A Valuation Primer for Renewables
Techniques Used in a Wind Power Valuation Engagement
This article is aimed at valuing renewable interests or rights which is straight forward requiring basic application of valuation techniques. Appraisals that consider diminution of land estate values, damage assessments, complex end of life considerations, repowering analysis require more specific analysis and build up methods to establish defensible valuations.
This article, part of a two-part series that focuses on renewable energy valuations, is written to provide a foundation for the novice appraiser who wishes to better understand renewable assets and the specific components that comprise a valuation. The forthcoming article will provide appraisers who wish to augment his/her practice with renewable engagements will cover a broader spectrum. This article is aimed at valuing renewable interests or rights, which is straight forward requiring basic application of valuation techniques. Appraisals that consider diminution of land estate values, damage assessments, complex end of life considerations, and repowering analysis require more specific analysis and build up methods to establish defensible valuations.
The following definitions delineate what constitutes an appraisal and specify adherence to applicable guidelines.
Definition of Appraisal
Appraisal (as defined by the Internal Revenue Service in notice 2006-96) means a written valuation report signed and dated by a qualified appraiser in accordance with generally accepted appraisal standards and containing the following information:
- Includes certain information, such as a property description, fair market value of an ownership interest, appraiser identification information, date of valuation, and valuation methods employed; and
- Relates to an appraisal made no earlier than 60 days before the date of contribution of the appraised property; and
- Does not involve a prohibited appraisal fee; and
- Meets the other relevant requirements of Regulations section 1.170A-13(c)(3) and notice 2006-96, 2006-46 I.R.B. 902.
Definition of Appraiser
Appraiser (as defined by the Internal Revenue Service in notice 2006-96) means a person or firm qualified to perform business “appraisals” of partnerships and ownership interests in partnerships, and has been certified with an appraisal designation from a recognized professional appraisal organization (such as the NACVA, Appraisal Institute, ASFMRA, NAIFA, ASA, etc.), or has met certain minimum education and experience requirements; and
- Regularly prepares appraisals for which the individual is paid; and
- Demonstrates verifiable education and experience in valuing the type of property being appraised; and
- Has not been prohibited from practicing before the IRS under section 330(c) of Title 31 of the United States Code at any time during the three-year period ending on the date of the appraisal; and
- Is not an excluded individual (someone who is the donor or recipient of the property).
The guidelines presented in this article present a foundation of knowledge to value an interest or rights of ownership an individual would have in renewable assets by virtue of a lease of their land to developers who have erected turbines on their property or, in the case of solar generation, a complex of solar panels forming a display. Most renewable valuations apply to interests in power generation from turbines. Most solar developments are relatively new with little revenue history to back up capacity performance projections to develop a reliable income approach. Although valuations can be made for proposed turbine placement, the analysis becomes more complex requiring probability analysis of a proposed development, not yet in place. Guidelines are much more straightforward and more likely for “already” developed turbine citing providing price schemes dictated by a lease, revenue data, and information regarding the credibility of the off taker to execute the terms of the lease.
The Wind Lease
The wind lease is widely used as the legal instrument through which the landowner leases to a wind company for a defined number of years, the nature of the interest conveyed, development rights conveyed, development timelines, bonus, minimum rents, and length of lease. Under the “ad coelom” doctrine, the owner of the land estate, in fee simple, is ownership in the bundle of sticks or ownership rights in everything from the center of the earth to the skies. This doctrine may characterize wind blowing across a piece of land as a property right that may be possessed just as concepts and methods.[1] If the wind power estate is viewed as part of the surface estate, then traditional notions of the dominant-servient estate and accommodation doctrines may apply, and wind flowing across a piece of land may be viewed as severable.[2]
Although it is well established under Texas law that the fee simple owner of the land estate can sever the surface from the minerals thereby creating two separate estates, in Texas there is no legal precedent directly addressing severance of wind rights. Deeds in Texas purport to sever wind rights creating income to landowners, in effect treating wind rights like oil and gas.
However, in Texas there are several case law analogs supporting severance of wind rights.
- Groundwater case law follows an “absolute ownership theory” that allows a grantor to reserve groundwater rights when it conveys the remainder of the fee.
