Assessing the financialviability of small-scale wind turbines in South Africa under different scenarios

Brendan Whelan

Masters of Science in Carbon Management

University of Edinburgh

Background Aim of this paper is to assess the investment case in

small-scale wind turbines for electricity consumers in South Africa in four different financial scenarios

Investigate whether this technology has a role to play in decarbonizing South Africa’s energy supply and providing greater energy security to consumers

Adaptation is often highlighted as the fundamental response to climate change in Africa

The SA case is a different case as it is a big emitter with a high emissions intensity

The country needs to move towards sustainable energy solutions

SA is only starting to capitalize on opportunities in carbon markets

Outline Background

Opportunities and barriers relevant to the energy market in SA

Resource and market potential for small-scale wind turbines in SA

Discussion of theoretical framework Discussion of methodology Discussion of results under four scenarios Policy implications Conclusion

Background SA’s significant carbon emissions: danger it may have to play

catch up SA is well endowed with renewable energy (RE) resources but

currently only contributes to 1% of consumption Government target of 10 000GWh (equivalent to 4% of

projected consumption): currently off track Energy security: window of opportunity

Electricity supply constraints: power outages and load shedding Recent hikes in electricity tariff and fossil fuel prices

The growth of microgeneration technologies in international markets

The most significant barrier: cheap electricity in SA

Background: wind specific drivers and barriers Wind power: one of the most economic RE alternatives Cost of wind power continues to fall through growing

economies of scale and technologically is continuously progressing

2004 World Energy Assessment Report estimates

Renewable Energy Alternative 2001 energy costs Potential future energy cost

Wind 4-8 ¢/kWh 3-10 ¢/kWh

Solar photovoltaic 25-160 ¢/kWh 5-25 ¢/kWh

Solar thermal 12-34 ¢/kWh 4-20 ¢/kWh

Large hydropower 2-10 ¢/kWh 2-10 ¢/kWh

Small hydropower 2-12 ¢/kWh 2-10 ¢/kWh

Geothermal 2-10 ¢/kWh 1-8 ¢/kWh

Biomass 3-12 ¢/kWh 4-10 ¢/kWh

Coal (comparison) 4¢/kWh

Backdrop: wind specific drivers and barriers Significant wind resource potential in South Africa

especially along the coastline and areas along the escarpment

Backdrop: wind specific drivers and barriers• Largely unexploited; current generation of

32,000MWh• Estimated that South Africa could meet 5-6% of

demand with economically feasible wind generation• Notable potential in areas where supply networks are

undeveloped• Small-scale wind turbine market in South Africa is in

its infancy and fragmented Barriers:

lack of technology awarenesshigh initial capital costsdifficulties in accessing financing absence of support framework

Theoretical framework A range of methods were considered: Supply Curve Analysis,

the Payback Period, the Net Present Value (NPV), the Internal Rate of Return (IRR) and Cost-benefit Analysis (CBA)

Internal Rate of Return (IRR) method: widely accepted method preferred for its relative accuracy and suitability to the decision-making process surrounding the acquisition of assets

IRR is the discount rate which delivers a net present value of zero on future cash flows

The rate at which returns on an investment outweigh the opportunity cost. The opportunity cost is the returns that would have been earned on an alternative investment

The hurdle rate or weighted average cost of capital (WACC) IRR > WACC to be viable All other things equal, the investment with the highest IRR is

the most attractive investment

Methodology - Overview of model Financial analysis was performed for a

1kW and a 5kW wind turbine The viability of a small-scale turbine

was investigated in four scenarios:For the ten windiest locations in South

Africa in a market with no support from any financial mechanisms

In a market with a tariff subsidy on top of standard tariff rates

In a market with a capital subsidyIn a market with revenues from the sale of

carbon credits

Discussion of cost value estimates Assumptions:

i) full value of the initial capital cost investment is incurred by the start of period one

ii) costs for the remaining periods are equal to the annual O&M cost

Value for initial capital costs Value of the annual O&M cost O&M costs likely to be higher in SA: US

has a far more developed small-scale wind turbine market

Discussion of benefit value estimates Financial analysis focuses on the viability of small-

scale wind turbines for consumers who are grid-connected

Yearly benefit = amount the consumer saves in generating their own electricity instead of purchasing it from the grid

