One of the most important tasks at the planning stage of an investment project for a hydroelectric power plants is to determine the capital structure.

In this context, experts identify the following criteria:

• Types of capital: a set of sources of financial resources and instruments available to the company that will be used for the construction and launch of the facility.

• Time frame: comparison of specific sources of capital and financial instruments involved in the implementation of the project at different stages. This kind of structure is built on a clear time frame for the start and end of financing / refinancing of the HPP project.

The complexity of the financial decisions taken during the construction and launch of large capital-intensive facilities is due to a number of factors.

The choice of the optimal sources of financing for the HPP project depends on the following:

• A clear understanding of the need for financial resources, the method and time of their receipt, the schedule for the use of funds and settlements with creditors.

• Rational choice of financial instruments, taking into account their availability for a specific project, advantages and disadvantages of use.

• Taking into account the peculiarities of the interaction of various financial sources and instruments, their influence on the effectiveness of each other.

• Understanding the relationship of each funding source and financial instrument to the project’s ownership structure and value.

• Minimization of the cost of attracting external financial resources.

• Correct assessment of the risks and constraints of the project.

These aspects require the project participants to take a comprehensive approach to drawing up the financial model of the hydroelectric power plant, constantly monitoring changes and promptly adjusting the relevant parameters within the project structure.

Financial model for a hydroelectric power plants

The construction of large hydropower plants is becoming an increasingly complex and costly task amid dwindling water resources and tightening environmental standards around the world.

Using an advanced financial models of hydroelectric power plants in the planning of investment projects is now of great essence for business.

Having high quality financial forecasts can be a key success factor that will push partners to invest in your multi-million dollar project.

The financial model is an important tool that opens the door to external financing in modern capital markets.

LTIP Funding Company Limited offers private and public customers professional assistance in financing energy projects around the globe, including long-term bank loans and project finance schemes.

We also develop tailor-made financial solutions for energy sector and other capital intensive areas.

Long-term hydropower plant financial model: theoretical basis

In corporate finance practice, the term “financial model” refers to a comprehensive analytical tool that is used to evaluate and compare projects.

This tool is based on initial project data with a set of assumptions that are processed using standard mathematical and statistical methods to obtain the most accurate predictions of future results.

Financial modeling of hydroelectric power plants principles include the following:

• Taking into account all significant aspects of the hydropower project and all future events.

• The analysis period should cover the years over which the values of the variables can be predicted with reasonable accuracy.

• The long-term financial model of the hydropower plants should help to generate financial statements (income statement, balance sheet).

• The model must be dynamic, which means that important financial variables can be changed with a corresponding recalculation of the results.

• Revenues and costs for a single project should be modeled separately for each activity.

• The model should take into account the trends observed in real-world projects.

Since the construction of hydropower plants currently requires significant investments (in most cases, at least 2 million euros for 1 MW of installed capacity, taking into account the construction of reservoirs and environmental costs), the role of a high-quality financial model of hydropower plant in the long term can hardly be overestimated.

Most often, such models should cover an investment period of at least 5–7 years.

The stages of forecasting the financial results of the Hydroelectric power plants include:

• Making a set of assumptions for financial analysis.
• Development of a detailed program to maximize profit (electricity sales).
• Forecasting revenues from electricity sales taking into account internal and external factors.
• Forecasting the costs of production and supply / sale of electricity.
• Drawing up a project budget with a plan of expenditures and sources of funds.
• Planning financial costs, taking into account the schedules of loan repayment.
• Drawing up a detailed report on the profit and loss of the project.
• Planning for working capital requirements.
• Drawing up detailed reports on cash flows.
• Determination of the cost of capital.
• Assessment of the effectiveness of the project.
• Risk analysis.

In practice, compiling a financial model for a hydroelectric power plants

will require the collection and processing of a large amount of information that is relevant to the future and therefore subject to uncertainty.

This activity requires complex calculations, taking into account changes caused by objective reasons or a change in the position of the project participants on specific issues.

Thus, the level of qualifications, practical experience and technical equipment of the financial team, along with access to project information, determine the result of financial modeling of each project.

Analysis of the financial needs of the hydropower project

To assess the financial viability of a hydroelectric project, a holistic model can be proposed that reflects the structure of revenues and costs for a given type of project in the light of current regulations and market conditions (any significant aspects related to the commercialization of generated energy are important).

