Emissions

Making a Change

Issue 10 and Volume 109.

To survive and thrive in today’s North American power generation market, owners of power generation assets must continuously reassess their market position to succeed in the changing market.

By Michael A. Rutkowski and Dale R. Probasco, Navigant Consulting

The business environment for generation assets in North America has undergone dramatic changes in the past decade – new market structures, new owners, new regional supply-demand balances and new environmental constraints. Generating units continue to age while owners facing increased competition and profitability demands are pressed to “do more” with older assets, fewer people and lower capital and O&M budgets. In the face of these pressures, the short-term goals of asset owners have, in some cases, become diametrically opposed to long-term sustainable performance. The culmination of all these dynamics has resulted in a North American generation market where many plants are being dispatched, operated and maintained differently from their intended “as-built” purpose. Consequently, the investment programs originally designed to support these plants are also disconnected from their new role in the market.

The recent magnitude and confluence of these changes requires immediate action by generation asset owners to ensure success now and in the future. When the various market structure evolutions stabilize, generation assets return to long-term owners, and a clearer picture of the supply-demand dynamic emerges in each region, asset owners who have not taken the opportunity to align O&M practices with the new environment will not be competitive in the newly stabilized market, and will thus be behind the curve in seeking internal operational improvements as a source of earnings growth.

Time is running out for generation asset owners. They must make a determined effort to reassess their current market position and achieve the optimum level of operating performance for the market conditions. The actions owners should take depend upon their understanding of the following key drivers (rules) behind these market dynamics.

Rule No. 1: New market structures are here to stay and will continue to drive uncertainty for the foreseeable future. California Assembly Bill 1890, FERC Orders 888/889, state-mandated generation asset divestitures, FERC Order 2000, evolution of independent system operators (ISOs) and the Energy Policy Act of 2005 are some of the major issues and regulations that have prompted change in the generation market structure. These new market structures have resulted in uncertainty regarding the future profitability of individual generating units – resulting in a series of short-term actions by generation asset owners. For example, many owners deferred or decreased the frequency of major planned outages from four years to 10 years with little or no corresponding preventive maintenance, condition monitoring programs or operating procedure adjustments to manage the increased risk of failure. These outage intervals were stretched under the rationale that if the unit was “in the money,” it should be operating and that OEM-recommended maintenance intervals were overly conservative. While this may be true in some cases, time will tell if the pendulum has swung too far.

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Rule No. 2: The “new” asset owners follow a different set of ownership criteria. Generation asset divestitures, initially driven by state-mandated restructuring and later by the merchant debt crisis, have resulted in more than 200,000 MW of power generating assets being sold or put up for sale since 1996. This equates to nearly 25 percent of the total installed generating capacity in the United States (Figure 1). While the transfer of assets has been highly publicized, some of the underlying consequences have received little or no attention from the new owners of these assets. There are various reasons for this lack of attention.

  • New owners will likely have different views of the life cycle for owning and operating the asset, which in turn affects long-term investment decisions related to the asset’s physical maintenance. Financial owners, such as private equity firms and debt holders of defaulted plants, may be waiting for asset resale opportunities afforded by a market recovery, and therefore will likely make the minimal investments necessary to keep the plant in satisfactory operating condition. Regulated generation owners may be driven by their position in the rate case timeline and/or uncertainty over future market structure rulings, until a more certain landscape justifies the necessary capital investments. Merchant owners’ views of investment continue to be driven by their cash flow situations, with even their best performing assets suffering a cash drain from other underperforming assets in a portfolio.
  • With new ownership comes an inefficient “transplant” of support functions. In some acquisitions, centralized support groups responsible for basic plant functions (administration, maintenance planning, major outages, project engineering, etc.) are severed, and the new owner often fails to reestablish a support structure. Where centralized support remains, it may not be effectively integrated into the needs of the newly acquired asset. Thus, plant managers utilize the resources on hand to keep the plant operational. Economies of scale and scope, as well as knowledge-sharing opportunities, are sacrificed, resulting in inefficient, high-cost operations with little possibility to continuously improve.
  • An aspect of changing ownership often overlooked is the human consequence. Plant employees already numbed by rounds of cost cutting, layoffs, changing O&M strategies and an overall uncertainty of who their employer will be in the future, fall into a “do nothing” behavioral pattern, reinforced by management’s lack of overall direction, measurements and rewards. The result becomes a lack of ownership, responsibility and accountability for maintaining a high level of plant performance. Additionally, instances of poor or no communication about ownership and market environment changes have resulted in confusion or misapplied actions by even the best-intentioned plant employees. With the aging plant workforce and expected upcoming turnover in the next few years, much of the institutionalized knowledge that has kept these plants running will soon be walking out the door.

