Optimizing Plant Value by Achieving a Virtuous Cycle

By Ramon T. Mischkot, President, Transactive Management, Inc., and Gary S. Page, Manager Energy Projects, Duquesne Power

The best way to optimize the value of older, unregulated, supercritical coal-fired plants is to implement a long-term maintenance strategy that positions them to compete in the low cost regime of plants selling power into deregulated markets. This paper, which is based on a 2006 study that determined the depreciable life of plants built in the late 1960s and early 1970s, explains how this can result in high dispatch levels, favorable operating economics, and the positive earnings necessary to sustain a capital improvement program designed to meet the combined goals of operational efficiency and environmental compliance. That is, how this can result in what is described below as a "virtuous cycle".

Last year, Transactive Management, Inc. (TMI) completed its first study of several supercritical coal-fired plants that have been operating for over thirty years. Unlike prior coal-fired plant studies, which were limited to plants coming on-line in the mid-1990s, this study provided the opportunity to assess how effective a well established long-term maintenance and capital improvement program could be in extending the life of plants that had already operated for almost all of their 30-to-40 year design life.

We found that conclusions in prior coal-fired plant studies, which estimated an operating life of 55 years, were too conservative. The established record of repairing, replacing, and upgrading components-including components subject to high pressure and temperature like superheaters, economizers, and steam boiler water walls-showed that the plants were literally being rebuilt on a piece-by-piece basis. Moreover, this effort was directed at improving reliability and availability, meeting or exceeding increasing emission requirements, and maintaining the original design heat rate. We ultimately concluded that, even though plants were designed for a 30-to-40 year life, their material condition, the high standard of maintenance care, and an established pattern of ongoing capital improvements would allow them to operate competitively for over 40 years, achieving an operating life of 80 years or more.

As in prior studies, this conclusion regarding plant physical, or technological, life, was based on: (1) developing a component-level breakdown of the plant's major systems; (2) assigning a service life to each component consistent with their design life, failure mechanisms, mode of plant operation, and client maintenance and accounting practices; and (3) calculating the service life of each system and the overall plant based on the percent of total plant cost represented by each component. In earlier studies of much newer plants, the component-level cost breakdown was based on original plant construction costs. In this study, however, we used general ledger data on capital improvements in combination with original plant construction costs as depreciated through 2005. The resulting cost profile was made up of about 84 percent capital cost improvements and 16 percent original construction cost. Thus, on both a physical and financial basis, the projected life of the plant reflected the remaining life of the components and systems that made-up the plant at the time of the study, rather than the cost and life of original plant components.

While it is one thing to systematically rebuild a plant on a piece-by-piece basis, it is another to do this in a way that allows the plant to remain economically viable. TMI studies assess the economic viability of plants over their projected technological life by comparing projected operating costs, including costs for capital improvements, with long-term projections of market clearing prices. Plants are economically viable if expected profit margins are sufficient to show that the cumulative undiscounted cash flow meets or exceeds total carrying costs consistent with applicable accounting standards.

In this regard, we have found that coal-fired plants have an economic advantage over combined cycle plants, the other major technology driving market-clearing prices, because the price of natural gas is high relative to coal. In addition, natural gas prices are expected to increase more than coal prices in the future. This economic advantage is greater for supercritical coal-fired plants, which typically have a heat rate of 9,500 Btu/kWh or better. This is true even for supercritical plants built in the late 1960's and early 1970's reflecting the maturity of coal-fired steam plant technology, which has not experienced the rapid rate of design advances of gas turbine technology. The larger the station, the greater the economic advantage because the more coal required, the more leverage in negotiating favorable long-term fuel contracts-i.e., the advantage of scale. This scale advantage also means that not only capital costs but also general and administrative costs for the plant staff are spread over the high level of megawatt-hours produced by the plants.

In the 2006 study we concluded that the plants assessed would remain economically viable over the estimated period of their respective technological lives. The low generating costs achieved, to date, put plants in the low-cost regime of baseload plants selling into the ISO-based market. As a result, they are amongst the first fossil-fired plants dispatched-after nuclear and hydro plants. Through 2010 generating costs were forecast to remain under $25/MWh compared to regional market clearing prices projected to be about $47.5/MWh in 2010 and over $95/MWh by 2025.

We also found that the stations would not be forced out of the market by the future introduction of "next generation" advanced coal-fired plants such as integrated gasification combined cycle (IGCC) plants. Our analysis showed that the plants would continue to have an economic advantage over newly constructed IGCC plants. The higher efficiency and emission advantages of IGCC plants are more than offset by their higher capital costs. Although the cost impact of technology necessary to provide for carbon capture and sequestration (CCS) could change this conclusion, the development and commercialization of this technology has not reached a point where it is possible to reach any definitive conclusion. While designing CSC technology into a newly built plant will have a cost advantage over retrofitting, this may not be sufficient to offset the much higher cost of building a new IGCC plant. One thing we have learned in the depreciable life studies conducted over the past 10 years is that plants will actually operate longer in a deregulated market because extending the life of an existing plant has an economic advantage over building a replacement plant. In addition, one sees a cash flow advantage because an existing plant continues to generate earnings during periods of capital improvement; whereas cash is not generated during the planning, development, and construction phase of a new

Insights gained in last year's study can also serve as the basis for optimizing the value of older, unregulated, supercritical coal-fired plants by implementing a long-term maintenance strategy that positions plants to effectively compete throughout an extended life. This strategy would be directed at achieving the virtuous cycle depicted in the figure to the right, whereby:

  • Low-cost operations allow low bids at positive margins;

  • Resulting in a high dispatch level;

  • Resulting in a high capacity factor, favorable operating economics, positive earnings, and capital to reinvest in plant improvements;

  • Sustaining the low-cost operations that continue the cycle.

As shown, this is a self-reinforcing process. The inherent advantage of low cost operations is reinforced because it allows for high dispatch levels. Correspondingly, high dispatch levels promote low-cost operations because plants operate on a full-time basis at their optimum capacity. This allows continuous operations within temperature and pressure design parameters, which yields favorable operating economics and reduces wear-and-tear on components. It also requires greater volumes of coal, which can mean lower coal prices due to higher leverage in negotiating favorable long-term fuel contracts. Higher output also allows capital and administrative costs to be spread over more megawatt-hours. Part of the resulting profits can go to ongoing capital improvements that sustain continued low cost operations.

The elements necessary to implement this strategy include an overall goal to maintain plants to have indefinite lives. The key to making this a reality is a 10-year capital improvement and budgeting program that identifies performance problems, develops cost effective solutions, and ranks capital improvement projects. Such a program is directed at improving reliability and availability, meeting or exceeding emission requirements, and maintaining the plant's original design heat rate which ultimately allows capital costs to be levelized and planned in a manner that minimizes the duration of major outages. It can also allow a two, or even, three-year outage cycle.

In conjunction with this effort, companies should develop the ability to annually update long-term plant financial pro forma projections based on future market clearing prices, changing emission requirements, and any other external business factors that have a significant impact on revenues, costs, and profitability. In short, they should annually assess whether or not the virtuous cycle described above will remain valid given future changes. Finally, plants should be depreciated over a period that is consistent with this commitment to an extended operating life.

We have found that the majority of unregulated plants are, in fact, undervalued because they are being depreciated at rates that fail to recognize their full potential useful lives. Overly cautious depreciation rates mean annual depreciation costs that are too high, which translates into understated book income, earnings per share, and-because stock valuations are based on earnings per share-shareholder value.

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