Assessment of HPP assets is the foundation for subsequent analyzes, because initially it is very important for companies to clearly establish the value that certain investments will add to achieve strategic goals. For this purpose, financial experts use different methods, depending on the specific type of asset and the use of unreliable data that can distort the results and create unnecessary risks.

Currently, a number of economic methods are used to evaluate investment projects for hydropower plants, which can be classified as follows:

• Comparative analysis of projects, which includes an assessment of the cost of a specific project with the assets of competitive projects with similar parameters.

• Valuation of the project using real options, which is most applicable to hydropower projects. This approach provides some flexibility in the future and is based on predicting value in accordance with cash flows that depend on the occurrence of certain events.

• The discounted cash flow method, which evaluates assets (projects) based on an analysis of future cash flows, and then allocates them at an appropriate rate according to the risks of specific flows.

For this type of project, it is necessary to determine the optimal financing scenario in advance.

Since the accuracy of the financial model of a hydroelectric power plants is dependent on the accuracy of the data, a professional approach is essential to success.

Recommendations for modeling the capital structure

The first step in modeling the capital structure should be a comprehensive study of the activities of the future facility.

In particular, it is necessary to assess the project’s capital needs and form the conditions for the use of borrowed funds in the interaction of project initiators with contractors, equipment suppliers, authorities, potential investors and creditors (large banks, IFIs).

Based on the data obtained, the participants in the enterprise can outline the circle of the most suitable sources of capital, determine the preconditions for attracting it and estimate the cost of borrowed funds from each source.

This model must be flexible enough to respond to changes in external factors.

A recommended approach to modeling the capital structure in a financial model of a hydroelectric power plant is shown below. This approach can be easily modified depending on the specific goals of the project participants.

Modeling the capital structure of a Hydroelectric power plants project requires taking into account such significant factors as expected income and expenses, the cost of attracting external funds etc.

Potential risks associated with the use of borrowed funds, ranging from a decrease in the company’s credit rating to the risk of loss of control over project assets, play a special role in decision-making.

The role of financial models and forecasts in hydropower power plants project

Financial forecasting means a set of activities through which financial forecasts are made.

The subject of forecasting in hydropower projects is financial flows, the models of which are compiled on the basis of initial forecasts of material flows, the most important of which is the forecast of electricity sales, as well as forecasts of consumption of materials, labor, etc.

A predictive model in financial forecasting can be represented as a financial model of a hydroelectric power plant, consisting of a system of equations.

Such models can be developed, for example, for the analysis and comparison of financial statements of several projects, preliminary cash flow estimates, investment cash flow projections and free cash flow projections.

Each of the financial forecasts is created by building a complex financial model as a result of changing a set of one or more initial parameters.

Financial forecasts can be created by specialists of the initiating company or developed under a contract by third-party organizations (contractors, rating agencies, financial analysts, consultants).

Typically, financial modeling of hydropower projects is performed with changes in assumptions about external factors such as economic growth, exchange rates and interest rates. The purpose of making financial forecasts is to reduce risk in the decision-making process.

For example, in the course of forecasting financial statements and assessing future cash flows of hydroelectric power plants on their basis, experts assess the financial needs of the project, which vary depending on external factors, methods and scale of the project, and planned electricity sales.

The source of meeting these financial needs are investments in working capital and fixed assets. This requires making the most rational investment decisions regarding the sources of attracting additional funds. On the other hand, based on cash flow forecasts, HPP investment projects are compared, which makes it possible to decide whether to accept or reject a specific project.

Depending on the objectives of the forecast, qualifications and the level of access of the performers, the composition of the variables included in the financial model of hydropower plants changes.

For external analysis, many parameters are uncontrollable variables, so the role of modeling is reduced.

In the literature on financial management of the energy sector, the goal of financial forecasting is reduced only to determining the financial needs of the enterprise.

In practice, this goal is much broader and covers not only the financing of the hydropower project, but also other needs.

Among them are the development of the enterprise, the management of working capital, the formation of the value of the project for investors, as well as the management of project risks of various nature, and much more.

If you are looking for professional financial modeling services for hydropower projects, contact the LTIP Funding Company Limited team.

Our company provides long-term financing for large projects, offering clients comprehensive support at all stages.

LTIP Funding Company Limited
Emails: admin@ltipfundingcompany.com // funding@ltip-funding.com
Website: https://ltip-funding.com/