioxl, Ireland. These notes were developed based on output from by Deutshe Bank, Paul Batelle, Director Renewable Energy Asset Finance & Leasing. While all bioenergy projects may not be financed using the project finance route the process of considering the issues and risks identified is a valuable one to put your project through.

When analysing biomass projects for credible, capable and creditworthy sponsors, banks will focus on five key areas
•  Feedstock supply
•  Feedstock storage, transportation, handling and treatment
•  Biomass conversion to energy (gas, electricity or heat)
•  Construction risks
•  Energy offtake contracts

Generally banks will want a minimum of four of these five elements to be fully proven with reference projects demonstrating a first class track record.

Feedstock supply

This highlights the need to consider carefully the fuel supply chain as part of your project and not only look at quantity, but quality of supply. Refer to columns 02, 03 and 04 in this handbook (i.e. chapters 02-00, -01…, 03-00, 03-01… and 04-00, 04-01 etc) for more details.

Feedstock storage, transportation, handling and treatment

Many projects fail to put sufficient logistic management controls in place to deal with the safe storage, transportation and management of the fuel supply. Without such control additional cost variability will be introduced into the project e.g. dealing with excessive moisture in wood chip and the cashflow of the project will be impacted.

Biomass conversion to energy (gas, electricity, heat or cooling)

The technology that will be used to produce the energy (your income) needs to be proven with evidence that can show that it can meet the demands and requirements for the site/project. Given the significant impact that fuel quality can have on bioenergy conversion technology performance a clear process where the variability of output can be clearly linked to either fuel supply or technology performance is important.

Construction risks

Larger bioenergy projects are complex construction projects which require significant control of risk and strong project management skills. Ensuring that the construction team have good communication processes in place will be vital to ensure that construction deadlines are achieved.

Energy offtake contracts

For projects where energy offtake contracts are available banks clearly have a preferences for Power Purchase Agreement (PPA) type contracts which offer certainty and minimise risk. PPA's typically apply to power and CHP systems but there will also be heat supply controls associated with district heating systems.

Green Certificates are a mechanism where a value is assigned to the 'green' value of energy produced from the plant. This can relate to the CO₂ savings relative to a baseline fossil fuel or the average CO₂ emissions from electricity in a particular country. They are normally an additional payment on top of the fixed price agreed via the PPA.

Case Study – AD Plant