Tag: Finance

Summary

For the purpose of a more efficient transition to renewable energy sources, decarbonisation, achieving the goals of the European Green Deal, but mostly due to increasing the availability and affordability of energy from photovoltaic power plants to its citizens, the Council of the European Union adopted on 5 April 2022 Directive (EU) 2022/542 supplementing Directives 2006/112/EC and (EU) 2020/285 as regards the possibility to reduce the VAT rate on the purchase price of photovoltaic power plants. Also, an initiative has been launched in our public space to reduction of the purchase price of photovoltaic power plants by the value of VAT paidWithin this text, the impact of such capital assistance on the financial justification of investments in rooftop photovoltaic power plants will be assessed. Also, attention is drawn to the fact that the regulations should enable the right of all citizens who decide to invest in rooftop photovoltaic power plants regardless of the procurement method (procurement of works, PVaaS or PPA). Otherwise, citizens who assess that the procurement of works is not the most acceptable option for them could be discriminated against.

Introduction

In the last few days, an initiative has been launched on the basis of which, every citizen who installs a photovoltaic power plant on their own, the state roof would return a value equal to the VAT contained in the invoice for the installation of the power plant. Therefore, the installation of photovoltaic power plants would be subsidized by 20% capital values of the project. The procedure would be relatively simple – the citizen presents to the Tax Administration an invoice for the power plant and a certificate from the authorised person that the power plant has been properly installed, and the Tax Administration pays the citizen the equivalent of the VAT contained in the invoice. Such capital assistance could have a positive impact on the financial soundness of investments in rooftop photovoltaic power plants. In order to assess the intensity of such aid, it is necessary, first of all, to establish, or to assess, whether the investment in rooftop photovoltaic power plants is financially justified in the absence of aid. In principle, it is justified to grant public aid to projects that are socially justifiable (eligible economic rate of return) and financially unviable (ineligible financial rate of return).

According to financial justification calculations that can meet in the media, investment in rooftop photovoltaic power plants is financially justified and No capital assistance (aid). In these presentations, citizens are encouraged to invest in photovoltaic power plants on their roofs because the investment is “returned” over several years. However, it should be noted that such calculations are based on the assumption that no costs other than capital investment and, possibly, the replacement of the inverter will be incurred in the 25 years of operation of the power plant. How realistic is this assumption can be judged by citizens from their own experience.

Savings

The basic principle of assessing the financial justifiability of an investment in a rooftop photovoltaic power plant results from the achieved savings from which project costs are covered. In this sense, the calculation of financial justification is primarily opportunite. Savings are the difference in energy costs before and after investment. In cases where the investor uses only electricity as the only energy source, the savings will be defined by the difference in annual electricity costs before and after the installation of the photovoltaic power plant. However, in cases where the investor uses other energy products (for example, liquefied gas, fuel oil, pellets, etc.), the savings will be determined by a combination of energy costs before the investment and a combination of energy products with included energy from a photovoltaic power plant. What Are Energy Costs Before

the higher the investment will be, and the savings from which the investment in the PV plant is settled will be greater. Of course, the installation of a photovoltaic power plant of optimal capacity is assumed. The optimal capacity depends on a number of factors, the most important of which are the ratio of consumed and produced energy (higher production relative to consumption poses the risk of changing the status of the investor from the manufacturer for own needs to the manufacturer for the market), the potential use of an electric vehicle, participation in the energy community, changes in the price of energy products and security in energy supply. The optimal photovoltaic power plant generates energy that will be fully consumed for its own needs. If regulations are changed in the future, the possibility of favorable sales of energy in the open market through aggregation, energy trading between members of the energy community, etc., optimality is likely to be determined by other parameters.  

Capital assistance

Capital assistance is a contribution to the proceeds of a project that reduces the capital value of the investment or, in other words, increases the proceeds that contribute to a higher value of the operational result and, therefore, the project is more financially acceptable. In general, subsidizing makes sense those projects that are economically justified, ERR(C) > marginal rates and financially unsustainable; FRR(C) < marginal rates. The financial marginal rate is usually determined by the average weighted price of the funding (WACC). In this regard, capital assistance contributes to the financial sustainability, or eligibility, of the project and, at the same time, its amount should be the result of a calculation based on a certain marginal financial rate of return of the project. In this sense, capital assistance equals the value of VAT in the invoice for the photovoltaic power plant (recalculated VAT rate of 20%), will certainly increase the financial eligibility of the investment project in the rooftop photovoltaic power plant, but it is not entirely clear why it is exactly 20% the capital value of the project and whether that amount is the result of the calculations described.

