ECONOMICS OF ELECTRICITY GENERATION

dr. Péter KaderjákDirector, REKK

NARUC Training on Tariff Development and Utility Regulation

May 7-11, 2007, Baku, Azerbaijan

2

OUTLINE

• Costs of generation• Demand for and supply of electricity in

the short run• Technology choice in the long run • Price setting at the plant level• Price setting at the wholesale level

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UNDERSTANDING GENERATION

• Converting one form of energy into electric energy

• Electricity generation:• Fossil: combustion – heat – steam cycle• Nuclear, geothermal: heat – steam cycle • Direct: wind, hydro

• Investment creates power or capacity (MW)

• Both capacity and energy are flows and the price of them can be measured in $/MWh

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COSTS OF GENERATION

• Total cost (TC) = Fixed cost (FC) + Variable cost (VC)

• FC: related mostly to investment and economic profits to be earned; in the short run O&M, wages, depreciation social fund and other obligations are also fixed; independent of the level of production

• VC: fuel cost; depends on the level of production

• Marginal cost (MC): the change of TC when output is increased by 1 unit

• MC = constant, when VC is linear (we assume)

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EXAMPLE: MARGINAL COST BY TECHNOLOGY AND MERIT ORDER

3026700CCGT

4060400OCGT

4020800Coal

4041000Nuclear

Life-time years

Marginal production

cost($/MWh)

Installed capacity

(MW)

Technology

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MARGINAL COST ESTIMATION

• Costing fuel conversion into electricity: short run marginal cost of generation• Cost of fuel ($/m3) • Heat content of the fuel (GJ/ m3)• Conversion of GJ into kWh• Heat rate (efficiency) of conversion

• Comparing costs to electricity prices• Spark spread: gas-to-electricity market

prices• Dark spread: coal-to-electricity prices

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COST OF FUEL

• Transparent market benchmarks• Coal• Gas: Henry Hub (US)• Oil (Brent)• Oil – gas link (log-term gas contracts)

• Long term contract prices• Self-reports• Extraction cost estimates (in case of own fuel

base; e.g. integrated generation and lignite mine)

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EXAMPLE: GAS PRICING FORMULA IN A TYPICAL EARLY TOP

si=96,8*(0,5*A/Ao+0,5*B/Bo)

A: average of last 9 months diesel priceB: average of last 9 months heavy fuel oil priceAo: diesel price on January 1, 1996 (147,95 $/t)Bo: heavy fuel oil price on January 1, 1996 (135 $/t)96,8 $/1000 m3: agreed starting price by January 1, 1996

Estimated gas import price / oil price link:

Si=4,9+4,4*brent

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CONVERSION TABLES

• Costing fuel conversion into electricity:

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HEAT RATE ESTIMATES

G a s /O il S T C o a l S T N u c le a r S T C C G T G a s G a s /O il G T1 9 6 0 3 7 ,0 % 3 5 ,0 % 2 5 ,0 %1 9 7 0 3 9 ,0 % 3 7 ,0 % 2 7 ,0 %1 9 8 0 4 1 ,0 % 3 9 ,0 % 2 9 ,0 % 3 0 ,0 %1 9 9 0 4 3 ,0 % 4 1 ,0 % 3 1 ,0 % 5 0 ,0 % 3 4 ,0 %2 0 0 0 4 5 ,0 % 4 3 ,0 % 3 3 ,0 % 5 5 ,0 % 3 6 ,0 %2 0 1 0 4 6 ,0 % 3 6 ,0 % 5 8 ,0 % 3 8 ,0 %2 0 2 0 4 9 ,0 % 3 9 ,0 % 6 0 ,0 % 4 0 ,0 %2 0 3 0 5 2 ,0 % 4 2 ,0 % 6 2 ,0 % 4 1 ,0 %2 0 4 0 5 5 ,0 % 4 5 ,0 % 6 4 ,0 % 4 2 ,0 %

S T : s te a m tu rb in eC C G T : c o m b in e d -c y c le g a s tu rb in e

G r o s s f u e l e f f ic ie n c y p a r a m e t e r s a s s u m e d in t h e K E M A s t u d y fo r p o w e r p la n t s c o m m is s io n e d in t h e in d ic a t e d y e a r s . F o r y e a r s in b e t w e e n , f u e l e f f ic ie n c y c a n b e l in e a r ly e x t r a p o la t e d .

