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Estimating the cost of capital for wind energy investments in Turkey

Estimating the cost of capital for wind energy investments in Turkey

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Estimating the cost of capital for wind energy investments in Turkey

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  1. Estimating the cost of capital for wind energy investments in Turkey Gustav Fredriksson, Simone Tagliapietra & Georg Zachmann Istanbul, January 2019

  2. Introduction • Promoting wind power investment will be crucial to realizing Turkey’s energy strategy • Turkey has a target of 20 GW installed capacity of wind power by 2023 • More wind power would contribute to: • Meeting Turkey’s rapidly growing electricity demand; • Reducing Turkey’s dependence on foreign energy; and • Decarbonising the Turkish electricity sector • High technical potential of wind power in Turkey (114 GW)

  3. Energy demand and imports Source: Authors based on BP Statistical Review of World Energy 2017 and Eurostat

  4. Electricity consumption 385 TWh expected by Turkey’s Ministry of Energy and Natural Resources Source: Authors based on EPDK (2018), Electricity Market Development Report 2017

  5. Generation mix (2017) Source: Authors based on EPDK (2018), Electricity Market Development Report 2017

  6. Installed wind power capacity over time Source: Authors based on Turkish Wind Energy Association (2018), Turkish Wind Energy Statistics Report 2018

  7. Turkey’s energy strategy • Turkey’s 2023 energy strategy consists of: • Strengthening security of supply to meet demand and reduce import dependence; • Giving due consideration to environmental concerns throughout the energy chain; • Increasing efficiency and productivity, establishing transparent and competitive market conditions through reform and liberalization; and • Promoting R&D in energy technologies • To realize these aims and to meet the 2023 wind power capacity target of 20 GW, attracting and retaining investment in wind power will be crucial • In this context, there is a need to assess the investment climate in the Turkish wind power sector, including investment risk and RE support

  8. Our study • Main aim: Estimate the cost of capital for wind power investments in Turkey • The cost of capital  A crucial element in wind power investment decisions • Due to the large upfront capital cost of wind power plants, a high cost of capital substantially increases costs, which can deter investment • Second aim: Calculate the total cost of the renewable energy support scheme YEKDEM • High inflation and depreciation of the Turkish Lira have increased FIT costs • This should be taken into account when assessing the investment climate, especially given the risk that insufficient support is given to wind producers in the future

  9. Literature - cost of capital of wind projects • Importance of WACC for RE investment is widely recognized in the literature (e.g. Hirth & Steckel, 2016; Steckel & Jakob, 2018; Steffen, 2018) • Diacore (2016) estimates the weighted average cost of capital (WACC) for onshore wind projects in EU Member States • Finds a range of 3.5% (Germany) to 12% (Greece) in 2014 • Ecofys (2017) updates the analysis for south eastern EU Member States for 2015 and finds a WACC range of 5% (Slovakia) to 13.7% (Greece) • Few studies have analyzed the cost of capital for wind power projects in Turkey • The most similar study to ours - Ertürk (2012) - finds a WACC of 9.4% for onshore wind energy in Turkey • However, as will be discussed, our methodology differs from Ertürk (2012)

  10. Renewable support schemes in Turkey • YEKDEM • Guarantees a feed-in-tariff (FIT) of $0.073/kWh for the first 10 years of operation • Local content bonus ($0.006-$0.037 per kWh) added to FIT during the first five years if plant components are produced domestically • Producers must apply for YEKDEM prior to 2020 • YEKA • Offers a ‘renewable energy resource zone’ and electrical connection capacity to firms investing in local R&D, buy domestically produced equipment and employ a large share of domestic workers

  11. Challenges in estimating the cost of capital • Typically, the cost of capital is calculated using a weighted average of the cost of equity and debt: Where: risk premium • We abstain from this approach because: • Reliably estimating most parameters is difficult • β requires information on the riskiness of wind power projects in Turkey relative to the market • Lack of data on the risk premium for wind power producers in Turkey • Information on the market value of debt (D) and equity (E) is confidential and difficult to obtain • Typically relies on subjective interviews with experts and self-reported estimates from stakeholders

  12. Methodology • In view of the shortcomings, we calculate the internal rate of return (IRR) of wind projects in Turkey, and use the IRR as an upper bound for the cost of capital • The IRR is the discount rate that sets the net present value (NPV) of a project’s cash flows (CF) equal to zero: • IRR > Cost of capital  Positive excess returns • IRR < Cost of capital  Negative excess returns • Assuming the average wind power producer in Turkey generates a positive return, we can deduce a plausible range for the cost of capital from the IRR

  13. Methodology Revenues - Revenues from electricity sales - Salvage value Costs - One-time capital cost for setting up the project - Operations and maintenance costs - Taxes

  14. Data - Revenue • Dataset from the Energy Market Regulatory Authority of Turkey (EPDK) • Covers all (136) wind installations that participated in YEKDEM and produced output in 2017 • Plant-level data on: • Feed-in tariff rates (USD/MWh) • Yearly production volumes (MWh) • Production capacities (MW) • Maximum yearly production volume guaranteed to be remunerated under YEKDEM (MWh) • We focus on projects under YEKDEM because the scheme: • Covered 136 wind power plants with positive output in 2017 (while YEKA covers only one) • Supports wind projects of various scale (while YEKA focuses on more large scale projects)

  15. Data - Costs Capital costs • Dataset on 21 wind power projects in Turkey partially financed by the Turkish Mid-size Sustainable Energy Financing Facility (MidSEFF) • Use total project cost and capacity to calculate the mean project cost per MW for wind installations in Turkey O&M costs • Estimates from IEA & NEA (2015)

  16. Overview of data

  17. Results – IRR (2017)

  18. Sensitivity analysis

  19. Distribution of IRRs

  20. Results - Total compensation under YEKDEM

  21. Share of different technologies in total compensation and production under YEKDEM (2017)

  22. Conclusions & policy implications • We estimate an average IRR of around 5% • This suggests the cost of capital in Turkey is not higher than in southern Europe • Continued support for YEKDEM will be crucial to attract and retain investment • As the FIT rate is denominated in USD, the depreciation of the Turkish Lira means the increased cost of YEKDEM is borne by electricity consumers • Crucially important is not to make retrospective reductions in the FIT rates as this would erode investor credibility in YEKDEM and possibly even YEKA. This would, in turn, deter wind power investment and finally impede Turkey’s ability to realize its 2023 energy strategy