The reserve is one PMT on an inflated net cost. When you start funding it is worth more to equity than the deposit rate it earns.
A decommissioning reserve is sized as a sinking fund: estimate the net removal cost in today's money, inflate it to the end of the project's life, and solve for the level contribution that, with interest, reaches that amount. For an illustrative wind project with a 4.0 million net cost today, that is 7.42 million in year 25 and 0.203 million a year over the whole life, or 0.968 million a year if funding waits until the debt is repaid.
Worked in full in The Project Finance Handbook by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
The obligation to remove turbines, foundations and cabling, and restore the land, sits in the land lease, the planning or permit conditions, or both. Landowners and authorities usually want to see that the money will be there; lenders want to know that putting it there does not eat into debt service. The sizing is a single PMT. The real question is when to fund it, because the reserve earns a deposit rate while equity is priced at much more.
| Input | Value |
|---|---|
| Gross decommissioning cost, today's money | 6.0 million |
| Salvage value of turbines, steel and cable | 2.0 million |
| Net cost, today's money | 4.0 million |
| Cost inflation | 2.5% a year |
| Project life / senior debt tenor | 25 years / 18 years |
| Interest earned on the reserve account | 3% |
| Equity discount rate | 8% |
| CFADS / debt service during the tenor | 10.0 / 7.7 million a year |
| Surety bond fee, on the indexed net cost | 1.5% a year |
Net cost at year 25 = (gross cost − salvage) × (1 + inflation)25 = 4.0 × 1.854 = 7.42 million.
Get the salvage assumption agreed early. Some permits require security for the gross cost, ignoring salvage, because scrap values can collapse. On the gross basis the target is 11.12 million, half as much again.
Sinking fund contribution = FV × r ÷ ((1 + r)n − 1), with r the deposit rate and n the number of contributions.
Over 25 years at 3%: 7.42 × 0.03 ÷ (1.0325 − 1) = 0.203 million a year. Total paid in 5.08 million; interest earned 2.33 million.
In Excel: =PMT(3%,25,0,-7.42). For funding over the seven years after the debt matures: =PMT(3%,7,0,-7.42) = 0.968 million.
Every option ends with 7.42 million in the bank in year 25. They differ in when equity gives up the cash. The benchmark is paying the full cost at the end out of that year's cash flow, whose present value at 8% is 1.08 million.
| Funding option | Annual amount | Total paid in | PV to equity at 8% | Extra cost vs paying at the end |
|---|---|---|---|---|
| Cash deposit on day one | 3.542 once | 3.54 | 3.54 | 2.46 |
| Level over 25 years | 0.203 | 5.08 | 2.17 | 1.09 |
| Surety bond from year 1, cash at the end | 0.061 rising | 2.10 of fees | 1.90 | 0.82 |
| Level over years 19 to 25, after the debt | 0.968 | 6.77 | 1.26 | 0.18 |
| Level over the last 5 years | 1.397 | 6.98 | 1.20 | 0.11 |
Funding over the whole life costs equity 1.09 million of present value more than paying at the end, because money that could earn 8% sits earning 3% for up to 25 years. Funding only after the debt is repaid costs 0.18 million. A surety bond sits between the two: its 1.5% fee is cheap in any single year, but it runs for 25 years on a growing amount and adds 0.82 million.
If the reserve is funded during the tenor and ranks ahead of debt service in the waterfall, it comes off CFADS: (10.0 − 0.203) ÷ 7.7 = 1.27x against 1.30x without it.
If the lenders size on a 1.30x DSCR, a 6% annuity over 18 years, the contribution removes 2.0% of CFADS and 1.69 million of debt capacity, from 83.3 to 81.6 million.
That is why sponsors push for the reserve to be funded after the debt, or below debt service in the waterfall, or replaced by a bond for the tenor. Lenders accept most of these if the decommissioning date falls well after maturity. Where the lease lets the landowner call for security earlier, a bond during the tenor and cash after it is a common compromise. The waterfall position is the same question as for any reserve, worked in how a project finance cash flow waterfall works.
| Deposit rate | Annual, over 25 years | Annual, years 19 to 25 | Extra PV cost, over 25 years | Extra PV cost, years 19 to 25 |
|---|---|---|---|---|
| 1% | 0.263 | 1.028 | 1.72 | 0.26 |
| 3% | 0.203 | 0.968 | 1.09 | 0.18 |
| 5% | 0.155 | 0.911 | 0.58 | 0.10 |
| Salvage, today | Net cost, today | Net cost, year 25 | Annual, over 25 years | Annual, years 19 to 25 |
|---|---|---|---|---|
| 0.0 | 6.0 | 11.12 | 0.305 | 1.452 |
| 1.0 | 5.0 | 9.27 | 0.254 | 1.210 |
| 2.0 | 4.0 | 7.42 | 0.203 | 0.968 |
| 3.0 | 3.0 | 5.56 | 0.153 | 0.726 |
The deposit rate matters most for long funding: at 1% early funding costs equity 1.72 million of value. Salvage moves the size of the target directly, and a project that counts 2.0 million of scrap today and gets none is short by 3.71 million in year 25.
The usual mistake is sizing on today's cost, 4.0 million, and calling it done. Without inflation, a 25-year sinking fund at 3% contributes 0.110 million a year and reaches 4.0 million, 3.42 million short of the inflated target. The second is treating a repowering as a certainty that removes the obligation. It may, but the reserve is sized for the case where the site is cleared.
For the term sheet: agree the salvage basis, the indexation, the date funding starts and whether a bond can stand in for cash. Each is worth more than the deposit rate you negotiate.
Size the reserve with one PMT on an inflated net cost, then spend the negotiation on timing: funding after the debt instead of level over the whole life is worth about 0.91 million of equity value here, more than four years of full-life contributions. The book's two fully modelled deals are in the free workbooks for the book.
It depends on what the lease or permit accepts. Net of salvage is cheaper but relies on scrap prices decades away; some authorities require the gross cost. In the illustrative case the year-25 target is 7.42 million net of 2.0 million of salvage and 11.12 million gross, and the annual contribution over the life rises from 0.203 to 0.305 million.
Yes, if it is funded during the tenor and ranks ahead of debt service. In the illustrative case a 0.203 million annual contribution lowers the DSCR from 1.30x to 1.27x, and a lender sizing at 1.30x on an 18-year 6% annuity lends 1.69 million less. Funding after maturity, or below debt service, avoids it.
Cheaper than cash from day one, dearer than cash funded late. In the illustrative case a 1.5% bond fee on the indexed net cost adds 0.82 million of present value to equity, against 1.09 million for level funding over 25 years and 0.18 million for cash funded over the seven years after the debt.
This article is one calculation from The Project Finance Handbook. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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