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Sustainable Asset Valuation (SAVi) ToolAssessing the financial impact of climate and other environmental, social, economic and governance risks on infrastructure
FOR MORE INFORMATION:
Oshani Perera: [email protected]
David Uzsoki: [email protected]
Fida Rana: [email protected]
Andrea Bassi: [email protected]
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THE CHALLENGEConventional project finance valuation methodologies ignore a range of material risks, intangibles and externalities.
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The financial impacts of climate and other environmental, social, economic and governance (ESEG) risks are not adequately assessed throughout the infrastructure deployment cycle. The Financial Stability Board (FSB) has recently issued recommendations to encourage the disclosure of such risks. This is especially important for long-term assets such as infrastructure that have an operating lifetime of several decades. Understanding the long-term financial impact of these risks would not only allow a more informed project-selection process, but would also enable investors to monitor their exposure under various climate change scenarios.
Traditional valuation methodologies often provide a less convincing business case for sustainable assets than for business-as-usual infrastructure, due to elements such as higher upfront capital costs, prominent technology risks, greater attention to safeguards, and higher project preparation costs. The problem lies in the fact that inadequate identification and pricing of risks leads to inaccurate asset valuation and feasibility assessments. Governments face additional challenges as they seek to position infrastructure as a catalyst for sustainable and inclusive development Infrastructure locks in land use, design, technologies and capital for long periods of time. It will therefore be a missed opportunity if these assets are not planned, designed, procured and financed in a manner that optimizes environmental stewardship, builds skills and crowds in domestic businesses and investors.
The problem lies in the fact that inadequate identification and pricing of risks leads to inaccurate asset valuation and feasibility assessments.
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THE SOLUTION IISD has developed the Sustainable Asset Valuation (SAVi) tool to assess the environmental, social, economic and governance (ESEG) risks of infrastructure projects.
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HOW CAN SAVI ADD VALUE TO INVESTORS?
→ The Financial Stability Board has recommended that institutional investors and financial institutions identify and assess financial impacts stemming from climate-related risks and opportunities. SAVi can be deployed to identify and assess these impacts and risks across all infrastructure investment portfolios. The outcomes can subsequently be used in corporate sustainability reports and dedicated climate risk disclosure statements.
→ Infrastructure projects and portfolios can be stress tested under the climate scenarios identified by the Financial Stability Board, including change in precipitation patterns, rising mean temperatures (physical risks), increased pricing of greenhouse gas emissions and more stringent regulation of existing assets (transition risks), among others. The output generated by IISD can be used as a more refined set of financial inputs in the financial model of the project, calculating how the internal rate of return (IRR) and credit ratios (e.g., debt service coverage ratio, loan life coverage ratio) change under these scenarios.
HOW CAN SAVI ADD VALUE TO GOVERNMENTS AND CITIES?
→ SAVi can be deployed to identity, quantify and monetize the various co-benefits and avoided costs (economic, social and environmental) of infrastructure projects, enabling decision makers to make more informed choices during project selection and design. Public policy-makers can thus have the necessary quantitative evidence to assess if the additional capital costs of resilient and sustainable infrastructure are indeed good value for money and contribute to fulfilling development policy objectives. In the same vein, policy-makers and taxpayers will be able to assess how sustainable infrastructure projects reduce risks (and associated costs) across the project life cycle and why these assets can be easier and cheaper to use and operate.
→ Policy-makers can also use SAVi to prepare sustainable infrastructure projects in a manner that crowds in domestic value chains and investors. Only then can infrastructure be positioned as a motor for sustainable growth.
→ SAVi can also be used to prioritize infrastructure projects based on their potential to provide sustainable public services, build skills, provide employment, trigger green industrialization and innovation, steward the environment, attract foreign direct investment and much more. Prioritizing is a critical step in the development of infrastructure project pipelines and broader infrastructure master plans.
→ SAVi can also be deployed to forecast and monetize how infrastructure projects contribute toward realizing the UN Sustainable Development Goals (SDGs). Governments will soon seek to report on the progress of policies and programs associated with the SDGs, many of which will be related to infrastructure.
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THE SECTORS SAVi has been developed for four sectors/asset categories: Energy, buildings, roads, water infrastructure. These assets were selected based on lending volumes and
consultations with stakeholders. In the latter of half of 2017,
we will focus on expanding focus on natural infrastructure.
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SUSTAINABLE ASSET VALUATION TOOL (SAVI) IN USEHow would the financial viability of a 600 MW gas-fired combined cycle power plant change under three climate scenarios?
Table 1 is an example of an output IISD has generated for a 600 MW gas-fired combined cycle power plant, limiting our calculation to two climate variables in this case: gradual rise of air temperature and decrease of water availability. The table shows how the plant load factor (annual capacity) and efficiency (rate of conversion of feedstock to energy) change under three different scenarios
Base Case Scenario 1 Scenario 2 Scenario 3
Air temperature (also proxy for water temperature)
24 +1.0 in 2050 +1.5 in 2050 +2.0 in 2050
Water availability 100%95% at
summer time90% at
summer time85% at
summer time
Plant load factor (% change) 0% -0.14% -0.42% -0.91%
Plant efficiency (% change) 0% -1.45% -2.21% -3.38%
For example, under Scenario 3, we can see a decrease of about 1 per cent in load factor and a decrease of more than 3 per cent in plant efficiency. These financial inputs in the project finance model can be adjusted accordingly, calculating the impact on the overall bankability of the asset. Depending on user preference, IISD can also run these numbers through a generic financial model (customized for each asset type and developed following Corality’s SMART modelling approach) and demonstrate how key financial indicators change under each scenario.