Rule No. 3: Competition and fuel price volatility have introduced a new supply-demand dynamic. Increasing competition and the unprecedented rise in fuel prices have introduced a new supply-demand imbalance, altering the traditional dispatch order. Many new gas-fired combined-cycle units, developed as low-cost baseload units in a merchant environment or as high-margin units with power sales agreements, are now often “out-of-the-money” and must operate in daily- or seasonally-cycling mode. Other older baseload coal-fired units are in the same position, due to the glut of new capacity in many regions and the life-extensions of existing nuclear or large coal assets. Many of the intended maintenance strategies of these assets have been sacrificed in the name of cost cutting, while the operating demands on the units have increased.

How to Win – The Alignment of O&M with Radical Execution

Given the challenging characteristics of today’s North American generation market, many would think that radical approaches are required by asset owners to position themselves for future success. Conversely, other experts, including this article’s authors, believe that relatively straightforward, historically tested approaches will work, but these require radical execution. The basic premises that follow comprise the formula upon which generation asset owners can align their plants’ operating and maintenance strategies with a changing market environment. Admittedly, these concepts are not new or groundbreaking, but in very few instances have they been flawlessly executed in a sustainable manner within a North American generation asset owner’s portfolio.

Premise 1: Plant owners must engage the people making the day-to-day operating and maintenance decisions – these are the individuals who will originate and own the performance-optimizing solutions. All too often, management makes short-term financial decisions that impact plant-level capital and O&M budgets and strategies planned or already in place, with little communication to the plant floor employees. Communication of these critical corporate and portfolio objectives and their potential plant-level impacts is a baseline requirement for involving all levels of plant decision-makers, from the plant manager to the equipment operators and maintenance mechanics. Furthermore, establishing trust between team members and leadership is essential for effective execution. Only through communication and established trust will plant employees take ownership of plant goals and improvement initiatives, and accountability for results.

Premise 2: Clear performance goals must be established for the business unit or portfolio, and translated to plant-level goals with unit-level goals accepted by plant management. Goal setting has traditionally been a “top-down” process, frequently diluted by unclear measurement, vague targets and too many performance metrics. For plant performance goals to be meaningful to those responsible for meeting them, they must be:

  • Few enough in number to ensure continued focus. Two to five performance indicators directly related to the plant business objectives are sufficient. These goals should include supporting performance indicators (ideally leading indicators) that can be tracked to ensure continued improvement.
  • Based on demonstrated performance levels of comparable peer group units. Many generation plant owners have stated goals of “industry leading,” “top quartile” and “best in class” performance. These nebulous statements are meaningless unless data from a comparable peer group of similar generating units, gathered in a controlled manner with data validation, is used as a basis for target setting. Performance levels can then be understood and viewed as realistic and achievable.
  • Measured and reported in a systematic, repeatable manner. Plants without an indoctrinated methodology of performance measurement will fall into a pattern of constantly questioning the data. They are therefore likely to endure longer than necessary time lags until the performance data is available, thus hindering timely and accurate corrective actions that could be taken to influence performance.

