Online Training Course on Nature-based Infrastructure

Module 5 – Block 1
Introduction to Project Finance Modelling

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About this slide deck
This slide deck is part of a training course about nature-
based infrastructure (NBI).

In this first block we address the following questions:

What is project finance modelling?

What are the main components of project

finance models? How to do financial
modelling for NBI?

How to integrate environmental and social

externalities in project finance models?
Table of Contents
Section 1: Basics of project finance
• What is project finance?
• What are the transacting parties and distinctive features?
Section 2: Use of project finance modeling
• What is the purpose of project finance models?
• What are their main components?
Section 3: Integrating environmental and social considerations in financial models
• How this integration could be done? Demonstrate our approach: SAVi methodology.
Section 4: Financial modelling for nature-based infrastructure
• How to do financial modelling for NBI?
• SAVi assessment example.
Project finance for nature-based infrastructure
An alternative way to finance NBI projects

• Built infrastructure often relies on project finance structures (non-recourse financing).

• Treating nature-based solutions as infrastructure opens up the possibility of using project
financing.
• Project finance would be especially appropriate for NBI projects that have sufficient revenue
streams to make them a viable investment opportunity.
• Alternatively, project finance could be used for hybrid infrastructure projects where NBI is
complementing a revenue generating built infrastructure project.
Section 1
The following slides explain what project finance is,
Basics of project
including its transacting parties and distinctive features.
finance
Financing infrastructure
The project financing structure involves a number of shareholders, known as 'sponsors'.

A sponsor can choose to finance a new project using two alternatives:

1. The project is financed on-balance sheet (corporate financing).

2. The project is incorporated into a newly created economic entity, the SPV (Special Purpose
Vehicle), and financed “off-balance sheet” (project financing).

Source: Project Finance in Theory and Practice by Stefano Gatti

What is project finance?

What is non-recourse finance?

• Project finance refers to the financing of • Non-recourse finance is a type of
infrastructure using a non-recourse or commercial lending that entitles the
limited recourse financial structure. lender to repayment only from the profits
• The debt and equity used to finance the of the project the loan is funding and not
project are paid back from the revenues from any other assets of the borrower.
(e.g. tolls, user fees) generated by the • Such loans are generally secured by
project. collateral.

Source: investopedia.com
 Parties in a project finance structure

1. Sponsors: they are typically also the owners 6. Financial Advisors

2. Lenders: they provide the debt financing to the 7. Technical Advisors
project 8. Legal Advisors
3. Off-taker(s): they purchase the output of the project 9. Regulatory Agencies
(e.g. MWh of energy produced) often having a long-
term contract in place. 10. Multilateral Agencies / Export Credit Agencies:
They provide development financing to the project
4. Contractor and equipment supplier: They are the often in the form of loans.
key suppliers of raw material. They also perform
crucial functions such as design, build, operations 11. Insurance Providers
and maintenance.
5. Operator: The are responsible for operating the
project.
Parties in a project finance structure

Source: efinancemanagement.com
Types of sponsors in project finance

• Industrial sponsors, who see the initiative as upstream or downstream integrated or in some way
linked to their core business
• Public sponsors, central or local governments, municipalities, or municipalized companies, whose
aim is to provide social welfare
• Contractor/sponsors, who develop, build, or run plants and are interested in participating in the
initiative by providing equity and/or subordinated debt
• Financial investors, often private equity investors, whose aim to generate a risk adjusted return.

Source: Project Finance in Theory and Practice by Stefano Gatti

Distinctive features of a project finance transaction
1. Debtor (borrower) is a project company (special purpose vehicle) set up on an ad hoc basis that is
financially and legally independent from the sponsors.
2. Lenders have only limited recourse (or in some cases no recourse at all) to the sponsors after the
project is completed.
3. Project risks are allocated equitably between all parties involved in the transaction, with the
objective of assigning risks to the contractual counterparties best able to control and manage them.
4. Cash flows generated by the SPV must be sufficient to cover payments for operating costs and to
service the debt in terms of capital repayment and interest. Because the primary use of cash flow is
to fund operating costs and to service the debt, only the remaining funds after debt servicing can
be used to pay dividends to sponsors.
5. Collateral is given by the sponsors to lenders as security for receipts and assets tied up in
managing the project.

