Risk and return key to valuing farm renewables

Calculating how much value a renewable energy project will add to a farm in the event of its sale can be a complicated process. Paul Spackman sheds light on what’s involved.

Most farmers have a good idea of what farms are worth in their area, but add in an array of solar panels or a hydro plant and that valuation is less clear-cut.

The lack of farms coming to market with renewable energy projects included means there is very little “comparable data” to go on so far.

See also: Hydro power offers farmers long-term renewables gain

Valuations can be further complicated depending on how easily a renewables project can be separated from the main farm or estate business, says Knight Frank’s Michael Ireland, who acknowledges there are no hard and fast rules for valuing renewables projects.

The “investment method” is generally regarded as being the most useful approach and relies heavily on having accurate financial data, including actual and forecast income and expenses, he says. It is most straightforward for larger schemes, typically over 250kW, that are set up as a stand-alone enterprise with a separate business structure and can therefore be divided into a “tradable asset” with an appropriate value, he says.

Income v costs

The investment method is based on two key criteria, namely the income (Feed-in Tariffs or Renewable Heat Incentive) and any costs associated with energy generation (for example maintenance or feedstocks) over the remaining lifetime of the project (usually the length of the FiTs/RHI), explains Mr Ireland.

This gives a “net present value” expressed as pounds per MW installed. For smaller schemes (sub-1MW), the value is multiplied up to a per MW figure, he says.

“Every scheme is unique in terms of costs and income generation, but this method gives us a range that we’d expect a project to fall into and we can cross-reference that against any other sales evidence. If it’s outside our expected range, we can look at reasons why.”

Savings associated with on-site use of electricity or heat are not included in this approach, Mr Ireland adds. “In theory the energy project is an individual asset that could be traded separately from the business, so the valuation can’t directly take personal or business savings into account. However, for many people, it is a big driving factor, so can’t be ignored.”

Equipment is also generally excluded, however the manufacturer may have some value, he says. Equipment from strong, well-established companies with proven and tested technology might be worth more than that from less well-known firms with unproven technology, he suggests. “You need to be confident that energy predictions over the next 20 years or so are going to be accurate and that the company will be around to fulfil its obligations.”

Integrated projects

A slightly different valuation approach is needed where projects are more closely integrated with the farm business and cannot be easily separated (for example rooftop such as solar supplying a dairy or biomass boiler heating poultry sheds).

In these cases the renewables installation is usually regarded as fixtures, plant and equipment and as such is a “wasting asset” due to its wearing parts and natural obsolescence, says Matthew Anwyl of Berrys.

But even if it is being sold as part of the farm, an investment value can still be attributed to it and that is usually done through a discounted cashflow method similar to that described earlier.

This method looks at total income and costs directly attributed to the project over its lifetime. It includes subsidy income (such as FiTs, RHI, ROCs), revenue from energy sales, plus cost savings to the operator as a result of lower energy bills, offset against costs of generating electricity, he explains.

A risk factor also needs to be built in, which will influence the rate of return that any investor is willing to accept. “For technology such as AD, there are potentially more things that could go wrong, so it is seen as higher risk than solar or hydro, for example. An investor might want a 15-20% return on capital for AD, whereas for lower risk technologies they might accept nearer 6-7%.

“Valuing renewables is all about weighing up the risks and returns, which is very different and more complicated than the traditional ‘bricks and mortar’ approach.”