Example of Sensitivity Analysis of a Wind Farm Project Cash flow model

What is a Sensitivity Test/Analysis of a Cashflow

Sensitivity analysis determines how different values of an independent variable affect a particular dependent variable under a given set of assumptions. In other words, sensitivity analyses study how various sources of uncertainty in a mathematical model contribute to the model's overall uncertainty. This technique is used within specific boundaries that depend on one or more input variables.

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from Investopedia

Sensitivity Test considered Parameters

The sensitivity test of nine variables as stated in Table 1 was carried out with a minimum and maximum outcome assessed. As indicated in the results in Table 2, the feasibility of cash flow variables of Equity IRR (leveraged), Project IRR (unleveraged), and minimum DSCR was assessed for the bankability and viability of the onshore wind farm proposed investment. Furthermore, the results are illustrated below in Figure 2, Figure 3, and Figure 4.

Sensitivity Test Parameters Considered

No.	Variables	Variation
1	Operating & Maintenance	(+/-20%)
2	Operating & Maintenance	(+/-10%)
3	PPA purchase rate	(45&60 EUR/MWh)
4	Interest Rate Increase	(+/-1.5%)
5	Annual Project power production probability	(P50 or P60)
6	Capital Cost	(+/-10%)
7	Inflation	(+/-2%)
8	Construction Duration	(+/-0.5 year)
9	Annual WTG degradation	(+/-0.5%)

Table 1 - Sensitivity Test parameters considered

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Base Model that this Sensitivity Analysis is based on :

Cash flow Base model spreadsheet example

Download Cash flow Base model

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Sensitivity Test Results

Table 2 - Cash flow Sensitivity Test Results

Figure 2: Sensitivity test - Equity IRR results

Figure 3: Sensitivity test - Project IRR results

Figure 4: Sensitivity test - Minimum DSCR results

Summary of Results

Operating & Maintenance Cost

A 10% or 20% O&M cost fluctuation indicates a minimal difference (0.3 – 0.5%) of equity return however the minimum DSCR drops to a low of 1.01 suggesting a high risk on debt service payments.

It could be considered that as the project progresses and the wind energy production popularity increases in the global markets, a potential decrease in O&M cost will increase the profitability of the project. However, this is a speculative statement and a high risk of assuming such an improvement is associated with it.

Power Purchase Agreement (PPA) purchase rate

A power purchase agreement (PPA) has the highest volatility towards the cash flow model of equity difference of 3.9% (see Table 2). If the SPC agrees to a PPA minimum tariff rate of 45 EUR/MWh, the DSCR drops to 0.87 indicating that the project is not going to be profitable.

Interest rate

A 2% interest rate increase results in a minimum DSCR of 0.88 with the cash flow model suggesting that the payments of the first year of operations (2025) cannot be paid. In this case, further debt sculpting is suggested to avoid negative net cash flow in the first year of operations. On the other hand, a decrease in interest rates as expected will increase shareholders' equity return.

Annual project power production probability

A power production probability of either P50 (750,000 MWh/annum) or P60 (725,000 MWh/annum) has a very low impact on the overall bankability and shareholders' profits. The values found from the sensitivity analysis indicate minimal variation and are similar to the base model results.

Capital cost

As seen in Figure 2, Figure 3, and Figure 4, a 10% capital cost overrun reduces the investor's profits by 1.7% and the unleveraged (project) IRR by 0.87% (based on the base model) as well as the DSCR drops to 0.92. This indicates that the project is struggling to pay off its debt in the first years of operations due to the minimum DSCR being lower than 1.0.

Furthermore, lenders and investors will demand a competent contractor to undertake the project under a turnkey contract to minimize the risk of construction overruns, nevertheless a low DSCR questions the viability of incurring high project risks.

Inflation

The current COVID-19 pandemic resulted in inflation rates fluctuation. An inflation variation of 2% has a minimum impact to min DSCR (1.01 to 1.05), however, costs and revenues will result in an Equity IRR range of 9.4% - 12.70% subsequently increasing or decreasing the profits of shareholders.

Construction Duration

A construction overrun of 6 months has a very minimal impact on shareholder equity return. However, a 6-month earlier completion increases equity IRR to 12.9% which is a 1.9% increase compared to the base model. Minimal impact on DSCR is found.

Wind turbine generators (WTGs) degradation

An annual WTGs degradation increase accounts for a minimal drop of 0.5% of base model equity IRR and project IRR. No change in minimum DSCR was found. It could be argued that a decrease in degradation factor will increase WTGs efficiency and hence increase the revenues. However, this advancement is solely dependent on technological improvements hence it cannot be included as a reasonable parameter in future cash flow models.

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Sensitivity Test Results Summary

Overall, inflation, capital cost, and PPA have the highest impact on the base cash flow. Lenders will demand, therefore, that these variables be considered with potential solutions such as debt sculpting to allow sufficient net cash flow for the initial years of operations and ensure the bankability of the project and the payment of interest and debt payments.

Furthermore, a potential capital injection/ further borrowing of capital could be required if the above variables are implemented in a combined worst scenario. It is advised that this should be avoided as extra borrowing could be challenging after the financial close.

Other Potential Sensitivity Tests

Further sensitivity analysis could be carried on to evaluate the viability of spot energy sales compared to a PPA. This could be found very challenging as it is very hard to accurately evaluate future market trends on energy costs and hence a higher risk is accounted for.

Also, if an unexpected maintenance cost is required throughout the project (e.g., WTG replacement), the equity IRR could substantially decrease if in some years a higher percentage of profits need to be allocated to unexpected maintenance costs.

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