Gene Freeman

1. Financial / Managerial Considerations in the Electric Power IndustryWhat’s Behind the SwitchLecture 6 Gene Freeman ECEN 2060 Fall 2013

2. Agenda • Decision Environment for Utility Companies • The Profit Equation & the Nature of Costs • Comparison of Generation Technologies & Decision Making Dilemmas • Predicting Future Costs for Facilities That Have Not Been Built Yet • Fixed Costs • Variable Costs • LCOE • Tactical Planning - Load vs. Capacity • Politics • Appendix Methods ECEN 2060 Fall 2013

3. Complex Environments Require Good Decisions • Lots of interdependent moving parts • Many Competing Priorities • Investor / Owner Expectations • Customer Demands • Employee Needs • Regulatory Requirements • Supplier Constraints • Social / Political Necessities • Economic Environment • Very large installed base – much of which is aged and mortgaged • Large capital investments with long payback periods • Technology choices with vastly different economics • Expensive solutions to minimize environmental impacts • Customer needs & attitudes about power • High levels of regulatory oversight • The whole thing is held together with $$$$ ECEN 2060 Fall 2013

4. $ $ $ $ $ $ Economics Are the Basis for 99% of the Decisions • Strategic investments • Retirement of old / obsolete systems • Selection of new technologies • Capacity planning & management • Cost optimization – Managing mix • What sources to turn on during peak loads • What sources to turn off during base loads • When to buy power / when to make power • Supply chain management • Rate setting / negotiation • Reporting & Governance OPS Rates Profit Supply Chain ECEN 2060 Fall 2013

5. Overall Objectives for Utilities • Make optimal use of existing assets • Large fixed costs must be covered by revenues • Debt servicing a big priority • Provide reliable service to customers at an acceptable price • Minimize operating costs • Meet regulatory requirements • Generate & deliver power Collect revenues • Pay bills Generate profit • Invest for the future ECEN 2060 Fall 2013

6. Some Terminology • Watt – Unit of Power – Work / time • Power = Current x Voltage = Watts • kW = 1,000 Watts = 103 Watts • MW = 1,000,000 Watts = 106 Watts • GW = 1,000,000,000 Watts = 109 Watts • kW hr = 1,000 Watts delivered for 1 hour • Standard unit for billable energy delivered • 20 - 50W incandescent bulbs (~600 lumens ea) operating continuously for 1hr • 71 - CFL bulbs (800 lumens ea) operating continuously for 1 hr • 25000 red or green LED indicators operating continuously for 1 hr ( I have about 50 in my house that are on 24/7/52) • 2 Hg Vapor street lights • 3333 cell phone chargers plugged in with no phone to charge for 1 hr • 1.34 lbs of carbon emissions (coal) according to 1 web site ECEN 2060 Fall 2013

7. Agenda • Decision Environment for Utility Companies • The Profit Equation & the Nature of Costs • Comparison of Generation Technologies & Decision Making Dilemmas • Predicting Future Costs for Facilities That Have Not Been Built Yet • Fixed Costs • Variable Costs • LCOE • Tactical Planning - Load vs. Capacity • Politics • Appendix Methods ECEN 2060 Fall 2013

8. 2 Basic Ways to Look At Utility Financials • Annualized Run Rates – e.g. $ / per year • Capital investment decisions • 20 to 50 year capital life cycles • Accuracy decreases as time increases • Most estimates are discounted to today’s $ • Per Unit costs – e.g. $ / kWhr • Allows comparison of various types of energy sources • Used in rate computations, load optimization programs, et.al. ECEN 2060 Fall 2013

9. A Mid-Western Utility – A Typical Company • IOU operating in 8 states, NSYE Traded • Generation Capacity – 110GWhrs • 13 coal plants - 7,697MW (Colo) • Largest Producer of Wind Energy Power • 27 Hydroelectric plants – 500MW • Purchased Electricity • Large amounts of Hydro from Canada • 110MW from biomass generators in Minn. • Model 3 unit bio-mass generation plant in Wisconsin • 2 nuclear plants • 4th largest transmission system in US • 115kV, 230kV, 345kV • 500kV line from Canadian supplier • Solar Rebate program for customers who install them • 10,600 systems generating 121MW • ~12000 employees • Also sell NG ECEN 2060 Fall 2013

10. Income Statement for a Local Utility Company ECEN 2060 Fall 2013

11. Cap Ex Forecast • Most of the capital expenditures will be funded by a combination of debt (borrowing from a bank) and equity (issuing stock) • Cost of capital in 2012 ~ $600M • Current Capital Platform ~ $24B • Any company’s cost of capital is highly dependent on credit worthiness and ROI • Sound investments • Stable / predictable profitability • Sustainable growth in earnings ECEN 2060 Fall 2013

