Techno-Economic Analysis in Agricultural Value Chains

Overview

This articel 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.

Micro-level: Investment planning

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 behavioral factors, geographic constraints and sustainability concerns.

The adoption of the technology/practice by an entrepreneur or farmer goes through different steps:

•  Awareness by an entrepreneur/farmer who learns about the technology/practice
  
•  Evaluation by an entrepreneur/farmer to assess the technology in terms of costs and benefits
  
•  Adoption by an entrepreneur/farmer who decides to adopt it in full, but modify or adapt it to suit the local situation and special needs
  

The adoption of the technological option depends also on the risk perceived by the farmer/entrepreneur, therefore stakeholder involvement is relevant. Weak connectivity between actors, social biases and traditions may represent constraints to the adoption of sustainable energy technologies.

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. The main goal of financial analysis (FA) is to examine the financial returns to project stakeholders (i.e. beneficiaries, institutions and governments, etc.) in order to demonstrate that all actors have enough incentive to participate. A financial analysis provides the foundation for an economic analysis (EA), which is carried out to ascertain a project’s desirability in terms of its net contribution to the economic and social welfare of the country (or sub-national entities) as a whole. In the area of development studies, the terms "financial" and "economic" are commonly defined as follows:

•  A financial analysis is undertaken from the perspective of individual agents, or categories of agent (farmers, retail traders, primary assemblers); it includes the analysis of production utilisation accounts, the profitability of investments, etc.
  
•  An economic analysis is undertaken from the perspective of the overall economic system (national economy, sector or chain) or large groups of heterogeneous agents; it includes the analysis of taxes, subsidies, etc.
  

The financial and economic analysis (FEA) of investment projects is a usual requirement of most governments and International Financing Institutions (IFIs) in order to ensure the financial and economic viability of an investment.

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 of two main steps:

1.  Financial Cost-Benefit Analysis: an assessment of the project’s financial profitability and sustainability in order to determine whether the farmers or other stakeholders have sufficient incentive to participate in the project
   
2.  Economic Cost-Benefit Analysis: an assessment of the project’s economic viability from the point of view of the national (or sub-national) economy. This step should also examine its expected impact on the government budget to ensure its fiscal sustainability. Furthermore, the economic analysis of investments in renewable energy usually includes an assessment of a project’s impact on social and environmental aspects.
   

 

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 fuelpowered 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.
   

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.
  
• The first step is the identification and description of both the benchmark scenario and the investment scenario.
  
• The second step is the identification of the investment’s outcomes, including the capital and operating costs and the monetized benefits.
  
• 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
  

Further Reading

• Powering Agriculture Portal
  
• Reader of the MOOC "Powering Agriculture - Sustainable Energy for Food"
  
• Opportunities for Agri-Food Chains to become Energy-Smart
  
• Energy within Food and Agricultural Value Chains
  
• Agri-food Enterprises in the Energy-Agriculture Nexus