MONEY MATTERS FLEXIBLE APPROACH
TOWARDS MORE FLEXIBLE INVESTMENT STRATEGIES FOR WIND PROJECTS
These days, the most commonly accepted concept of financing projects in the power sector is through project finance. In project finance, the cash flows resulting of the project can be used as repayment for the debt financiers and shareholders. The ownership structure of such projects is established through the creation of a so-called special purpose vehicle (SPV) in which the investors are not liable if the project fails, making project finance a form of limited-recourse financing.
As the success of the project finance concept heavily relies on the future cash flows of the project, risks affecting these cash flows need to be adequately anticipated (and mitigated) to prevent the project from failing. In a risky environment such as the (offshore) wind business, following a flexible approach may help mitigate risks and uncertainty. This has been proven in ‘real option theory’, in which the options to expand, contract or delay have been investigated, for example.
Also in the power sector, research has been done on the added value of incorporating flexibility into the investment strategies of project developers. The prevalent idea in these studies was that flexibility in investment strategies is equivalent to ‘waiting for better conditions’ (also known as ‘develop and delay’). Indeed, waiting for better conditions avoids risks, but may at the same time prevent developers from reaching optimal returns. In other words, it is questionable whether a ‘develop and delay’ strategy generates optimal results (realised return).
ONE STEP FURTHER
Flexibility in investment strategies can be taken one step further than ‘waiting for better conditions’ and can be found in determining the optimal capacity at each stage of the project (this strategy could be called ‘flexible cautious’). Royal HaskoningDHV – Investment Services (Karremans and Van der Beek, 2013) investigated different investment strategies for a varied set of simulated scenarios. In a ‘flexible cautious’ strategy, a project developer would not only expand the project at the moment the expected return exceeds the desired return, he would also invest in the minimum amount of turbines for which the expected relative return is highest. This is a break with the ‘develop and delay’ strategy, which would at this point expand the project maximally, employing a maximum amount of turbines.
RESEARCH RESULTS
From our research, it can be concluded that in case of the relative realised return on equity the ‘flexible cautious’ strategy in the model is superior over the ‘develop and delay’ strategy in any modelled future scenario. This means it is, in all scenarios, wiser to invest using a piecemeal approach.
This finding contains an important message for project developers, financiers and governments alike. By consciously deciding to develop a less ambitious initial project (a pilot), a developer can learn lessons that can be exploited in the next stages of the project. This will lead to cost reductions due to avoiding mistakes as well as due to reductions in manufacturing over time.
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