Gasification Technologies Conference

October 10, 2005

David Berg Andrew Paterson

DOE, Office of Policy & International Affairs

www.ClimateVISION.gov

Understanding Gasification Incentives: Risks, Benefits, & Cost

2

Overview

• Context: Drivers of Energy Policy– The “Energy Investment Challenge” – Enhancing energy security – Storm damage recovery – Climate challenge

“Business Case for Commercial Deployment of IGCC”• Business Case Team: DOE, EPRI, EPA (with DOD)

– Financial Advisors: Scully Capital RISK: Findings from key risks questionnaireLIFT: Results from financial analysis of incentivesSCORING: Results of budget scoring analysis

3

The Energy Investment Challenge

IGCC at Tampa PECO

IGCC in Wabash, IN

4

The Energy Investment Challenge (IEA)“We don’t have an energy crisis, we have an energy investment crisis. We will need billions invested.”

Admiral Skip Bowman, Nuclear Energy Institute, 2005

Roughly $1,000 billion needs to be invested in North Americaeach decade to meet energy demands, half of it in the electric sector.

World Energy Investment

Outlook, 2003IEA

For U.S. & Canada $Billions

$- $100 $200 $300 $400 $500

Oil - Explore & Develop

Oil sands, other

Oil Refining

Gas - Explore & Develop

LNG terminals

Gas Transmission

Gas Distribution / Storage

Coal - Mining

Electricity - Generation

Elec- Transmission

Elec- Distribution

2001-2010 2011-2020

Investments in energy efficiency are additional

5

Situation Briefing: Damage from Hurricane

D

CAB

U.S. oil firms examine Katrina damageThe U.S. Coast Guard reported at least 20 oil rigs or platforms missing in the Gulf of Mexico, while officials estimated 95 percent of regional oil and natural gas production and eight refineries along the coast remained shut down. Several crude pipelines on the Gulf Coast remained out of service due to power outages, damage and flooding, creating more strains for the sector. What's more, DOE said Port Fourchon in Louisiana, which handles a large share of U.S. crude oil and natural gas imports, was severely damaged by Hurricane Katrina and cut off by flood waters. In all, about 1.4 million bpd of crude production -- about 7 percent of domestic demand -- was down, and concerns about the lack of feedstock for refineries prompted the United States to offer to loan crude from its Strategic Petroleum Reserve to companies to replace lost output. The offer helped ease oil prices from record highs above $70 per barrel. But U.S. crude still remained at a red-hot $68.94 a barrel, down 87 cents from Tuesday when crude, gasoline and heating oil futures set record peaks.

• 20-25% of national oil & gas rigs shutdown;

• Nearly 60 rigs damaged in Gulf

• Several pipelines damaged, crimping supplies to other regions

• 8-10 refineries down, some more damaged than others; could take weeks or months

6

$12.00

$6.00

Oil,Gas Supply Constraints & Price Volatility

Crude OilAscent of crude oil prices in 2004-2005 threatens economic growth and provides a painful reminder of U.S. commercial vulnerability arising from the Nation’s dependency on oil imports.

Natural GasNatural gas price volatility, >100% variation in a year, is damaging key industries that depend on gas (e.g., chemicals, fertilizers, metals, cement). Stakeholders resist LNG terminals.

Create opening for coal gasificationCreate opening for coal gasification

$45.00

$70.00

7

U.S. Power Plant Sector, 1950 – 2004 The wave of NGCCs built since 1998 faces bankruptcy, mothballs, or idleness due to high gas prices. Many new plants are under study.

-

50,000

100,000

150,000

200,000

250,000

300,000

1950's 1960's 1970's 1980's 1990's ‘00-’04

OtherRenewableOilHydroNuclearNatural GasCoal

Sources: EIA, Form 860 for 2003; EIA, Electric Power Monthly, Nov. 2004, Table ES-3.

Actual capacity factor (<20%)

Actual capacity factor (<20%)

New power capacity by decade

8

Challenge: CO2 Emissions by Sector, 2002

Electr

Resident

Comcl

Industr

Transp

Coal

Nuclear

Petro

N.Gas

0

100

200

300

400

500

600

Mill

ion

Tons

of C

arbo

n (M

tC)

CO2 emissions are concentrated in electricity, industry, & transportation sectors. Expanding nuclear reduces power’s GHG intensity. Programs in hydrogen, fuel cells, biofuels, and “Freedom Car” are aimed at the transport sector.