12. The Profit Equation • Operating Income (OI) = Revenue - VC - FE Where: Revenue = Q x ASP VC (Variable Cost) = Q x uVC Q= quantity sold ASP = Average Selling Price uVC = unit Variable Cost FE = Fixed Expenses Salaries Utility Costs (e.g Water, Sewer, Telecommunications Rent / Insurance / Maintenance on Vehicles Other fixed costs Note: Later on we will add Interest, Depreciation, Taxes etc. • OI= Q x (ASP - uVC) - FE • Profit is Computed Monthly • Aggregated Quarterly & Annually • Quarterly earnings reports • Annual Report ECEN 2060 Fall 2013

13. VC = $0.407/ kWhr Residential Commercial Civil Combined Industrial Wholesale Revenue • Average Selling Price • Total Revenue / Unit Volume • Units sold must be similar • Revenue =Q x ASP ECEN 2060 Fall 2013

14. Variable Costs • Per Unit Cost = $/kWhr • Total variable cost increases as quantity sold increases • VC total = Q x uVC • 3 components of variable cost for utility companies • Fuel • Ops & Maint. • Supplies • Repair Parts • Some Labor • Purchased Power • $.0407 / KWhr in our mid-Western electric company for all energy sources combined – 2012 data • These do not represent costs for a new facility ECEN 2060 Fall 2013

15. Fixed Costs – General Discussion • Fixed cost independent of quantity sold • Fixed Costs Include • Operations & Maintenance • Salaries • Tools • Equipment • Supplies • Utility costs • Rentals • Depreciation / Amortization • Property Tax / Insurance • Interest on debt for the facilities • Income Taxes (For Investor Owned and Merchant Utilities) • $3.540B for our example for all plants combined – 2012 data (Note NG Fixed cost backed out) • These do not represent costs for a new facility ECEN 2060 Fall 2013

16. Total Costs = Fixed + Variable ECEN 2060 Fall 2013

17. Break Even Macro Model for Eaxmple Utility - 2012 Data Profit @ 105GkWhrs = $701.5M 10,000,000 Break Even 87.6GkWhrs Total Cost 9,000,000 } 8,000,000 7,000,000 Fixed Cost 6,000,000 5,000,000 Total $ ($M) 4,000,000 Revenue 3,000,000 110GkWhrs Generated 105GkWhrs Sold Where did 5GkWhrs go? 2,000,000 Variable Cost 1,000,000 0 0 10 20 30 40 50 60 70 80 90 100 110 120 130 (GkWhrs) The Volume / Cost / Profit Macro - Model • ASP = $0.0805 /kWhr • Assumes Operations & Maintenance is 30% Variable / 70% Fixed • VC = $0.040 / kWhr • All other expenses are fixed (85% allocated to Electric) ECEN 2060 Fall 2013

18. Break Even Point • Cross over point of the revenue line and the total cost line is the break even point, i.e. profit = 0 • Profit = 0 = (ASP * Q) – (uVC * Q) - FE • 0 = [(ASP – uVC) * Q ] - FE • Q = FE / (ASP – uVC) • In our example the break even volume is 87.6 GkWhrs • Each company has its own unique breakeven point based on its fixed costs, revenue and variable costs • Each plant has its own break-even point • The utility industry has a unique version of this curve – shown in Fig 1.29 in the book ECEN 2060 Fall 2013

19. Agenda • Decision Environment for Utility Companies • The Profit Equation & the Nature of Costs • Comparison of Generation Technologies & Decision Making Dilemmas • Predicting Future Costs for Facilities That Have Not Been Built Yet • Fixed Costs • Variable Costs • LCOE • Tactical Planning - Load vs. Capacity • Politics • Appendix Methods ECEN 2060 Fall 2013

20. Types of Generation Facilities - Coal Total Ops Costs are without Interest & Taxes PC = Pulverized Coal. Typical CF =0.85 Pellet sized coal fed to burners to make steam which drives a steam turbine generator set Lowest Operating Cost , Lowest Installation Cost of coal alternatives Highest CO2 and particulate emissions of the major sources Dual Unit preferred because they share common buildings and condensate facilities IGCC = Integrated Gasification Combined Cycle Coal is converted into a gas, then burned in a gas turbine to turn a generator Waste heat generates steam to run a steam turbine – most efficient conversion of coal to electricity Adds $900M to Dual PC facility construction, $2.75 per MWhr to production cost and increases fixed OH CCS = Carbon Capture and Storage – Removes CO2 and stores it underground Adds $1.4B to construction for a dual units More than doubles operating cost and fixed OH Emissions from burning or conversion of coal are removed from effluent and stored IGCC with CCS – Cleanest, but most expensive of coal options per GW ECEN 2060 Fall 2013