Source: Project Finance in Theory and Practice by Stefano Gatti

Greenfield vs. brownfield projects
The financing needs and the optimal financing structure are different for greenfield
and brownfield projects.

Greenfield project
• It refers to an asset that has some level of development or construction requirement. For example:
building a new power plant.
• It has a higher risk than projects that are already operating.
• It often requires a more expensive construction loan before using long term debt financing.

Brownfield project
• It is a developed asset that may still require ongoing capital expenditure and expansion.
• The operating asset is used as a collateral for the additional financing / re-financing used.
Section 2
The following slides explain the purpose of project
Use of project finance
finance models and discuss their main components.
modeling
Project finance modelling

• Project finance modeling is an excel-based analytical tool used to assess the risk-reward of
lending to or investing in a long-term infrastructure project based upon a complex financial
structure.
• All financial evaluations of a project depend upon expected future cash flows generated by
activities of a completed project and a financial model is built to analyze this.

Source: wallstreetprep.com
What are project finance models used for?

The main purposes of a project finance model are to:

1. Identify the optimal capital structure

2. Assess the financial viability of the project
3. Calculate the expected return on investment under different operational and risk
scenarios.

The following slides provide more information on these three points.

What are project finance models used for?
1. Identify the optimal capital structure

• Project sponsors use financial models to determine the optimal debt-

equity split used in the financing of the project.

• This largely depends on the project’s revenue and cost profile: The
timing and size of incoming cash flows during operations and the
associated costs in each period.
 What are project finance models used for?
1. Identify the optimal capital structure

Most infrastructure projects follow a so-called

“J-curve”: They have high upfront costs and
relatively small but steady revenue streams.
The “J” represents a certain number of years
before the project breaks even and generates
a return on investment.

Source: cnlsecurities.com
What are project finance models used for?
2. Assess the financial viability of the project

• Project finance models can also calculate whether the cash flows generated by
the project will be sufficient to service the debt and generate an attractive
risk-adjusted return for both equity investors.

• This assessment includes the calculation of key performance indicators, such as

the internal rate of return and the net present value.
What are project finance models used for?
3. Calculate the expected return on investment

• Project finance models are also well placed to stress test projects and assess how the
expected return changes under certain operational and risk scenarios.

• This can be calculated by a so called “scenario table,” which modifies key project
assumptions and shows how key financial indicators react to these changes.
o Scenarios could be simple operational events, such as an increase in the price of
feedstock, disruption in operation, or more complex climate events, such as
heatwaves, sea-level rise, or a carbon tax.
What are project finance models used for?
3. Calculate the expected return on investment – impact of climate change

Climate change can potentially have a material impact on the financial viability of infrastructure
projects. Financial models can be used to assess the financial impact of climate scenarios.
Climate change can impact the following data points in an infrastructure project:
• Construction costs: Making the project more climate resilient (e.g. withstand floods) can
increase the cost of construction and/or make the construction time longer.
• Operating costs: The cost of production can increase due to loss of efficiency as a result of
higher temperatures for example.
• Production: Outages caused by climate events (e.g. violent storms) can negatively impact
the number of units produced.
• Cost of financing: Financial institutions and investors are increasingly pricing in climate
related risks in their interest premiums. This can lead to higher cost of financing for
infrastructure that are not climate resilient.
Key financial indicators

Net Present Value (NPV): The difference between the present value of cash inflows net of financing
costs and the present value of cash outflows. It is used to analyze the profitability of a projected
investment or project.
Internal Rate of Return (IRR): An indicator of the profitability prospects of a potential investment.
The IRR is the discount rate that makes the net present value of all cash flows from a particular
project equal to zero.
Payback period (PP): The term payback period refers to the amount of time it takes to recover the
cost of an investment. Simply put, it is the length of time an investment need to reach a breakeven
point.
Sustainable IRR (S-IRR) & Sustainable NPV (S-NPV): In this case traditional financial indicators of
IRR and NPV are modified by integrating environmental, social and economic costs and benefits in
the calculations.
Main components of project finance models
The “Input” worksheet includes the main project assumptions / data.

Input Name Explanation

Development costs Development costs are also known as capital expenditures. This includes information
on when these costs are spent during the construction phase. This could inform
decisions on when to tap additional financing.

