red | the new green 1 diy: how businesses can install their own generation sean casten president...

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DIY: How Businesses Can Install their Own Generation

Sean CastenPresident & CEORecycled Energy Development, LLC

ISO-New EnglandHolyoke, MA

Presentation to YPO Energy SummitApril 23, 2009


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Deep Thoughts

“It’s easy to sit there and say you’d like to have more money. And that’s what I like about it. It’s easy. Just sitting there, rocking back and forth, wanting that money.”

- Jack Handey


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Deeper Thoughts

• It’s easy to operate industrially-sited on-site generation that creates consistent, long-term value

• But it’s hard to design, finance, build, permit and commission that generation.

• It’s easy for a typical industrial to buy energy

• But it’s hard for a typical industrial to buy on-site energy generation.


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Good news: Far easier than it should be to build generation with innately lower costs than your utility.

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~8% of US grid is served by combined heat & power plants with efficiencies of 50%+, and overwhelming economic advantages. Why not more?


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CHP / DG industry has been limited by both regulatory and commercial constraints.

Regulatory Environment is anti-competitive, favors

status quo

DG / CHP players undercapitalized and starved for entrepreneurial

talent

Entrepreneurs & investors not attracted to disruptive portion of industry

Absence of strong, organized advocacy

for regulatory reform

Energy users not alerted to opportunity, don’t see competitive pressure to deviate from status quo

“Losers cry louder than winners cheer”


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Good news / bad news

• Good news: the world is changing

• Regulatory stranglehold is loosening

• Lots of recent innovation in sector, rising investor activity

• Proof: total US generation capacity additions since 1998, in rank order are natural gas (200 GW; almost entirely by unregulated), CHP (45 GW; entirely by unregulated) and wind (11 GW, largely unregulated). Essentially zero (net of retirements) by regulated utilities during same time period.

• Bad news: DG industry still not fully mature.

• Too many good opportunities squandered by bad design / contracting.

• DG industry sales process doesn’t map very well to energy users’ purchasing process.


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Key design principles underlying good on-site generation.

• Don’t design for your power needs.

• Designing to thermal demands and/or opportunity (including but not limited to traditional renewable) fuels delivers much higher overall returns and minimizes fuel volatility exposure.

• Don’t assume static energy costs or regulation

• Many projects would still be running today if natural gas was always $3/MMBtu (just like their spreadsheet promised!)

• Energy regulation is in a high degree of state & federal flux; significant opportunities, but only if you’re nimble.

• Be holistic, and start on the demand side.

• No one wants electricity, but everyone wants cold beer. Optimize your energy island, not your electricity generator.

• Minimize energy use first, then design energy supply to avoid stranding capital.


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Thermal matching: simple example

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Electric-matched system follows

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Thermally-matched system follows thermal

demand, displaces electric as available


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Thermal matching: simple example

Electric-matchedThermally-matched

Rated Power Output 40 MW 24 MW

Average Thermal Output 67 MMBtu/hr 67 MMBtu/hr

Annual fuel efficiency 46% 91%

Total Capex $44 million $27 million

Annual cash gen $4.4 million $4.7 million

20 year pretax ROA 8% 17%

Assumes gas turbine with 9,500 Btu/kWh heat rate @ $1100/kW, 75% thermal recovery in HRSG, $10/MWh O&M costs, $7/MMBtu natural gas and $75/MWh electric sale.

Full-matching should also be constrained by supply of on-site opportunity fuels (waste heat, waste gas, etc.) to maximize “spark spread” and life-cycle economics.


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Key contracting principles underlying good on-site generation.

• Think like debt, act like equity

• Stress test models, look hard at downside; but make sure your whole project team has an incentive for upside gain.

• Typical approach (owner gets upside, suppliers get LDs) typically fails.

• Overpay for value-creation.

• Value-creation happens during the design stage, value-realization comes during the execution stage. With $ heavily back-ended, value creation tends to get short-shrift.

• People who are really good at design unlikely to work for T&M

• Don’t confuse breadth for depth.

• The world doesn’t need any more power plants designed by failed HVAC engineers!


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Compare this to the “too many cooks” way that most projects are staffed…

TaskTask Who Usually Provides?Who Usually Provides?

Conceptual Design

• Developers• Consulting engineers

Detailed Design

Financing

Construction

Equipment specification

Permitting

Operations• Owners• Asset managers• Developers

Contracting

• Owners• Developers• Consulting engineers

• Developers• Consulting engineers• Packagers

• Banks• OEMs• Owners

• EPCs• Owners• Packagers

• Packagers• Distributors

• Packagers• Distributors

• Owners• Outside counsel• Debt providers

• EPCs• Developers

• Developers

• OEMs• Developers

• Owners• Environmental consultants• Developers


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…and the way those cooks are incentivized.

• Typical contract structure over-penalizes downside, under-rewards upside.

• Fixed price contracts + LDs/performance guarantees

• RFQ-type solicitations encourage those parties who can add most to early-stage value-creation to stay quiet, lest their ideas get “stolen” to go to low-cost bidders.

• Multiple contacts often not well-aligned.

• Do your contracts encourage multiple parties to work together, or encourage them just to point fingers when things fail?

• Lesson from big projects

• $50M+ projects always have single, sole-coordinator to tie everything together, smaller ones have 10 sous-chefs.

• Irony: both projects are equally prone to $100K coordination mistakes; but they are proportionally much more expensive on small projects.


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The awkward truth: bifurcation in the DG / CHP industry

Small Projects (<$10M) Big Projects (>$50M)

Odd result – lots of churn in small project space. Successful companies move to bigger projects where they can capture more value, or else expand into other areas (HVAC, ESCO, etc.). Unsuccessful ones exit.

Who’s in the market?

Small balance-sheets, startups dominate (except OEMs).

Big balance-sheets, deep experience dominates

Typical contracting structure

Many independent contracts with owner / host

Single umbrella contract with owner / host

Contracting challenges

Defining boundaries of responsibility

Gain-sharing

Who succeeds in this market?

Low-cost providers High-value providers


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So how do you do small DG projects effectively?

1. Look hard at your procurement processes

• Probably work well for purchasing of commodities; probably don’t work well for purchasing of high value-add services from non-competitive industries.

2. If equity has expertise, use it.

• If not, find partners who want to be compensated like equity, with balancing upsides & downsides.

• Execution is a commodity; value creation isn’t. Procure, price and manage those disparate tasks accordingly.

3. Address demand side first, size for opportunity fuels and thermal demand second, power needs last.

• This hierarchy applies to system design and to operating protocols.


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So how do you do small DG projects effectively?

4. Don’t constrain your analysis too early

• Engineering bias to impose constraints, then analyze, and artificially limit options to a finite set of prime movers, energy cost environments, scopes, etc.

• Good on-site generation starts with a much more entrepreneurial focus, bounded by what you want rather than what you can’t have.

6. Favor experience, but don’t demand it.

• Can’t be guaranteed to find someone who’s tied together all the complexities of a project like yours before; a company with a strong entrepreneurial culture can create far more value than one that consistently does the wrong thing the right way.

red | the new green 1 diy: how businesses can install their own generation sean casten president...

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