21. Types of Generation Facilities – Natural Gas (NG) Total Ops Costs are without Interest & Taxes CC = Combined Cycle. Typical CF = 0.85 Gas turbine burns NG to turn a generator Waste heat generates steam to run a steam turbine Installation cost comparable to dual coal PC, operating cost lower than coal Displaced all oil fired and many coal fired plants Half of the CO2 emissions & 1/3 the NOx emissions compared to coal. Negligible SOx CCS = Carbon Capture and Storage Adds 3.6B to construction cost per generator More than doubles operating cost CT = Centralized Turbine. Typical CF < 0.20 Used for peak generation capacity only Can be turned on and off quickly & efficiently Triple the operating cost of CCNG facilities 2 x more expensive than conventional CCNG ECEN 2060 Fall 2013

22. Types of Generation Facilities – Big Capital Total Ops Cost are without interest & Taxes Nuclear – Thermonuclear generation of Steam Low operating cost Installation per GW are comparable to coal Issues with spent rod waste disposal, no atmospheric emission Historic concerns over safety Hydroelectric – Gravitational fall of water to turn generator Construction costs comparable to coal (excluding land for retention), $0.00 fuel costs Limited to areas where continuous flow of water is available over a suitable drop in elevation Permitting is difficult because of land inundation Issues in some watersheds over fish reproduction (e.g. Columbia River Project and salmon fisheries) Geothermal – Recovery of earth’s core heat to generate steam Construction costs very high, payback on energy cost is measured in centuries Limited to areas with access to geothermal sources ECEN 2060 Fall 2013

23. Total Ops Cost are without interest & Taxes Wind – Atmospheric air flow drives generator Typical CF = 0.34 Issues with inconsistent output due to lack of adequate wind energy. Needs a storage solution Must be located where prevailing winds are continuous Capital costs are high because of relative low volumes of production Solar – Photovoltaic generation in semiconductor film. Typical CF = 0.25 Requires large surface areas to accumulate energy and convert to electricity Issues with inconsistent output due to sun cycle. Needs a storage solution Installation costs are very high because of low volume production Fuel costs $0.00 Biomass & Municipal waste – Burn organic material to generate steam. CF comparable to Coal Dirty and expensive to set up, Does reduce landfill contributions Types of Generation Facilities – Alternative ECEN 2060 Fall 2013

24. Alternative Energy vs. Fossil Fuel Summarized from EIA data shown on next 4 slides Total Ops Cost do not include interest or taxes and assumes a CF of 1 ECEN 2060 Fall 2013

25. Alternative Energy vs. Fossil Fuel • Alternatives (Wind & Solar) have lowest operating costs • However • Irregularity of output for wind & solar also requires additional capital investment not shown in tabes • Work is required to make alternative sources competitive • Solve storage issues • Bring down costs of installation • Coal Plants are expensive to clean up and come in very large chunks of capacity • NG fuel prices have come down but are subject to market demand vs. supply pricing dynamics – this is only a short term fix • There are no easy (or cheap) solutions! ECEN 2060 Fall 2013

26. What’s Happening Now In the Industry • CCNG & CTNG plants are replacing PC plants at a rate of 50 -100 per year • Slightly higher overall operating cost • NG fuel cost > Coal cost (~ $0.04 / kWhr) • Lower Construction cost • Lower CO2 emissions (1/2 of PC) • Very low aerosols, SOx, NOx and Hg emissions • But this is not a long term solution either! • NG supply limitations will eventually drive up fuel costs • CO2 emissions are cumulative with other natural sources • Non-combustion alternatives will be needed eventually • Solar – Requires a lot of surface area & storage for dark periods • Wind – Only works when / where wind is persistent, needs storage • Hydroelectric – Big issues with permitting, environmentalists & land costs • Nuclear – Big Issues with waste storage and public opinion about safety ECEN 2060 Fall 2013

27. Basic Strategic Investment Decisions • When should a generation asset be retired? • When Regulatory requirements for emissions cannot be met profitably • The age of the asset causes the plant to be unreliable or unprofitable • When newer technology would reduce the operating costs such that margins ($) would improve significantly • The book value of the asset is close to $0 • When should a new asset be added? • Before future demand exceeds current capacity by more than X% • Lead time for planning, permitting, construction & start up of a new facility is 3-5 years • Note these criteria vary from company to company • ROI’s must pass the company’s thresholds • Which technologies should be added & where? • How Big? ECEN 2060 Fall 2013

28. Capacity w 1 big addition Demand Growing 50k KWhrs / year Capacity w 4 small additions Capacity Addition Dilemmas Is it better to add 1 big plant (1,000,000 kW) 10 years from now or add 4 smaller plants (250,000 kW) spaced 5 years apart? Why? What happens to operating cost / profit when the plant has more capacity than demand? What happens to operating cost / profit when the plant has less capacity than demand? ECEN 2060 Fall 2013