July 25, 2019

Why renewable energy financial models are always wrong, and how to mitigate it

by James Pagonis

Here’s a universal truth about financial models in renewable energy: they suck. But that’s OK!   

 

A senior manager at a major financial institution oncproclaimed to the audience at a conference I attended: “The only thing I know for sure about my financial model, is that it’s wrong.”  I’ll never forget that.

 

The goal of financial models for renewable projects is to predict what’s going to happen within the next 10 or 20 years. Making the best possible assumptions using the best possible information you can access is often all you can do. So here’s a universal truth: the only way to build a good financial model is to go into it knowing that it’ll be wrong.  

 

As long as you’re aware of the limitations, practice asset intelligence, and know that your assumptions will inevitably change over time, you’re golden. 

 Why Financial Models Are Often Wrong

So why are financial models so inaccurate? It’s because everything changes: from revenue, to production, to labour rates, to technology costs,  to the actual technology itself and whether it’ll be available in 20 years.  We’ve already talked about the impact of asset management on income stream projections and investment. Does your financial model take this into account?

 

Early models might have completely missed certain line items, like regulatory changes, renewable energy taxes, equipment manufacturer bankruptcies, and contingencies for random damage or vandalism.  Your “Full Wrap” O &M agreement may have assumed a lot of the operations and maintenance were already covered, or that repairs were planned for and covered.

 

Something else we’ve experienced recently is that at the start of a new market opening, that market may be ripe in terms of opportunity and available tariffs. But by the end of a political cycle or two, the politician of the day may have changed everything and those encouraging tariffs may no longer exist. A renewable energy financial model drafted at the beginning of that market will be useless. And that’s OK!

 How to Fix Them

As an asset manager, your only path forward is to go with current assumptions, make reasonable predictions, assume costs will increase, and break out your expenses into reasonable buckets.

 

By breaking fees into buckets, you’ll understand your costs better. You’ll be able to identify missing chunks. For example, financial models often include predictions about refurbishment/equipment repair, but they might forget to consider the cost of labour. Often, after the facility is up and operational the labour is more expensive than the equipment. As a result, the actual costs can end up being significantly higher even when equipment costs come down.

 

There is no such thing as a perfect financial model for renewable energy, and rarely, an accurate one.  What you have is, at best, and are a series of educated assumptions, and so long as you plan for what happens when you’re wrong, that’s really ok.

 

Want to learn more about the financial side of renewable energy? Check out the 5 questions we think you should ask before you invest.

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