Construction time The construction phase can be expressed in number of quarters or years. The start of
construction will also determine the model’s starting date.

Operational Operational expenditure includes the fixed and variable costs of operating the project.
expenditure
Operations time The operations phase is expressed in number of years. Construction and operation
phases can overlap if the generation capacity is gradually being increased.

Production / This data point represents the quantity produced when calculating the revenue.
generation / quantity Depending on the type of infrastructure, it can be the amount of energy generated for
a wind farm or the number of cars on a toll road.
Main components of project finance models
The “Input” worksheet includes the main project assumptions / data.

Input Name Explanation

Unit price This data point represents the price variable when calculating the revenue generated. It can
be the expected nominal electricity prices or the toll for a highway. Base, low, and high price
levels can be included to make assessing different price scenarios easier.

Senior debt This covers all the debt-related financial information, including the size of debt financing
used, the interest rate premium on top of the risk-free rate, various financing fees, debt tenor,
and the initial time period when interest payments are waived (also called the grace period).

Equity Equity-related information includes the amount of initial equity financing and any additional
increase needed during construction. In addition, the financial model should be able to take
into account the percentage of profits that is paid out as dividends as well as the equity cost
of capital.
Macroeconomic Macroeconomic data includes the risk-free interest rate for the currency used in the model. If
data any currency conversions are required, the relevant exchange rate can also be specified here.
Finally, the expected inflation rate is also included here.
Project finance model
example – Wind farm
The input worksheet includes most hard coded
data points for the financial model.

Construction costs and their

associated spending schedule.

Production related data for each

year of operation.

Unit price data forecast including

three price scenarios.

Data on cost of operation including

fixed and variable costs.
Main components of
project finance
models – construction
worksheet

• It includes the costs and

spending profile during the
construction phase. In addition,
it can include contingency costs
to account for potential cost
overruns.
• It also provides information on
how the project is financed
(equity / debt) and how much
financing needs to be available
for each time period.
Main components of
project finance
models – operations
worksheet
• It calculates the revenue
generated by the project.
• It also calculates the relevant
variable and fixed costs of
production for each time
period.
• The worksheet needs to be
able to integrate any potential
inflation (cost escalation)
during the operation phase of
the project.
Main components of
project finance models
– debt financing
worksheets
• It models how the debt
financing will be serviced and
repaid during the life of the
project.
• It includes the base rate
estimation for each time
period during the life of the
loan (relevant for floating rate
loans).
• It also integrates the “grace
period” when the project does
not need to start making
repayments for the loan yet.
Main components of
project finance
models – equity
financing worksheets
• It calculates the profitability of
the project for shareholders
(i.e. equity investors).
• It also calculates the dividend
generated by the project,
which can either be reinvested
in the project or withdrawn.
• It includes the IRR and NPV
calculations.
Section 3
Integrating The following slides explain our approach of integrating
environmental and social externalities using our Sustainable Asset Valuation
considerations in (SAVi) methodology.
financial models
Our approach: Sustainable Asset Valuation (SAVi)
Characteristics

Based on systems thinking, system dynamics simulation, spatial

modelling and financial modelling.

Customized to each individual infrastructure project or policy.

Co-created through a multi-stakeholder approach that enables the

identification of material risks and opportunities that are unique to the
project.

Incorporate best-in-class climate data from the EU Copernicus Climate

Data Store.
Core Features of SAVi: Simulation
SAVi combines the outputs of systems thinking, and system dynamics simulation,
spatial models and financial models to assess the value and performance of
infrastructure projects.

The System Dynamics simulation uses Vensim. The financial model is built in Excel following
F1F9 FAST best practices . The spatial modelling uses GIS and InVEST. You can watch a short
video about the methodology here.
SAVi simulates how the costs of material risks and externalities affects the following financial
performance indicators:

• Levelized costs • Gross Margin

• Net Present Value (NPV) • Debt Service Coverage Ration (DSCR)
• Internal Rate of Return (IRR) • Loan Life Coverage Ratio (LLCR)
Core Features of SAVi:
Valuation – Cost of Externalities
Potential positive and Environmental: water and air pollution, greenhouse
negative externalities: gas emissions, degradation or rehabilitation of land and
habitats, deforestation or reforestation, biodiversity impact.