- Oil and Gas case law is subject to the rule of capture but owned in fee simple absolute. Texas has long recognized severance of oil and gas.
- Flowing Surface Water and Wild Animals. Wind is analogous to flowing water and wild animals that move across property lines. Case law supports leases, grants, and contracts dealing with the transfer of rights in flowing water in a natural course. IRS Regulation §1.611-2 provides guidance in determining the fair market value of surface and sub-surface assets.
The Regulation provides that the comparative value method should be used to determine the fair market value of surface and subsurface interests inclusive of oil and gas, water, and renewable estate interests, if applicable. The use of other methods, such as the discount cash flow method should only be used when the comparative method cannot be used.
Valuing Wind Interests
There are three approaches to be considered in valuing real estate and the various associated estates or components: market, income, and replacement. The market approach is not a reliable valuation method for wind rights; there are few sales of non-producing acreage.
Comparative Value Method
The comparative value method values the interests of similar properties that have been transferred or sold recently. According to Regulation §1.611-2, the due weight and consideration will be given to factors such as:
- Cost
- Actual sales and transfer of similar properties and improvements
- Bona fide offers
- Market value of stock or shares
- Royalties and rentals
- Valuation for local or state taxation
- Accounting records of litigation in which the property and improvements may have been inventoried or appraised in probate or similar proceedings
- Disinterested appraisals by approved methods
Comparative sales that have occurred are limited, highly discounted, and not verifiable. Replacement cost is inappropriate since revenues are based on royalties of long-term power purchase agreements. Consequently, the income approach utilizing a discounted cash flow methodology is the most appropriate.
Most valuation engagements are based on existing wind or solar generators where the existing lease and revenue history provides the basis of the valuation. In most cases, applying escalators to revenue per turbine through end of life. In most assignments, the existing wind turbines on the subject property will exist through the end of the lease. No consideration of additional turbines need be addressed since the development engineering firm has optimized the number of economically feasible turbine siting and has been engineered to incorporate the most efficient and feasible use of the land for wind farm development. Consequently, a valuation would not include speculative value for future add-ons.
Discounted Cash Flow (DCF) or Net Present Value (NPV)
This method may be used when the value cannot be determined upon the basis of cost or comparative values or any other method. Factors considered when using the method are: the future price of produced goods and the estimated total future production from the property based on historical renewable revenue, and future estimates impacted by commodity trends; a present value discount based on the cost of capital and the risks associated with the property (costs of shutting down, dry holes, decrease in production, due to unseasonable weather patterns, mandated curtailment, and transmission constraints due to either excess power generator developments crowding power lines or expansion of existing lines or corridors into load zones). An income approach utilizing a DCF analysis is used that would take into consideration annual energy production revenue, renewable energy credits, minimum production royalties, escalation factors, and an appropriate discount rate analogous to appraising oil and gas mineral rights, incorporating applicable risk factors. Most wind leases offer the lessor royalties based on a percentage of total wind turbine energy generation with set minimum annual income, whichever is greater. The income streams, usually based on an off-taker agreement (power purchase agreement), are fixed for a fixed term. Most royalties also include a price escalator.
Valuation Analysis
The following discussion provides an example analysis of a wind farm where the subject property has four wind turbines sited on the subject property. The appraiser obtains a land and lease agreement and revenue reports since the beginning of commercial operation. Specified in articles of the lease are GRANT OF RIGHTS; TERM and BONUS PAYMENT AND RENT from which a NPV analysis can be constructed. In this example, Base Rent is based on Lease Year; the actual rent payment owed under the lease is the greater of Base Rent or Year-to-date Royalty.
Base Rent:
Lease Year Per MW Amount
1-7 $4,200.00
8-14 $5,200.00
15-21 $6,700.00
22-30 $7,700.00
Royalty Rent (the following amounts, payable on Gross Sales payable as provided):
Lease Year Percentage of Gross Sales
1-7 4.0%
8-14 5.5%
15-21 6.5%
22-30 8.0%
Revenue totals are a function of the energy generation from the turbines at the applicable royalty established under the lease terms. The price for the energy is established by contract known as a power purchase agreement (PPA), whereby the producer enters an off-taker arrangement where a utility or corporate buyer who, through mandates, purchases per MWH power produced by the wind farm. The 18-year PPA, through its term, fixes the price for energy so that a DCF analysis does not have to account for any systematic price changes. Primarily the DCF involves an applicable discount rate reflecting the project, renewable systematic risks and the integrity of the PPA, and production variances caused by seasonal weather changes.
