Sweden: High Internal Rates of Return Attract Investors
Wed, 28 May 2014
Swedish company Absolicon Solar Concentrator has developed a Solar Energy Calculator to enable commercial clients to determine the Internal Rate of Return (IRR) when purchasing and operating solar thermal systems with collector areas of between 500 and 5,000 m². “We were influenced by the PV sector, where customers are much more used to assessing solar investments based on the cash flow over the economic life of the system than based on the payback period,” CEO Joakim Byström explains. Byström founded Absolicon, a producer of concentrating process heat collectors. According to Byström’s experiences, many projects with long payback periods fare much better if you calculate the IRR. The Solar Energy Calculator, which is available online on the company´s website, has already been used by 70 potential clients from all around the world over the last 10 months.
The IRR offers a way to express the value of a project from the investor’s point of view. Byström finds simple words to explain the complex IRR assessment: “First, you calculate the money that you earn or save through your solar thermal investment over the economic life of the system, minus operation and loan costs. But you cannot borrow 100 % of the money that you invest; you need to provide some funds of your own. The IRR percentage tells you how much interest you would have received annually if you had put your money into a savings account instead. The term internal refers to the fact that its calculation does not incorporate inflation.” In times of low interest rates on savings, such as right now, any IRR higher than 2 % already implies an earning compared to just putting the equity capital into a bank account. The Absolicon calculator also considers loan costs and energy cost increases (including inflation).
The Solar Energy Calculator needs the following input from the client:
Choose between 30 different sites in 25 different countries. The site determines the annual radiation and the subsequent solar yield.
Select between four different collector field sizes from 200 to 5,000 m², which will have the investment costs declining for larger projects.
Choose the source of the energy replaced by solar thermal and the energy costs, including all relevant taxes, which results in the amount saved over 20 years.
Finally, select the economic life (15 to 25 years), the annual increase in energy costs, including inflation (2.5 to 15 %), the O&M costs (0.75 to 2 %), the share of the bank loan in the total investment (0 to 90 %) and the loan’s interest rate (2 to 6 %).
“We know that it requires a number of assumptions to carry out a calculation and that some uncertainty is part of the results,” Byström explains. “Therefore, we do not consider the absolute value of the IRR, but we use the tool to compare different investment options with the same calculation factors.” The following table shows the results for a 1,000 m² solar collector field at three different sites for a hotel that wants to replace oil by solar thermal. The prices of the backup fossil fuel are set at 80 EUR/MWh in Germany, including taxes, and, accordingly, higher in Italy and Sweden. The IRR is positive in all three examples, but shows a large variety from 18 % for the German installation to 103 % in Italy. The payback periods from the table were estimated by dividing the total investment of 420,000 EUR by the annual savings. Whereas the German hotel owner will not view a 12-year payback period as very attractive, the 18 % interest rate on the equity capital will look all the more appealing.
1,000 m² hotel collector field with EUR 420,000 investment
End consumer costs of heating oil, including all relevant taxes
Solar yield per m² of collector area
Calculations with Absolicon’s Solar Energy Calculator: Operational costs are set at 1 %, economic life at 20 years, the energy cost increase, including inflation, is 5 %, the share of equity capital is 20 % and the loan’s interest rate is 5 %.
The most uncertain assumption in the IRR calculation is the increase in energy prices, which can be set at between 2.5 and 15 %, including inflation. According to the experiences of Byström, potential customers who have used the tool so far have usually had a clear-cut opinion on how much energy prices would increase in their region and have entered a fairly high percentage, mostly at 7.5 % and above. The following table shows the wide gap of IRRs: Using different energy price increases, the calculation results in an IRR of between 12 and 24 %.
1,000 m² hotel installation in Munich, Germany, replacing oil
Energy price increase
Calculations with Absolicon’s Solar Energy Calculator for a EUR 420,000 investment. The variables have the same values as in the first table above, including energy costs of 80 EUR/MWh.