SAVi identifies, quantifies and Social: Loss of traditional jobs, generation of new jobs,
explains how externalities today increase and decrease of wages, impacts on human health
can transform into material risks
and health costs, effects on urbanisation trends and rural
tomorrow.
livelihoods, impacts on public space, social conflicts,
Such valuations help stakeholders contribution to education and skills building.
make decisions in favor of
sustainable infrastructure. Economic: Contribution to economic development,
effects on land and real estate prices, revenues in affected
sectors, new trade opportunities, commercialisation and
acceleration of technological innovation.
SAVi financial models

• The financial model used in SAVi is built in Microsoft Excel and follows F1F9 FAST best practices
in order to improve the readability and auditability of the model by a third party.
• The outputs of the system dynamics model are used as inputs in the financial model. The
system dynamics model quantifies and monetizes the relevant environmental, social, and economic
externalities associated with the project.
• It also defines what scenarios to use in the financial model. Depending on the purpose of the
assessment and the target audience, some of the externalities are included as costs or benefits.
Outputs of the system dynamics model can also change some of the key assumptions of the
financial model.
Illustration: SAVi financial models
Explanation

The financial model extends the

integrated cost benefit analysis
to account for inflation and the
time value of money. It is used
to calculate key financial
indicators such as IRR and NPV.

Project Finance Model

Financial indicators

NBI Grey

NPV USD USD

IRR % %

S-NPV USD USD

S-IRR % %
Integrating environmental and social considerations
in financial models (1)

• The purpose of integrating environmental, social and economic externalities is to inform capital
allocation of governments and investors when taking a more holistic approach to project
selection, design and development.
• The list of externalities that are appropriate to include in the financial model depends on the user
and the target audience of the financial model.
o The reason for this is that the financial model would treat these externalities as cash flows
and therefore affect the risk-return profile of the project, including its financial indicators such
as the IRR and NPV.
Integrating environmental and social considerations
in financial models (2)

• For governments taking a more holistic approach is normally not an issue, as they are by nature
expected to apply “systemic perspectives” when making decisions on infrastructure.
• On the other hand, for investors, whose mandate is to generate a financial return, using this
approach would only make sense for externalities that could potentially have a cash flow impact
during the life of the project.
• A carbon tax would be a good example. If it was implemented, it would indeed have a cash flow
impact at the project level. On the other hand, integrating the positive economic contribution of
the project same way, for example, would be hard to justify for an investor.
• In this case, the integration of externalities in the cash flow statement would be more
appropriate. This approach would avoid changing the taxable income, alongside other key
modelling components, and keep externalities “outside the model,” while still allowing the
calculation of a sustainable internal rate of return.
Integrating environmental and social considerations
in financial models (3)

• Externalities can be integrated either Operational Expenditure

as costs or benefits (“revenue”) in the Fixed Costs
Labour GBP M p.a. 0.50
financial model.
Land & Leasing GBP M p.a. 1.00
Regular Maintenance GBP M p.a. 1.00
• In example on the left externalities
Insurance GBP M p.a. 0.50
have been integrated as costs: see Fixed O&M GBP M p.a. 1.00
“SAVi externalities” row (currently at Spare GBP M p.a.
Spare GBP M p.a.
zero on the screenshot). Externalities Spare GBP M p.a.
have been calculated on a per MWh
basis in line with the variable Variable Costs
Other GBP / MWh 1.50
operating costs. SAVI externalities GBP / MWh -
Spare GBP / MWh
Section 4
The following slides explain financial modelling for NBI
Financial modelling
using a SAVi assessment of an NBI project as an
for nature-based
example.
infrastructure
Financial modelling for NBI

• A financial model for nature-based infrastructure might differ significantly from that of
traditional grey infrastructure.
o As these projects generally rely on philanthropic and concessional sources of financing, a
typical project finance structure might not be appropriate in most cases.
o However, as stakeholders are increasingly treating NBI as just another form of infrastructure,
the use of project finance may be used more frequently.
• NBI projects often do not generate revenue in the traditional sense of incoming cash flows. Instead,
they provide a range of direct benefits for different stakeholders as well as externalities in the
form of avoided costs and added benefits. This means that financial models for NBI can be
simplified in some areas.
 SAVi Assessment in Indonesia
Maintaining and Enhancing Water Yield through Land & Forest
Rehabilitation

