Key elements of a strong renewable energy valuation report

When evaluating the quality of a valuation report, due diligence should cover the following areas:

• Project metrics: The appraiser should understand the project specifics like location, capacity, technology employed, and overall project economics. These should be part of any valuation report as well as an overview of the regulatory environment, permits obtained, any contractual agreements in place, and renewable energy credit programs that might be available to the project.
• Market analysis: A comprehensive market analysis is vital to assess the potential value of a renewable energy project. This includes evaluation of expected demand for renewable energy, government policies, available incentives, and an analysis of comparable projects in the market.
• Financial analysis: The valuation report should develop a detailed assessment of the project’s financial feasibility and its key components like capital costs, operating expenses, revenue projections, and cash flow.  Additionally, sensitivity analysis may be considered to analyze the potential impact different inputs might have in assessing a project’s financial viability.
• Risk assessment: Identifying and assessing risks is crucial for stakeholders considering an investment in renewable energy projects. Both external and internal risks should be evaluated. External risks include fluctuations in energy prices, market competition, or changes in government policies. Internal risks include equipment failure, project management issues, or regulatory noncompliance.
• Best practices: The Uniform Standards of Professional Appraisal Practice (USPAP) is the generally recognized ethical and performance standards for the appraisal profession in the United States. It is critical to follow best practices per USPAP and the American Society of Appraisers (ASA). This will help ensure adherence to IRS/GAAP requirements and that the valuation is performed in a way that is widely acceptable and reliable in the market for various purposes.
• Value reconciliation: Appraisers utilize three approaches to valuation: income, cost, and market approach. A valuation report should consider all three approaches to value, perform the applicable approaches, and then reconcile the value indications into a value conclusion.  This allows for an accurate and reliable picture of the project valuation as discussed in more detail below.

In reviewing hundreds of valuation reports on behalf of potential investors or lenders, CohnReznick has identified several recurring items of interest that result from less rigorously prepared valuations.

Less disciplined valuations typically involve the following areas and can be subject to challenge:

• Lack of adherence to best practices: One common issue CohnReznick has encountered is a lack of adherence to best practices in valuation methodologies. Valuation reports should be built on robust methodologies recognized by industry standards. Failure to employ such methodologies can undermine the credibility of the entire report and raise doubts about the accuracy of the valuations. For instance, we reviewed a valuation report that did not consider all three approaches of valuation. As per USPAP, it’s important to consider all three approaches and provide a rationale for the approach utilized to conclude at the final value. The final valuation conclusion could be based on a blend of all three approaches, or it could be just two of the three with different weighting.
• Relying solely on the income approach: When valuations for investment tax credit projects rely solely on the income approach, the value can be artificially inflated by as much as 40% or more due to the circular relationship between the fair market value conclusion of the project overall and two of its interconnected inputs: the investment tax credit amount and the project’s depreciation. When the value conclusion is “anchored” by weighting in conjunction with either the cost or market approach or in conjunction with the income approach, we do not see these inflations. The “step up” from cost to FMV should be analyzed as to whether it is attributable to the fixed assets, or an intangible asset such as a favorable PPA or IX queue position. We help clients address such issues and help investors get a true market valuation of the project.
• Merchant curves: Another potential red flag is merchant price forecast utilization.  We commonly review reports using price curves that appear aggressive or optimistic as compared to other curves from different sources to increase the revenue margins and therefore, the overall valuation. A reasonable valuation report includes detailed research of various sources available and reliance on the best curve which shows an accurate forecast of the future market. Depending on the offtake structure, an analysis of basic risk may be performed by studying both hub and node market prices and making sure the curve utilized can be relied upon for valuation purposes.

A reliable valuation report is one that is well thought-out and considers all of the key elements of a rigorous valuation analysis. By employing widely accepted valuation methodologies and following industry best practices, valuation reports can provide a solid foundation for decision-making and should withstand scrutiny from the IRS or other arbiters. A comprehensive analysis of financial feasibility, market dynamics, financial projections, and regulatory compliance will help ensure that all critical factors are taken into account during the valuation process. A credible report is one that can pass all scrutiny tests and provide an accurate/holistic view of a project.

Arushi Jain, Consultant, Value360 – Valuation Advisory

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