IGCC can play a role in alleviating gas shortages and building “carbon management” options.

CO2 from electricity shown in total and then allocated to residential, commercial, and industrial.

ElectricityTransport

Fuel SourceEnd-use

Sector

9

Energy Policy Act 2005

• $14.5 billion in tax benefits + other funding assistance

• Provides incentives for power and fuels from coal gasification, nuclear power, grid upgrades, energy efficiency, and renewable power and fuels

• Clarifies rules for siting power infrastructure and investment, and grid reliability

• Addresses climate challenge through sound voluntary actions and acceleration of technology

President George W. Bush signing H.R. 6, The Energy Policy Act of 2005, at Sandia National Laboratory in Albuquerque, NM, on Monday, August 8, 2005. Congressmen Ralph Hall (R, TX) and Joe Barton (R, TX), and Senators Pete Domenici (R, NM) and Jeff Bingaman (D, NM) also are on the stage.

August 8, 2005

May 2001

10

DOD’s “Clean Fuel” Initiative

• To gain secure fuel supplies, DOD seeks domestic commercial sources of clean fuels.

• To start, DOD will catalyze industrial clean fuels production based on coal gasification for FT fuels.

• DOD will develop fuel specifications; procure supplies of fuels for testing; and evaluate, demonstrate, certify, and implement clean fuels.

• DOD’s analysis confirms that production of sufficient fuel supplies for testing requires government incentives.

• DOD faces similar roadblocks as IGCC: High cost of fuels production, plant reliability concerns, environmental uncertainties, financing difficulties.

• Collaborative analysis of risks and incentives can create synergies for DOD, DOE, EPA, & states—and opportunities for industry to build commercial plants.

11

Business Case: Coal’s Lead Role in Power

By 2020, EIA forecasts that U.S. will still use coal for 45% – 50% of U.S. electricity…

Climate VISION:How do we best shift to coal gasification to reduce emissions and build “carbon capture” potential, or move to coal refining capacity?

EIA forecast for U.S. electricity generation, 2002 – 2020 (AEO 2004)

-

1,000

2,000

3,000

4,000

5,000

6,000

2002 2012 2020

Elec

tric

ity G

ener

ated

(Bill

ion

KW

hs)

Coal Nuclear Gas Dual fuel

Hydro Bio+MSW Wind Solar

2002 2012 2020

12

Risk: Analysis of Transaction Chain Views

Severity

Probability

RISKEVALUATION

13

Overview and Approach to Risk Assessment

Energy Project

Development Timeline

Risk Analysis of Project

Development Stages

Rating and Ranking of Risks by Stages

Evaluation, Application

of Risk Mitigation

Mechanisms

This diagram depicts the study’s logic flow and approach to the analysis.

$

$

Design & Development

Engineering &Construction

Operations &Maintenance

CloseFinancing

Permitting

Repayment and profit

possibledowntime

Regulatory and policy risks

Technical and operating risks

Market risks

$

$

Design & Development

Engineering &Construction

Operations &Maintenance

CloseFinancing

Permitting

Repayment and profit

possibledowntime

$

$

Design & Development

Engineering &Construction

Operations &Maintenance

CloseFinancing

Permitting

Repayment and profit

possibledowntime

Regulatory and policy risksRegulatory and policy risks

Technical and operating risksTechnical and operating risks

Market risksMarket risksCashTimeline

14

Risk Ratings: Broad Set of IntervieweesExamples• GE, ConocoPhillips, Praxair, GTC• Bechtel, Fluor, Parsons, B&W • AEP, Cinergy, Duke, TVA• Excelsior, Baard, Tondu, TriGen• APPA coal group, NRECA• DOE, EPA, NETL• NARUC + OH, IL, IN, PA• NASEO + Coal boards, RDAs• Eastman, Peabody, Kennecott• CSFB, JP Morgan, SwissRe• S&P, Fitch, Moody’s• PJM, MISO• NRDC, CATF, WRI, EDF• UND-CEED, SIU, UK

Interviewee Categories1. Vendors & Tech firms2. Engineering contractors (EPCs)3. Utilities (regulated, merchants, hybrids)4. Independent power co’s (IPPs)5. Public Power & Co-ops6. Government agencies7. Public Utility Commissions8. State / Local Agencies (Comm; Devel)9. Fuel / Coal / Chemical companies10. Financial (Banks, Funds, Insurance)11. Rating agencies12. Transmission entities (TransCos)13. “Pragmatic” NGOs (vs. “ideologues”)14. Universities / Research centers

15

IGCC Risk Ratings 2005 – 1: Technical

0.0 5.0 10.0 15.0 20.0 25.0

High capital cost

High labor/operating cost

Excessive downtime

Poor tech performance

Lack of standardization

Lack of workforce to build

Lack of skilled operators

Lag in engineering progress

Damage from accidents

Thin EPC/vendor support

Waste disposal disruption

Rating of IGCC Risks (probability x severity)1) Technical Risks

Problem: standard IGCC system not resolved fully.