Table 2 is another example of an output from our model. It was generated taking into consideration policy-makers who are prioritizing employment creation as a main policy objective.
Coal Gas Solar Wind
Jobs created during construction 3,202 786 13,538 1,877
Jobs created during operation 116 159 689 439
This table shows the number of jobs created during construction (including manufacturing and installation) and in the operating phase (operation and maintenance) for four different technologies: coal, gas, solar and wind, based on the assumption of all generating 600 MW of power.
Finally, table 3 shows the lifecycle CO2 emissions (generated during manufacturing, construction and operation) for four different technologies: coal, gas, solar and wind, based on the assumption of all generating 600 MW of power.
Coal Gas Solar Wind
100.4 million tons 95.2 million tons 11.29 million tons 2.8 million tons
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THE SERVICEIISD seeks to work with policy-makers, project developers, sponsors and investors, to assess the climate and other ESEG-related risks and externalities of their projects, portfolios and project pipelines.
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IISD CAN PROVIDE ASSISTANCE IN THE FOLLOWING AREAS:
→ Work with governments and cities to prioritize and deploy infrastructure projects based on their ESEG co-benefits and avoided costs.
→ Work with investors to analyze their infrastructure portfolios and prepare climate and other ESEG-related risks and opportunities mapping.
→ Customize SAVi to fit a specific portfolio, run different scenarios to assess potential impact stemming from climate-related risks and opportunities, demonstrate relevance to realizing SDGs.
→ Assess and report on how infrastructure projects contribute toward realizing the SDGs.
→ Assist in preparing climate and other ESEG-related risk disclosure.
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METHODOLOGYUsing the System Dynamics Methodology allows us to define problems dynamically, calculating complex correlations using feedback loops and delays in a non-linear fashion.
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The Sustainable Asset Valuation Model (SAVi) is based on the System Dynamics Methodology. It serves as a knowledge integrator, generating a conventional cost-benefit analysis as well as a more comprehensive assessment of the broader social, economic and environmental impacts of infrastructure projects. This includes the quantification of co-benefits, avoided costs and project risks. For example, forecasted impacts could include reduced fish stock following the installation of a hydropower dam. Avoided costs could be reduced energy consumption in sustainable buildings or reduced construction costs in the case of better road siting. Finally, added benefits could be increased productivity triggered by improved human health, which in turn was achieved by improved ambient air quality. This methodology also allows project risks to be identified and estimated, filling an important information asymmetry for investors. Examples of these risks are provided below:
→ Regulatory risks: Carbon taxes, changes in feed-in tariffs, changes in availability payments, air pollution laws.
→ Market risks: Price volatility and disruptions in supply of inputs (coal, building materials, water, feedstock) and outputs (energy and water services).
→ Technology risks: Unexpected costs in installation and O&M, losses related to poor performance, cost of decommissioning, losses related to extreme weather, insufficient track records.
→ Social risks: Issues related to land acquisition, disputes and delays related to environmental impact assessments and social impact assessments, disputes and delays related to other safeguards such as clearances and permits.
Investors use project finance models to estimate the financial viability of the project by modelling how project cash flows can service debt and generate return for sponsors. Using financial models following Corality’s SMART Financial Modelling approach, SAVi demonstrates how the different project variables (such as capital expenditures, construction time, operation costs, operation efficiency, corporate tax rate, etc.) change under a range of risk scenarios. These include delays in construction, disruption in operation due to social or technological risks, and the impact of climate change—such as heat waves—on the operation of the asset, among others.
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© 2017 The International Institute for Sustainable Development Published by the International Institute for Sustainable Development. INTERNATIONAL INSTITUTE FOR SUSTAINABLE DEVELOPMENT
The International Institute for Sustainable Development (IISD) is one of the world’s leading centres of research and innovation. The Institute provides practical solutions to the growing challenges and opportunities of integrating environmental and social priorities with economic development. We report on international negotiations and share knowledge gained through collaborative projects, resulting in more rigorous research, stronger global networks, and better engagement among researchers, citizens, businesses and policy-makers.
IISD is registered as a charitable organization in Canada and has 501(c)(3) status in the United States. IISD receives core operating support from the Government of Canada, provided through the International Development Research Centre (IDRC) and from the Province of Manitoba. The Institute receives project funding from numerous governments inside and outside Canada, United Nations agencies, foundations, the private sector, and individuals.
The IISD Public Procurement and Infrastructure Finance Program is a multidisciplinary team of experts on procurement, public–private partnerships and project finance laws and policies, infrastructure finance, tender cycle advisory, project preparation, environmental and social safeguards, among others. Our core focus is to increase value for money for the public purse in procurement of goods, services and infrastructure.
For more information on the SAVi tool please visit: http://www.iisd.org/project/SAVi-sustainable-asset-valuation-tool
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