Most likely it is not, but in any case it can contribute to motivating citizens to invest more easily.

Example

The example will show the impact of the costs included in the calculation on FRR(C) and the payback period.

Since there are still, for the most part, no photovoltaic power plants in our country whose exploitation has been completed due to wear and tear or obsolescence, and no data on the proper recording of all details of costs and production are known, simulations of calculations based on known data from the operations of other power plants described in various studies, professional and scientific articles will be presented here. Data on energy consumption and prices are taken from the actual household of citizens who prepare the investment decision using systematic calculations.  Given the doubts about the financial sustainability of photovoltaic power plants presented in the media, the investor organizes simulations with regard to:

• Cost coverage (investment, replacement of inverters, costs and financing structure, maintenance and replacement costs of spent materials, removal costs, etc.);
• Availability of the plant over its lifetime;
• Protection effect against future electricity price increases;
• Inflation;
• Risks;
• Impact of capital assistance on financial eligibility;
• Inclusion of new household appliances (electric vehicle) and the like.

Project assumptions are described in Table 1:

Explanation of project assumptions

The investor uses electricity from the grid to meet its energy needs. Considering the total annual consumption of 4 693 kWh, it will install a 4.15 kWp photovoltaic power plant consisting of 10 photovoltaic panels with a peak power of 415 Wp. The lifespan of the plant is 25 years, and its production efficiency will be reduced by 20 years.% in the last year of the planning horizon. It is assumed that the plant will operate continuously over its lifetime, i.e. that its availability will be 100% although there is a certain probability that this assumption will not be viable especially at the time of replacement of the inverter.

It is assumed that the inverter will be replaced in the 12th year, and its price (calculation is prepared on the basis of constant prices) will be 392 €. The investor uses the so-called white tariff model with total unit prices (after 1 April 2022) of HRK 1.15/kWh for a higher daily tariff (VT) and HRK 0.531/kWh for a lower (NT) night tariff, which considering the consumption ratio of VT and NT of 86% and 14% gives a weighted average price of electricity from the grid of 1,063 kn/kWh.

The purchase price of the turnkey power plant is € 4,905 or €1,182/kWp. The investor assumes that the cost of the insurance premium of the power plant will be 15 €/year and that the cost of preventive maintenance will be 5 €/year. As part of the analysis of financial effects, the impact of capital assistance (grant, subsidy) announced to the public will also be assessed. At the end of its life, the investor assumes on the basis of the collected information, it will bear the costs of removing the panel in the amount of 25 €/panel and disposal of 20 €/panel.

The costs are grouped into five groups: 

1. Capital costs (namely, the capital value of the project),
2. Maintenance (preventive, inverter replacement, removal, disposal),
3. Management (insurance premium)
4. Funding and
5. Risks.

Financing costs

Financing costs refer to the interest rate of the loan that the investor obtains to settle the capital value of the project at an interest rate of 4% per year for 10 years and compensation 0.75%. Risks were estimated based on the calculation of the difference between the most probable value and the expected value within the applied triangular probability distribution where the reliability of the most probable value (ML) is corrected by uniform distribution – the reliability of the ML value of 100% produces triangular distribution, and reliability of 0% produces a uniform distribution of probabilities.

Simulations (cases) of several cost coverage options have been prepared:

• S0: It is assumed that the investor will finance the investment entirely from its own sources of financing and that, in addition to the capital value of the project, there will be no other costs in 25 years[8];
• S1: It is assumed that the investor will bear the capital value of the project and the costs of replacing the inverter;
• S2: It assumes the costs of capital value of the project, replacement of inverters and financial costs in case of financing from other people's (banks) debt (loan) sources of financing;
• S3: All costs included and option S2 plus operating costs (preventive maintenance, insurance premium and dismantling and disposal costs);
• S4: All costs included in S3 plus risks;
• S0G, S1G, S2G, S3G, S4G: Previous options with a 20 grant included% the capital value of the project including VAT.