+ annual revenue from a tariff subsidy if applicable

+ revenue generated from the sale of carbon credits if applicable

Savings = annual generation harvest multiplied by the tariff rate

Discussion of benefit value estimates: tariff rate & subsidy Tariff rate: reflects the most recent tariff

prices

Tariff inflation: assumed to be 10% per annum over the lifespan of the wind turbine

Tariff subsidy: take the shape of a Power Purchase Agreement which will pay the small-scale wind turbine owner an additional rate per kWh of electricity generated

Annual revenue from a tariff subsidy = product of the output of a turbine over a year and the value of the tariff subsidy

Discussion of benefit value estimates: power performance curve Annual harvest is calculated with the

use of a power performance curve formula

P = power output; ƿ = the air density; A = rotor area covered by the turbine’s

rotor blades; V = cube of the mean hourly wind speed; Cp = the power coefficient of the rotor

Power output is then annualized

Discussion of benefit value estimates: carbon credit revenue

Carbon credit revenue: product of the total carbon savings and the negotiated price of the carbon credit

Risk of projects can vary greatly thus credits are traded at a broad range of prices

Validated baseline emissions level for the national grid = 0.000963 tons of CO2/kWh

Results: Scenario I Case where there is no support from any financial mechanisms

A mean annual wind speed in excess of 8m/s is the minimum wind speed required for a 1kW turbine to be viable at any location

Site

Annual mean wind speeds

IRR for 1kW turbine (38.34c/kWh)

IRR for 1kW turbine (45.05c/kWh)

IRR for 5kW turbine (38.34c/kWh)

IRR for 5kW turbine (45.05c/kWh)

Gains Castle

13.9452% 60% 48% 55%

Springbok 8.27 15% 17% 14% 16%

De Aar 6.88 9% 10% 7% 9%

Langebaan

6.889% 10% 7% 9%

Simonstown

6.657% 9% 6% 8%

Cape Town

6.637% 9% 6% 8%

Koningnaas

6.25% 7% 4% 6%

Ixopo 5.82 4% 5% 3% 4%

Geelbek 5.62 3% 4% 2% 3%

Noupoort 5.6 3% 4% 2% 3%

Results: Scenario II Tariff subsidy granted to the small-

scale turbine owner by means of 20 year long PPA

What level of tariff subsidy surplus to the standard tariff charge would be required by an investor in order to achieve the WACC of 15% at any location given a specific wind resource?

For this scenario an annual mean wind speed of 5m/s will be used as a benchmark

Results: Scenario II For a 1kW turbine a tariff subsidy of

R1.30 per kWh on top of the standard tariff would make the investment viable

Results: Scenario II For a 5kW turbine a tariff subsidy of at

least R1.40/kWh in surplus to the standard charge is required

Results confirm that coal-based electricity in South Africa is rather too cheap for renewable energy sources such as wind to be competitive

• The major reason why coal-based electricity is cheap is the excessive support which the power utility company has been given by government

Results: Scenario III The case for a capital subsidy grant For an increase in the level of subsidization on the

initial capital investment there is an exponential growth in the IRR for a 1kW turbine

A capital subsidy grant of at least R33 000 is required by the owner of a 1kW turbine

Results: Scenario III 5kW turbine will require a capital

subsidy grant around R35 000/kW (over 70% of the initial capital cost) in order to generate a rate of return greater than WACC

Capital subsidy grants theoretically have the potential to enhance the viability of small-scale turbines on a broad scale

Results: Scenario IV The case where a small-scale turbine owner has secured

a twenty year contract of sale for forward priced carbon credits from a willing buyer in the carbon market

Assumptions: no transaction costs and additionality requirements for CDM are met

Revenues generated from carbon credit sales, even at prices at the top end of the market, will be insufficient

Prices of around R2,700 per tCO2 saved by owners of 1kW turbines and exorbitant prices of around R3150 per tCO2 saved by owners of 5kW turbines will be required

The annual avoided emissions of equivalent CO2 for the turbines are low

Thus the revenues from sales of carbon credit are outweighed by the large initial capital investment

Cash flows of small-scale wind turbines are not highly elastic to changes in carbon credit prices