IGCC system not fully developed, and faces extra downtime early onto fine tune performance. Lack of EPC confidence shows up here.

40 ratings

Workforce issues are not rated as high risks.

Average

High capital cost and excessive downtime remain key risks, though lower than in 2004. Technical risk also ranks high.

16

IGCC Risk Ratings 2005 – 2: Regulatory

0.0 5.0 10.0 15.0 20.0 25.0

State air permitting on PC

Fed mercury regs favor PC

Fed SOx/NOx regs help PC

Little carbon capture value

IGCC reg tied to NGCC

No cost edge on CO2 sequest

No state policies for IGCC

Nat'l policy on IGCC lags

Rating of IGCC Risks (probability x severity)2) Regulatory Risks

Regulatory issues are not seen as "deal-killers", though doubts remain about national policy commitment and that carbon capture value will ever materialize.

40 ratings

Average

Concerns about state & national regulation of coal grew. Unclear advantages on emissions for IGCC pose an investment risk.

17

IGCC Risk Ratings 2005 – 3: Market

0.0 5.0 10.0 15.0 20.0 25.0

LT electric demand

Coal transport erosion

Old coal competition

Lower gas prices

Coal prices rise

Interest rates rise

PUC rate approval fails

Financing difficult

By-product revenue lags

IGCC customer fails

Rating of IGCC Risks (probability x severity)3) Market Risks

Vulnerability to interest rate rises is keyed to high capital costs; though some buyers have access to low rate debt. PUC approval (or long-term off-take) and financing are still viewed as problematic.

The competitive position of coal has improved with recent gas price spikes and volatility. "Old coal" poses some challenge, but not overwhelming because of its low efficiencies. Most believe that gas prices will stay higher now.

40 ratings

Average

IGCC units will be baseload, so PUC support would help with market risks. Financing difficulties are derivative from other risks.

18

Recap: Highest Risk Ratings (2004 v. 2005)High capital cost and excessive downtime remain high risks for all owner types. Critical regulatory issues (e.g., where IGCC carries advantages) are also a focus. Environmental (state, national) & utility commission policies are not well defined.

Risk Area for IGCC A B A x B 2004Highest Risks Probablty Severity Rating Rating

1 High Capital Cost 3.8 3.9 14.5 19.23 Excessive Downtime 3.5 3.7 13.1 15.28 Materials & Budget Overruns 3.3 3.5 11.2 10.410 EPC/Vendor Wrap 2.9 3.6 10.3 6.812 State Air Permitting on PC 3.8 3.5 13.3 10.915 Little Carbon Capture Value 3.4 3.2 10.8 10.818 No State Policies for IGCC 3.2 3.6 11.2 11.719 Nat'l Policy on IGCC Lags 3.2 3.7 12.0 13.726 PUC Rate Approval Fails 3.1 3.9 12.0 12.527 Financing Difficult 3.4 3.9 13.4 16.1

Overall Average 2.8 3.2 9.1 9.5

Q#

19

“Lift”: Analysis of Financial Incentives

• Covered incentives discussed during development of Energy Policy Act of 2005.

• Included the incentives approved in EPAct 2005.

20

Range of LCOE Benefits for IOUs ($/MWh)

• Tax incentives provide the most “lift” for IOUs—tracking well with EPRI findings.

• IOU results are less sensitive due to normalization process embodied in rate making.

• The “juice” in the 3Party Covenant is tied to its “leveraged return” assumption.