Land Restoration Water Management

Reforestation/improved management of 597 absorption wells (2 x 2 x 2 m)
3,697 ha in the buffer zone 8,000 biopori (10 cm across, 80-100 cm
Avoided loss of 22,336 ha of forest deep)

Outcomes: Outcomes:
• Nutrient removal • Groundwater recharge
• Sediment retention • Flood mitigation
• Carbon sequestration
• Income from agroforestry and
bamboo production
SAVi Assessment Goals

Quantify the costs, benefits, and financial performance of

forest restoration and water management

Assess the impact on downstream water availibity if land

restoration occurs on a large scale

Identify mechanisms to fund reforestation

Financial Analysis Methods
Sustainable and conventional net present value and internal rate of return

• Conventional indicators (NPV and IRR)

o Include only cash flows to calculate financial indicators
• Sustainable indicators (S-NPV and S-IRR)
o Include externalities and avoided costs in calculations
• Goals
o Assess value for society over the project lifespan
o Determine the importance of externalities and avoided costs in value creation
 Financial Analysis Scenarios

All benefits Investment Exclude carbon Exclude Exclude carbon

included opportunity cost storage benefit avoided costs and avoided costs
Includes all indicators Includes an investment Includes all indicators Includes only cash Includes only cash flows,
from the integrated opportunity cost, from the integrated CBA flows (i.e., the added excluxive of carbon storage
CBA, inflated and representing the cost of except carbon storage benefits and
discounted to present not investing in other investment and
values projects maintenance costs)
Cumulative Present Value
250,000

Explanation of graph 202,632

200,000
182,495
Extreme rainfall has large
impact on S-NPV. 150,000

USD (thousands)
For the first ten years,
100,000 65,648 86,298
carbon storage dominates 57,637
66,160
the shape of the curve. 50,000 45,511

After the first ten years, 37,500

7,457 7,593

avoided costs dominate. 0

Year 0 Year 5 Year 10 Year 15 Year 20 Year 25 Year 30

-50,000

All benefits and monetary costs - RCP 4.5 All benefits and monetary costs - RCP 8.5

All benefits and costs - RCP 4.5 All benefits and costs - RCP 8.5

Added benefits and monetary costs - both climate scenarios

Financial Analysis Results (USD thousands)
Project lifetime 20-year lifetime 30-year lifetime
(2021-2040) (2021-2050)
Climate Scenario RCP 4.5 RCP 8.5 RCP 4.5 RCP 8.5
All benefits S-NPV 63,539 71,551 208,593 92,259
S-IRR 62.8% 74.8% 62.9% 74.8%
Investment opportunity S-NPV 50,862 58,874 195,916 79,582
cost S-IRR 44.0% 51.2% 44.4% 51.2%
No carbon storage S-NPV 41,850 49,861 186,903 70,569
benefit S-IRR 56.5% 69.5% 56.6% 69.5%
No avoided costs S-NPV 13,359 13,359 13,554 13,554
S-IRR 22.5% 22.5% 22.6% 22.6%
No carbon storage NPV -8,330 -8,330 -8,136 -8,136
benefit or avoided costs IRR -11.0% -11.0% -4.8% -4.8%
Financial Analysis Key Takeaways

• The project generates high societal value, but this is only realized if carbon storage
and/or avoided costs are included in the analysis.
• Carbon financing plays an important role in making the project financially
attractive.
• When all benefits and avoided costs are monetized, the project demonstrates
value for money after four years.
Conclusion

• Environmental and social externalities can have a material impact on the financial performace of
the project once internalized.
• Integrating externalities in feasibiliy studies enables a more holistic decision making and a more
efficient resource allocation.
• Project finance structures are becoming increasingly relevant for NBI as the value generated by
these projects are monetized.

As part of Module 5 Block 2 we will discuss the challenges and potential solutions of financing NBI.
What’s next?
This was Block 1 of Module 5.
You can continue the
In case you want to learn more please download the full financial course with
model used for the Indonesian SAVi assessment discussed in this
slidedeck. Module 5 – Block 2
about financing NBI