Policy implications of the financial analysis Only likely to be a viable investment in select

locations in South Africa where mean annual wind speeds are high

Financial analysis demonstrates that the viability of small-scale wind turbines can be enhanced notably if the investment is supported by financial mechanisms

If this technology is going to be employed on a significant scale in SA it is likely that it will need to be backed by a financial mechanism of some form – market or policy induced

Policy context Setting the example: American (Renewable Energy

Portfolio Standards/production incentives/tax credits) and the Chinese (capital subsidies/production incentives in certain regions) small-scale wind turbine markets are testament to the fact that an enabling policy environment will bolster viability

South African renewable energy policy framework offers no known facility which directly supports investors in microgeneration renewable energy technologies

No tariff subsidy system for renewable energy in SA – proposals for a feed-in tariff have been submitted

Mechanisms for growth and development of the SA small-scale wind turbine market: capital subsidization High initial capital investment: single most significant financial

barrier Majority of South Africans can’t afford this large initial

investment Capital subsidy grants can reduce this capital cost and

significantly enhance the viability of the turbines The Low Carbon Buildings Programme implemented in the UK Renewable Energy Finance and Subsidies Office or the Energy

Development Corporation may have the capacity to provide such a subsidy grant, but do they have the resources or commitment?

Low-cost financing Partnerships making access to finances potentially easier Criticism: capital subsidies will not necessarily result in the

growth of the local manufacturing industry Production incentives: export credits or tax breaks/credits

Mechanisms for growth and development of the SA small-scale wind turbine market: tariff subsidization Feed-in Tariff mechanism:

driven the expansion of wind energy industry in Germany

how does this function? Not of advantage to small-scale turbines owners: function

of turbines is predominantly to provide energy for their own consumption and not for export back into the grid

Second form of tariff subsidy: pays the IPP based on the sum of electricity that is generated from renewable energy regardless of whether this electricity is consumed by the producer or distributed back to the grid – applied in financial analysis in this paper

Instituted in the UK under the Renewables Obligation Certificate programme

More advantageous to small-scale wind turbine owners

Mechanisms for growth and development of the SA small-scale wind turbine market: tariff subsidization Financial analysis indicates that subsidies

well in excess of current electricity charges will be required for turbines to be viable

Case of a 5kW turbine: a tariff subsidy of around 80c would be required; 200% inflation on the current tariff charge

Too demanding for Eskom or SA government: competing with other programmes

Local consumers have displayed great resistance to hikes in electricity tariffs and are unlikely to support cross subsidization of tariff subsidies

Mechanisms for growth and development of the SA small-scale wind turbine market: carbon credit markets Global carbon market is growing rigorously doubling in size in

2007 as climate change moves increasingly into the foreground of government and corporate agendas

Renewable energy project developers in the non-industrialized countries can access carbon credits through the CDM market or voluntary markets

CDM opportunities A number of emission reduction projects in South Africa are participating in

the sale of CER credits Small-scale projects typically cannot afford to partake in the CDM process

as a result of the high transaction costs involved Executive Board of the CDM has designed modalities through which these

costs can be significantly reduced for small-scale projects Option of a collective of small-scale projects bundling together to minimize

transaction costs

Opportunities in voluntary carbon markets At current carbon prices the viability of small-scale wind

turbines in SA is not viable

Conclusions The wide-scale application of small-scale wind turbines can potentially

make a contribution in assisting government meet its RE target

Small-scale wind turbines offer SA consumers a number of benefits: an opportunity to protect themselves against the impacts of power-

outages and load-shedding and rising fossil fuel and electricity tariff prices

an opportunity reduce their personal carbon footprint and assist South Africa in curbing its high level of emissions

an opportunity to improve the quality of their own power supply

This paper has suggested that under certain conditions the benefits from the turbines would outweigh the costs to consumers and if they were to be supported by financial mechanisms they would be even more viable

Conclusions• A tariff subsidy based on the total amount of

electricity generated or an upfront capital subsidy grant would appear to be the most effective form of financial support and will offer the greatest assistance in overcoming the obstacles presented by the low tariff rates in South Africa and the high initial capital costs of the turbines

• The financing of these support schemes will however present a number of challenges especially given the number of socioeconomic challenges in SA

Thank you.