Estimating the beta in the valuation of renewables

This article was authored by our experts Dr Alexander Budzinski and Lukas Flick.

Many companies are currently trying to work out how they can get their energy supplied in a way that is carbon-neutral and at the same time reliable, whilst being as self-reliant as possible. This is making renewable energy installations one of the fastest growing areas amongst infrastructure investments. In this article we take a brief look at the risk and proper valuation of these kinds of installations.

Stages in the life cycle of a renewable energy installation project

The life cycle of a renewable energy installation project includes various stages: development and licencing, construction, operation and dismantling. The individual phases are very different in terms of their length and in terms of the operational risk associated with them. But taking account of this risk and properly factoring it into the planned cost of capital is one of the chief tasks to be carried out in a valuation. In traditional business valuations, the beta is typically estimated by taking a group of comparable businesses that match the market risk premium the investors require as closely as possible and applying them to the individual subject to be valued. For listed companies, the data required for this can be found by observing the capital market. The operating activities of such companies in renewable energies encompass a variety of renewable energy installations that are planned, erected, operated and to some degree then sold on a revolving basis. Thus the betas that can be observed for these companies reflect a portfolio of energy installations with various risk levels. In valuing individual installations, such as a single solar farm, a more thorough analysis is therefore needed to estimate the appropriate beta since, regardless of project stage, only the operational risk of one (or a few) solar farms is to be factored in.

Valuation of wind and solar projects

With wind or solar farm project transactions that are still in their early stages before the operational phase, the valuation is often done in a simplified way using multiples. Consequently, valuations using the discounted cash flow model are particularly used in practice for transactions concerning turn-key installations and those already in operation alongside the use of appropriate multiples. Because comparison between the project being valued and the comparable businesses is limited, the characteristics of the wind or solar farm to be valued should be appraised. A selection of the main characteristics that are mostly responsible for creating uncertainty about future profitability are explained below:

• Feed-in tariff: Subsidies are typically available for renewable energy installations that ensure a certain minimum rate for a certain period for electricity generated and fed into the grid. The feed-in rate fixed in Germany by the Renewable Energy Sources Act (Erneuerbare-Energien-Gesetz – EEG) guarantees installation operators a standard minimum rate for a period of 20 years and also gives the possibility of making additional income by selling directly. Such a wide-ranging subsidy scheme with a fixed minimum rate is the exception, however, and in other European countries compensation schemes are considerably shorter and more involved with the market. A subsidy system of this kind offers a certain degree of security with regard to the ability to make forecasts, even if direct selling is initially assumed in planning.

• Length: Although subsidising in Germany is designed for twenty years, there is no legal specification laid down for how long the renewable energy installations are to be in operation. Past experience can provide indications for this but is typically limited because of the development in technology that has occurred since. The output data and stoppage rates of older farms cannot be directly drawn on for comparison with modern and newly built farms due to the ongoing competition in technology both in solar modules and wind power installations. And many installations are not even much more than 20 years old. Reliable figures are provided in particular by the length of manufacturers’ warranties that guarantee a minimum period of operation. The duration of other aspects of projects may also be technically possible, but tend to be subject to greater fluctuations in performance and generally to higher levels of uncertainty.

• Contract drafting for operational expenditure and leases: For renewable energy installations, long-term contracts are typically concluded for maintenance and operation as well as for the rented area. Just as the feed-in rate gives a high level of long-term certainty for planning on the income side, so do the contracts usually concluded before the start of the operational stage on the expenses side. Together, this significantly limits the uncertainty concerning future cash flows.

• Availability of current production data: In valuing renewable energy installations that have already been in operation for a certain amount of time, the results of the energy yield assessment undertaken before construction of the wind farm should be benchmarked using definite current data. Even if it has only been in operation for a short time, this allows the planning figures calculated in advance to be checked for plausibility, which is typically set for the entire period of operation. Regardless of the result of the comparison between actual figures and planning figures, actual figures or even carrying out an operational energy yield assessment reduces the level of uncertainty concerning earnings during the further duration of the project.

Opportunities for investors

Renewable energy installations offer present and future investors exciting but to some extent contested opportunities. A reliable and understandable valuation is therefore often a crucial departure point for the commercial considerations that follow.