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ESTIMATION: INDIVIDUAL GENERATION UNIT

1. Generating plant2. Number and type of units3. Unit capacity – Total plant capacity –

Available capacity4. Year of commissioning5. Fuel type6. Fuel cost (cent/GJ) (C)7. Marginal cost: C*0,036/e 8. Correction for self consumption

Gross efficiency (e)

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LOAD DURATION (SUPPLY) CURVE: EXAMPLE

26

60

$/MWh

2900

20

MW250018001000

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hydronuclear lignite

coal

CCGT

GT

Supply

Capacity

Mar

gina

l Cos

t

Prices are set by the marginal plantPrice formation on competitive short-term electricity markets

Market price

Demand

hydronuclear lignite

coal

CCGT

GT

Supply

Capacity

Mar

gina

l Cos

t

Prices are set by the marginal plantPrice formation on competitive short-term electricity markets

Market price

Demand

Source: EU Energy Sector Inquiry Report

SHORT RUN MERIT ORDER AND MARKET PRICES

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Preis

Menge

P1

Q1

D1

S

Price

Volume

P2

S2

P2

Q2

D2

Preis

Menge

P1

Q

D

S1

Price

Volume

PRICE FORMATION BY CHANGES IN DEMAND AND SUPPLY

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APPLICATION BASED ON PUBLIC DATA –estimated merit order for SEE markets

-

10.00

20.00

30.00

40.00

50.00

60.00

0 2,000 4,000 6,000 8,000 10,000 12,000 14,000 16,000 18,000MW

€/M

Wh

ROBG

RS

BA

HR

MKUNMIK

ME

AL

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APPLICATION BASED ON PUBLIC DATA –estimated aggregate merit order for SEE

-

10.00

20.00

30.00

40.00

50.00

60.00

0 5,000 10,000 15,000 20,000 25,000 30,000 35,000 40,000

MW

€/M

Wh

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APPLICATION BASED ON PUBLIC DATA –peak demand, January 2006; source: UCTE

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

9,000

AL BA BG HR ME MK RO RS UNMIK

MW

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APPLICATION BASED ON PUBLIC DATA –estimated equilibrium in peak and off-peak periods

-

10.00

20.00

30.00

40.00

50.00

60.00

0 5,000 10,000 15,000 20,000 25,000 30,000 35,000 40,000

MW

€/M

Wh

Supply

Peak demand

Off-peak demand

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EFFICIENT INVESTMENTS: ACCOUNTING FOR FIXED COSTS

• Coal vs. gas based generation unit: which is the better investment option?

• Additional information is needed:• Price of capacity ($/kW)• Capacity factor (usage % of 8760 hours)

• Price of capacity: conversion of the overnight cost of capacity into the annual fixed cost of a kW

• Overnight cost of capacity: lump sum up front payment to construct the capacity

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LONG RUN: ACCOUNTING FOR FIXED COSTS

$12,21$106,96$1050$87.6$10Coal plant

$4,62$40.48$350$306.6$35Gas turbine

FC(/MWh)

FC(/kWy)

OC(/kW)

VC(/kWy)

VC(/MWh)

Technology

TrT rOCr

eOCrFC

)1/(111 +−∗

≈−∗

= −Converting overnightcost into fixed cost:

r: discount rate (in % per year); here r = 10% (or 0,1)

T: life of the plant; T = 20 years for gas turbines and 40 for coal plants

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SCREENING CURVES (OR TOTAL COST CURVES)

$106.96$12.21

$/MWh $/kwy

$40.48

coalgas turbine

ARR

Capacity factor 10.3Annual Revenue Requirement: ARR = FC + cf x VC

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LOAD DURATION CURVE

6000

8500

MW

Capacity factor 10.3

Efficient generation park (only coal and gas): 6000 MWcoal, 2500 MW gas

gas turbine

coal

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• Objective:

Total Revenue (TR) = ARRPrice*electricity sold = FC + VC

Price = (FC + VC) / electricity sold

GENERATION PRICE REGULATION

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• Cost of capital• Weighted average cost of equity and debt

• Cost of equity (e.g.12%)• Cost of debt (e.g.10%)• Financing structure (e.g. 70% equity and

30% debt)• WACC = 0,7*12 + 0,3*10 = 11,4%

• Capital employed for electricity production• Combined generation?• Overnight cost?• Book value?

COSTS: FIXED OR VARIABLE?

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• Depreciation• Operating & Maintanence• Wages• Social obligations (if any)• Taxes• Fines• Fuel cost

• Is pass-through efficient?+ Production projection

• Uncertainties?

COSTS: FIXED OR VARIABLE?

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GENERATION PRICE REGULATION

Follow the example of Azeri wholesale revenue requirement worksheets

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SUMMARY

• Fixed cost, variable cost, marginal cost• Short run operations

• Demand curve• Merit order (marginal cost) curve

• Investment planning• Load duration curve• Overnight cost of capacity• Screening (total cost) curve

• Price regulation• Annual revenue requirement• Weighted average cost of capital