Projections of total living costs are shown in Table 2:

Table 2: Coverage of costs with respect to the simulated option

Project savings

The inclusion of certain types of costs reduces the overall savings from which project costs are met. The logical consequence of the inclusion of new costs with regard to the option is also an increase in the unit price of electricity produced from a photovoltaic power plant. The projected savings and unit energy prices are shown in Table 3:

Table 3: Projection of savings and unit prices of energy from a photovoltaic power plant

The unit cost of energy from a power plant is calculated as the ratio of total living costs to the energy produced, while the unit savings equal the difference between the unit price from the grid and the photovoltaic power plant. This indicator is also linked to an indicator that is often used in the analysis and evaluation of the impact of photovoltaic power plants: LCOE (Levelized COsts of Electricity) with the difference that when applying LCOE items are discounted. Each option is also shown with the impact of capital assistance and the consequences of reducing the total cost of living due to the refund of VAT contained in the capital value of the project.

Financial justification of investment in a photovoltaic power plant

Financial justifiability of investment in a photovoltaic power plant measured by the financial rate of return indicator of the FRR(C) project, which represents the average annual ‘recognition’ rate of roles in the lifetime of the project. That rate shall also represent the maximum eligible average weighted funding rate. The value of the investment (capital value of the photovoltaic power plant) is compared to the annual differences in savings (differences in energy costs before and after the investment) and operating costs (insurance premium, maintenance and replacement of spent materials, panel cleaning, dismantling and end-of-life management, risks, etc.). The eligible financial rate of return of the project shall be assumed to be greater than or equal to the average weighted cost of funding consisting, as a minimum, of own and others’ (e.g. loan) funding sources. FRR(C) represents, at the same time, the return that an investor can expect if he invests in a photovoltaic power plant project if he finances the project from his own sources of financing.

The second, derived indicator of the justifiability of investments is an indicator of the payback period most commonly used by the public, and represents the period (year) in which the cumulative value of the difference between investments and costs is equal to the cumulative value of savings. The third indicator is the financial net present value of the investment FNPV(C). This indicator stems from the same function as FRR(C) with the result showing in another way. In particular, for the calculation of this indicator, a target discount rate is determined and the absolute value of CUs is discarded. If the absolute value of CUs is positive, the benefit of the investment is higher than the discount rate (e.g. WACC) and the investment is eligible because the operating result allows for full settlement of the funding. This CU value represents the difference between the discount rate and FRR(C).

If the operation of the photovoltaic power plant is carried out in accordance with the assumptions described in Table 1, then the investor can expect the returns shown in Table 4:

Table 4: Financial justification indicators

Recovery period

As stated above, the inclusion of costs in the projection reduces the rate of return of FRR(C) and increases the payback period. If the most likely projection for the investor is described in the S4 case, then it can expect a return of 2.65% annually. The decision on the acceptability of this value will depend primarily on the investor's alternatives. For example, an investor can invest an amount equivalent to the capital value of an investment of € 4,905 on a deposit with a commercial bank.

The yield will be relatively small, less than 1%. If these two investments carry the same risks for the investor, then it is more acceptable to invest in a photovoltaic power plant. However, if he is eligible for capital assistance of 20% capital value of the project (VAT refund of 25% in the bill for the power plant) then this yield of 2.65% increase to 8.82% annually, which may constitute adequate compensation for other unquantified risks. A comparison of the project rate of return and the investment payback period with and without capital assistance is shown in Graph 1:

Chart 1: Dependence of FRR(C) and payback periods on capital assistance for different simulation options

The impact of the change in the price of electricity

The payback period from 11.63 years to 21.63 years (S0-S4 without grant) will be reduced to 8.79 to 14.34 years with grant. Grant has a similar impact on the rate of return of the project, i.e. the expected return on the bet of € 4,905 over 25 years. Yield of 7.84% to 2.65% (S0-S4 without grant) will increase to 14.20% to 8.82% with a grant. However, irrespective of the justification for investing in a photovoltaic power plant under the conditions described above, the main justification for investing in a rooftop power plant lies in the protection against the increase in the price of electricity from the grid. Of course, if the investor uses other energy sources, then this calculation should include the expected rates of increase in the prices of other energy sources. The ratio of the rate of return to the period of return on investment to the average annual rate of increase in the price of electricity is shown in Figure 2:

