Techno-Economic Analysis in Agricultural Value Chains

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Overview

This article presents steps to plan investment in renewable energy technologies and energy efficiency in agricultural and food enterprises. It highlights opportunities for sustainable energy interventions along agri-food chains and analyses their feasibility and financial and economic cost-benefits related to the investment. Lastly, this section presents existing tools that can be used to assess the financial and economic viability and environmental impact of such interventions.


Investment Planning on Micro-Level

When planning an investment, the operator or project manager should first perform a feasibility analysis (and sometimes a prefeasibility analysis). This is an analysis of the ability to complete a project successfully, taking into account legal, economic, technological, scheduling and other factors. A feasibility study allows investigating the possible negative and positive outcomes of a project before investing too much time and money.

A clear identification of financial, economic, institutional, social and technical opportunities and risks is required as a first screening for the goodness of the investment. In fact, the identification of significant barriers or constraints could make an investment in a specific technology unfeasible in a particular environment, even though it would seem financially attractive. In case of investment in renewable technologies, examples of constraint are: lack of access to finance, high cost of capital, market failures, network failures, insufficient legal and institutional framework, lack of skilled personnel, social, cultural and behavioural factors, geographic constraints and sustainability concerns.

While deciding whether to invest in renewable energy technologies and energy efficiency, an agricultural and food enterprise would compare this option with the energy source or technology currently used (e.g. fossil fuels). Analysis from many demonstration and commercial renewable energy plants show that costs of projects are very site-specific. Levelized costs of many renewable energy technologies are becoming more and more competitive with current average costs of fossil-fuel powered electricity, heat and transport fuels they displace. Moreover, costs for renewable energy technologies are declining as the size of their markets is increasing. For example, in remote rural regions with no electricity grid access, autonomous renewable energy systems avoid expensive grid connection costs and are already competitive.

In order to assess quantitatively the attractiveness of an investment in sustainable energy options a Financial and Economic Analysis (FEA) needs to be performed.

In the context of the project’s logical framework, the financial and economic analysis starts with investigation of the proposed project’s main objectives and targets. Then the relevant project benefits and costs are identified and monetized to perform a quantitative analysis.

The financial and economic analysis basically consists in the following two main steps.

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Financial Cost-Benefit Analysis

The standard and comprehensive approach for performing a Financial and Economic Analysis is a Cost-Benefit Analysis (CBA). A CBA consists in monetizing all major benefits and all costs generated by the investment and presenting their streams over the lifetime of the technology, expressed usually in number of years (cash flow). Costs and benefits can then be directly compared between different scenarios, as well as with reasonable alternatives to the proposed project.

Generally speaking, a project is considered “viable” if the sum of expected incremental benefits is larger than the sum of all costs accrued in project implementation. This can be assessed through profitability indicators. In general, CBA provides four main indicators, the Net Present Value (NPV), the Internal Rate of Return (IRR), the benefit/cost (B/C) ratio and the payback time. These indicators assess attractiveness of investment by comparing the present value of money to the value of money in the future, taking the time value of money (discount rate) and returns on investment into account.

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Profitability Indicators

Therefore, these indicators are important decision-making tools for investors, national governments, as well as for donors and IFIs.

  • Net Present Value (NPV): The NPV indicator is determined by calculating the costs (negative cash flows) and benefits (positive cash flows) for each period of an investment and by discounting their value over a periodic rate of return. The NPV is defined as the sum of the results when the initial costs of the investment are deducted from the discounted value of the net benefits (revenues minus cost, Rt ). Read more.
  • Internal Rate of Return:The IRR indicator is defined as the discount rate at which the NPV equals zero. This rate means that the present value of the positive cash flow for the project would equal the present value of its costs. If IRR exceeds cost of capital, project is worthwhile, i.e. it is profitable to undertake.
  • The Benefit/Cost Ratio (B/C) indicator is the ratio of the present value of benefits to the present value of costs over the project lifetime. The B/C ratio provides some advantages when a ranking of alternative investment projects is needed under budget constraints. If B/C ≥ 1 the project is accepted; if B/C < 1 the project is not profitable.
  • Payback Time (PBT):The (PBT) measures the time required for the net cash inflows to equal the original capital outlay. It is the number of years required for the discounted sum of annual savings to equal the discounted investment costs, or in other words the time span after which the investment will start to pay back.

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Steps in Financial Cost-Benefit Analysis

  1. Identify benefits and costs for both investment and benchmark scenarios for their lifetime.
  2. Compare the discounted flows of benefits and costs and calculate the differences between the obtained results and the benchmark scenario in order to determine the net incremental benefits of the proposed interventions.
  3. Calculate the project financial profitability indicators of each scenario (i.e. financial NPV, financial IRR, B/C ratio, payback time), applying these investment criteria to make an investment decision (positive or negative).

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Economic Cost-Benefit Analysis

The basic principles for carrying out financial and economic analysis are the same and both are required for project screening and selection. However, the Financial Analysis deals with the cost and benefit flows from the point of view of the individual, farmer or food processor in our case, while the economic analysis deals with the costs and benefits to society. The Economic Analysis takes a broader view of costs and benefits, and the methods of analysis differ in important aspects. An enterprise is interested in financial profitability and the sustainability of that profit, while society is concerned with wider objectives, such as social and environmental issues, and net benefits to society as a whole.