Projected Revenue
Projecting revenue streams of wind turbines requires an assessment of the uncertainties inherent in the key market drivers of wind power generation. A simple appraisal of wind rights based on the life of a PPA where a perpetuity calculation provides projected revenues through end of life does not require further assessment of the energy market. The two key components to forecast are the amount of wind energy produced and the energy market price for each available time frame. The uncertainty in fossil fuel prices, environmental penalties, and proposed legislation impact future market entry, wind output profiles, etc. Those considerations become significant for appraisals of wind farms nearing the end of life where a PPA has ended, and economics of merchant pricing must be calculated. What constraints impact wind generation such as dispatch variability due to curtailment and transmission bottlenecks? These questions are addressed in the subsequent valuation primer.
Revenue Growth Escalators for Royalty Calculation
In our example, the base rent royalty in 2020 escalates on average at a 2.1% compounded rate per year through the 30-year term of the contract based on the step up base rents. The royalty rents escalate on average 1.8% through the term of the lease. With the price of wind energy escalating on average 1.1% per year (see Lawrence Berkeley Lab Exhibit December 2014 valuation), the annual royalty rent price escalator is 2.9% for projected revenue in 2020 and to perpetuity. Based on these escalators, the base rent revenues are still greater than royalty rents 10 years out.
Discount Rate
A 2018 Grant Thornton discount rate survey indicated, for the U.S. renewable market, a discount rate of 8.25% levered used in financing arrangements. A risk factor of 3% is added for lack of fixed forward pricing (no PPA) and future commodity risk, which equals a total discount factor of 11.25%.
Present Value Computation
Calculated Value and Final Estimate as of June 12, 2020
Year 2020 2021 2022 and Perpetuity (Terminal Value)
Cash Flow 24,171 48,878 549,988
PV Factor 0.9604 0.8873 0.8197
PV of Cash Flow 23,214 43,369 450,825
The Calculated Value would be equal to PV of Cash Flows:
2020 = 23,214
2021 = 43,369
2022 = 450,825
Calculated Value = $517,408
Parts of this valuation are from appraisal engagements and serve as a guide for performing a valuation of wind rights associated with a land estate. These wind interests are associated with relatively new developments. As the wind farms age, many are near the end of revenue streams dictated by a power purchase agreement. As wind farms age outside the off taker (power purchase agreement), valuations become more complex where the developer is faced with merchant pricing (market pricing) or a replaced power purchase agreement. That requires not only assumptions and analysis of transmission upgrades and commodity pricing but also operations and maintenance issues on an aging infrastructure. And, finally, useful life inferences must be analyzed for appropriate terminal calculations, which may be biased based on inappropriate developer assumptions prior to initial development.
These considerations form the basis of the second primer to complete a more thorough understanding of the issues confronting valuations of renewables.
[1] Chavarria, Lisa. “Undertaking the Severance of Wind Rights.” Oil and Gas & Energy Resources Law Section Report Dec. 2007
[2] Horak, Frank and Rod Wetsel. “Current Issues in Wind Energy Law 2008–2009.” University of Texas at Austin, School of Law. Microsoft Power Point. 10 November 2009.
Frank Horak, CVA, MAFF, MBA, has over 30 years’ experience in energy, economics, and valuation. His experience began as an engineering intern at Texas Instruments Inc. and Boeing Aerospace. He had a broad range of financial consulting engagements with Arthur Andersen & Co., Price Waterhouse, and several other management consulting firms.
Subsequently he played a lead role in the concept development, management, and oversight of venture-based technology projects including energy economics, portfolio valuation modeling, and renewable energy development.
Mr. Horak was an Acting Director of Real Estate and a lecturer in finance and accounting at the Graduate School of Business at the University of Texas at Austin. He also has been a guest lecturer at the Schools of Law at The University of Texas and University of Houston. He is a frequent speaker on the valuation of minerals and alternative energy assets and interests.
Mr. Horak can be contacted at (512) 470-1771 or by e-mail to Frank@AstekEnergy.com.
