An Index-Based Model for Determining the Investment Benchmark of Renewable Energy Projects in South Africa

In a globalised world, financial markets observe the optimal level of asset allocation and returns based on risk inherent in the economies. Whether public or private investors, they need to have an optimal return on their investment given the finite resources. In relatively new sectors like grid-connected renewable energy, many investors face difficulty in assessing proper return, making them more averse to financing such projects, affecting transborder project development opportunities. In developing countries like South Africa, which has tremendous potential for renewable energy projects, an arbitrary choice of the required rate of return for project evaluations can negatively affect funding decisions. This paper explores an index-based model to make fair estimates of the required equity benchmark internal rate of return (IRR) using financial markets observation for renewable energy projects in South Africa. The index-based model is parsimonious and captures common macroeconomic factors. More specifically, it provides a simple and effective mechanism to calculate IRR for renewable energy projects given different gestation periods.