Chart 2: Dependence of FRR(C) and RP indicators on the increase in the price of electricity from the grid 

The simulation results in Graph 2 are compiled on the basis of the S4 and S4G cases and the assumption of an inflation rate of 4% annually. In case of inflation of 4% and without an increase in the price of electricity from the grid, investment in a photovoltaic power plant would not be financially justified under these criteria. However, with the increase in the price of electricity from the grid, the investment is justified in particular with capital assistance. With an inflation rate of 4% annually without an increase in the price of electricity from the grid, in the case of option S4, the investment would not be financially justified, however, with a capital assistance of 20% the capital value of the FRR(C) project is 5.82% yearly, which would be acceptable. With the expected average annual increase in the price of electricity from the grid, the investment is financially justified with and without capital assistance. It is precisely in the case of S4 with inflation and without an increase in the price of electricity from the grid that the justification for capital assistance to citizens when investing in rooftop photovoltaic power plants is based.

Purchase of photovoltaic power plants and capital assistance

In discussions on capital assistance to citizens in the procurement of rooftop photovoltaic power plants by refunding the VAT paid, it is assumed that the citizen, the owner of the building on whose roof the power plant is installed, is the investor. The supplier supplies the power plant, installs it and delivers the invoice to the citizen for the completed works. The citizen – investor is the recipient of the invoice and with such an invoice proves to the Tax Administration the right to the payment of capital assistance, in kind 20% of the total value of the invoice relating to it. However, there are also alternative models on the market for the procurement of photovoltaic power plants that do not involve a citizen – the owner of a building on whose roof the power plant is installed as an investor and on which no invoice is issued for the works carried out.

PVaaS

These are models in which a third party (investor) installs a photovoltaic power plant on the roof of the building owner (energy user) and supplies it with the service of availability of a photovoltaic power plant (PV).PVaaS - PhotoVoltaic as a Service), and the citizen-user of the availability service pays the investor a monthly fee for the availability service of the power plant usually about 10 years. A similar situation occurs when a citizen concludes a contract for the supply of electricity from an investor who has installed a power plant on the roof of a building owned by a citizen and sells it to the citizen at a predetermined price of electricity (PPA - Power Purchase Agreement) the same over a period of about 10 years or more. In this case too, the citizen – the owner of the roof – is also not the investor and the invoice for the works carried out for the installation of the photovoltaic power plant does not refer to him, but to the investor – a third party.

If regulations are adopted that will enable the right to capital assistance only to citizens - investors, other citizens who assess that alternative models are more acceptable to them, will be unfairly discriminated against, their affordability and availability of affordable energy will be reduced. In the case of the citizen-investor, VAT is included in the invoice for works, and in the case of the citizen-user of the service, in the invoice for the delivered availability fee or in the invoice for the delivered electricity. Therefore, the regulations, which will regulate the payment of the paid

As capital assistance, the circumstances of all the legitimate models available should have been taken into account.  

Conclusion and recommendations 

The entry into force of the new Directive of the Council of the European Union (EU) 2022/542 has created the possibility for the Government of the Republic of Croatia to propose a regulation that will further stimulate citizens to invest in rooftop photovoltaic power plants by reducing or abolishing the VAT rate. The conducted analysis has shown that, despite often unsupported media thesis about unquestionable profitability and financial justification of investments in photovoltaic power plants, there are borderline cases and risks of financial unjustified investments.

Therefore, the adoption of the proposal regarding the VAT refund in the invoices of procured and installed photovoltaic power plants would be a good measure to protect citizens from precisely the described borderline cases. But the question remains whether this measure is fully elaborated. For example, the question should be asked: Will citizens who do not procure works to install solar power plants on their roofs and are not investors, i.e. citizens entering into a PVaaS or PPA contract, also be entitled to capital assistance that will allow them to pay a lower price for the availability fee (PVaaS) or a lower price for the energy produced (PPA)?

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Expanded version of the text originally published in the Journal the Center for Public and Non-Profit Sector Development, Tim4Pin No.5 2022

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