An economic analysis takes into account energy subsidies and taxes, the impacts of the renewable energy project on land, labor and human rights, local people livelihood, environment, GHG emission, etc. (FAO, 2015). These and other externalities and co-benefits are context specific and can be inserted in the analysis in order to modify the structure of economic costs and benefits of the project. These include for example economic incentives to renewables or fossil fuels, or costs to mitigate climate change or to ensure the more efficient use of water and land, costs accrued in the treatment of water, measures to contain negative environmental impact, etc. which are of course part of the picture, although not present in the financial investor business plan.

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Analysis Tools

Cost-Benefit Analysis can be unfriendly to a non-professional audience. Several online tools are available to support small and medium businesses in performing cost-benefit evaluation of their investment in an energy-food context. A non-exhaustive list with some examples is provided below:

  • WinDASI - a software for Cost-Benefit Analysis (CBA) of investment projects:FAO provides this tool to carry out cost-benefit calculations of investment projects. After cost and benefit data are inserted in the database, WinDASI guides the user how to calculate. In addition, WinDASI allows for calculation and comparisons of different projects alternative scenarios (with–project versus without-project). The WinDASI program is downloadable from the FAO EASYPol website.
  • VCA Tool - a software for Value-Chain Analysis to assess socioeconomic and environmental policy impacts: developed by FAO, this tool allows different scenarios to be built and to analyse the socio-economic impact of various policies such as the adoption of new low-carbon energy efficient technologies or support for renewable energy. The information about how inputs and outputs would change before and after the intervention is exogenous and can come from other sources. The software is available at: HERE
  • Power Irrigation Tool: this FAO tool evaluates economic, environmental and social aspects of different energy sources for irrigation in order to help operators to assess the economic viability of different power supply options and water pumping technologies. The tool assesses the economics associated with different energy sources for irrigation including the cost, price, and payback time. It can be accessed: HERE
  • RuralInvest - A Participatory Approach to Identifying and Preparing Small/Medium Scale Agricultural and Rural Investments: developed by the FAO Investment Centre, it provides support to local communities, private entrepreneurs or producers’ associations to conceive and implement their own investment projects through a range of materials and training courses including technical manuals, custom developed software, user guides and instructor’s materials. More information: HERE
  • RETScreen: the tool performs cost and financial analysis considering for instance: base case system energy cost (e.g. retail price of heating oil); financing (e.g. debt ratio and length, interest rate); taxes; environmental characteristics of energy displaced (e.g. oil, natural gas, grid electricity); environmental credits and/or subsidies (e.g. GHG credits, deployment incentives); indicator such as payback period, ROI, NPV, energy production costs. It has been developed by CanmetENERGY and can be downloaded HERE

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Steps in Economic Cost-Benefit Analysis

  1. Convert all market prices into economic/shadow prices that better reflect the social opportunity cost of the good.
  2. Remove transfer payments (taxes and subsidies) and quantify externalities (positive and negative).
  3. Compare costs and benefits of the project with the benchmark scenario to obtain the project's incremental net flows.
  4. Calculate economic performance indicators adopting a social discount rate: ENPV, IRR, B/C ratio and payback time.
  5. Perform sensitivity analysis in order to deal with the main risks and uncertainties that could affect the proposed project.

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Investment Planning in Agricultural and Food Enterprises

In agricultural and food enterprises, renewable energy technologies are usually adopted as substitutes to traditional energy sources usually fossil fuels- therefore the financial and economic analysis of the investment requires a comparison with this benchmark. Project FEA is concerned with the incremental costs and benefits of a project, and therefore it requires a comparison between the potential situations “with” and “without” the project.

  1. The first step is the identification and description of both the benchmark scenario (which normally consists in fossil fuel powered and/or inefficient technologies) and the post-energy intervention scenario (where the technology is adopted). For instance, an irrigation system can be powered by a diesel pump (benchmark scenario) or by a solar photovoltaic (PV) powered pump (post-energy intervention scenario). The financial analysis of an investment in the PV pump would require the comparison between the two scenarios.
  2. The second step is the identification of the investment’s outcomes, including the capital and operating costs and the monetized benefits. Because costs and benefits do not occur at the same time – with costs generally preceding and exceeding benefits during the first years of the project – the comparison requires discounting techniques.
  3. The third step is the determination of the project’s incremental net flows (financial and/or economic), which results from comparing costs and benefits of the project with the benchmark scenario. With these elements, it is possible to calculate the corresponding project profitability indicators.

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Conclusion

  • Before performing financial and economic cost-benefit analysis, the investment must be contextualized into an economic, institutional, social and technical framework to identify relevant barriers and constraints.
  1. The first step is the identification and description of both the benchmark scenario and the investment scenario.
  2. The second step is the identification of the investment’s outcomes, including the capital and operating costs and the monetized benefits.
  3. The third step is the determination of the project’s incremental net flows, which results from comparing costs and benefits of the project with costs and benefits of the benchmark scenario. With these elements, it is possible to calculate the financial project profitability indicators.
  • The next steps are converting market prices into economic/shadow prices; removing transfer payments (e.g. taxes and subsidies) and quantifying positive and negative externalities to calculate the economic flows.
  • Perform Sensitivity Analysis in order to deal with the main risks and uncertainties that could affect the proposed project.

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Further Information

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References

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