Premise 3: A Center of Excellence network (internal/corporate and external) must be established to effectively support plant needs in achieving performance goals. Given that the plant managers and business leaders must drive the performance improvements and set performance targets, these individuals must be equipped with the resources and tools necessary to achieve the improvement goals. Without an adequate support network, one of two possible outcomes will likely occur.

In one outcome, plant management will continue to perform admirably to strive toward the performance targets. Unfortunately, the day-to-day demands of plant operations and the inability to leverage knowledge through standardization and sharing of best practices and skill sets will likely limit the progress towards these performance goals. Before long, “business as usual” will resume.

With the other outcome, plant leaders will reject the performance targets (often justifiably) because there are no new means by which to achieve them. They have utilized all existing resources and ideas available to them to meet plant performance expectations, so there is little room for improvement.

In either of these two outcomes, an external perspective, specialized skills and the sharing of best practices is needed to equip plant management with the incremental capabilities to achieve a higher level of operating performance. This support network, or Center of Excellence, can include several combinations of plant, corporate and external resources, depending on the organizational structure, skills and staffing levels of the organization. A key aspect of the Center of Excellence’s success is acknowledging that the plant leaders have ultimate ownership and accountability for achieving the plant’s performance targets, rather than relying on corporate-provided mandates.

Premise 4: Plant and portfolio investment decisions must be based on meeting each plant’s business objectives as well as a quantitative and qualitative evaluation of the value of each investment idea. One aspect of performance that will likely be included in overall portfolio performance objectives is cost – both O&M expense and capital investments. However, cost objectives are not single dimensional, they can impact other aspects of plant performance (reliability, availability, heat rate, longevity, etc.) and must be considered. In an extreme example, reduced nonfuel operations and maintenance costs can be easily accomplished – cease all maintenance activities. The likely effects of such cost cutting are obvious – lower availability and reliability, reduced revenues and higher risk. So, the game becomes achieving an optimal level of cost, given the tradeoffs between spending and operating performance.

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Particular spending levels do not guarantee an associated level of operating performance, however. Navigant Consulting’s work in benchmarking the cost and operational performance levels of thousands of generating units indicate that not every unit is on the frontier of optimized cost and performance (Figure 2). In short, many firms’ capital and O&M spending decisions do not result in “money well spent.” Experience has shown that this is the product of several factors:

  • Silo spending at the plant level, with little regard for alternative uses of funds across the portfolio
  • Spending decisions not aligned and justified with the business goals of the plant and the portfolio
  • Lack of a sophisticated process and supporting tools to identify, evaluate, prioritize and measure the benefit of capital and O&M spending
  • Poor execution of projects, resulting in cost overruns and non-achievement of anticipated benefits

To achieve cost targets, “smarter projects” are required – less unneeded work and the best use of funds to achieve the most benefit across the portfolio. Clear leadership direction, well-established processes/supporting tools and the establishment of a “resource scarcity” mindset among all employees are essential.

“Radical” Execution: Business as Usual Will Not Suffice

The premises described above may seem to be basic fundamentals of business management and have all been tried in one form or another by the leading generation owners in North America over the last few decades. However, even the industry leaders would admit to not having fully executed this formula for success. With the changing elements of the North American power industry, strong leadership vision and communication are required at the corporate management, business unit, plant and functional group level to ensure constant refinement and continuous improvement of each of these elements. As the generation sector continues to stabilize, both in financial and market-structure terms, only the generation owners who are determined to execute this formula with their reassembled asset base will see performance levels synonymous with the term “industry leader.”

Authors

Michael A. Rutkowski, P.E., is a Director in Navigant Consulting’s Energy Practice, focusing on the area of business planning and strategy for generation companies. Mike has more than 16 years’ experience in the energy and utilities industry. He may be reached at [email protected]

Dale R. Probasco is a Director with Navigant Consulting Inc. He has more than 25 years’ experience in managerial and consulting positions in the electric utility and construction industries. He may be reached at [email protected]