IOUBenefits: $ / MWh 55 / 45

Cost of equity 11.5%

Structural IncentivesLoan guarantee $0.58Direct loan $1.713Party Covenant (no leverage) $0.323Party Covenant (with leverage) $10.52

Tax IncentivesProduction tax credit (0.9 c / KWh) $4.04Investment tax credit (20% on gasifier) $3.14Tax credit bonds N / A

21

Range of LCOE Benefits for Merchant Power ($/MWh)

Benefits: $ / MWh 60 / 40 60 / 40High IRR ( 15% )

Low IRR ( 13% )

Structural IncentivesLoan guarantee $0.31 $4.40Direct loan $1.38 $5.423Party Covenant (no leverage) $3.58 $6.773Party Covenant (with leverage) $15.48 $16.95

Tax IncentivesProduction tax credit (0.9 c / KWh) $6.38 $9.57Investment tax credit (20% on gasifier) $1.18 $4.90Tax credit bonds N / A N / A

Merchant

MPPs and IPPs exhibit more LCOE sensitivity than IOUs.– Reflects “price taker” status and dynamic tax effects.

• Both types of incentives benefit MPPs

• MPPs are more cash-flow driven than IOUs

• Ratepayer / owner benefit tradeoff (IRR vs. LCOE)

22

Range of LCOE Benefits for IPPs ($/MWh)

Benefits: $ / MWh 70 / 30 70 / 30High IRR ( 17% )

Low IRR ( 15% )

Structural IncentivesLoan guarantee $7.96 $10.27Direct loan $9.41 $11.683Party Covenant (no leverage) Not done Not done3Party Covenant (with leverage) $15.77 $17.31

Tax IncentivesProduction tax credit (0.9 c / KWh) $5.08 $8.90Investment tax credit (20% on gasifier) $2.68 $5.67Tax credit bonds N / A N / A

IPP

MPPs and IPPs exhibit more LCOE sensitivity than IOUs.– Reflects “price taker” status and dynamic tax effects.

• Structural tools benefit leveraged IPPs due to lower interest rates, higher leverage—and better access to debt.

• Tax incentives provide less “lift”.

23

Scoring Analysis for Financial Incentives

24

Budgetary Costs ($ Millions)

Budget Cost ($Millions) (10 yrs) Life (10 yrs) Life (10 yrs) LifeBudget Score

Total Score

Budget Score

Total Score

Budget Score

Total Score

Structural IncentivesLoan guarantee $11 $11 $61 $61 $61 $61Direct loan $11 $11 $60 $60 $60 $603Party Covenant (no leverage) $2 $2 $3 $3 N / A N / A3Party Covenant (with leverage) $2 $2 $3 $3 $3 $3

Tax IncentivesProduction tax credit (0.9 c / KWh) $234 $344 $234 $344 $234 $344Investment tax credit (20% on gasifier) $114 $101 $114 $101 $114 $101Tax credit bonds N / A N / A N / A N / A N / A N / A

Merchant IPPIOU

• Tax incentives, which score dollar-for-dollar, are expensive.• IOUs’ better credit standing translates into lower budget scoring.• 3Party Covenant improves scoring by reducing default exposure.

25

Budget Scoring Factors (FCRA)

Reduces Scoring• Robust independent credit

rating (S&P, Moody’s, Fitch)• Short term of guarantee• More equity financing• Very strong off-takers or PUC

support / mandate• Confined terms for trigger• Additional collateral or

recovery • Superior rights in liquidation• Tighter payment terms• Higher interest rate or fees• Solid environmental permits

Increases Scoring• Weak credit rating, or below

investment grade• Longer term of guarantee• Less equity from owners• Weak off-take agreements

and/or tepid PUC support• Broader terms for trigger• No collateral beyond project

assets• Inferior liquidation position• Liberal payment terms• Lower interest rate or fees • Questionable permit status

26

Backup slides

27

Plant Cost and Configuration AssumptionsTechnical Parameters

Net Capacity 520 MWe (600 MWe gross) Net Heat Rate 8600 Btu/kWh Coal Type Pittsburg 8 Spare Gasifier Yes SOx Control Technology MDEA (Methyl Diethanol Amine) SCR Included No Construction Time 3 Years In Service Date 2009 Plant Life 30 Years

Capital Costs (in 2004 Dollars) Plant Costs $839 Million Financing and Development $122 Million Other $ 19 Million TOTAL $980 Million

Operating Parameters (in 2004 Dollars) Fixed Costs $30.2 Million / Year Insurance Costs $3.6 Million / Year Property Costs $10.9 Million / Year Variable Costs 0.9 mills / KWh CAIR and CAMR Compliance Costs 0.7 mills / KWh to 0.95 mills / KWh Fuel Costs $1.5 /MBtu Availability Ramp-Up in Years 1,2,3 60%, 70%, 80% Availability in Steady State (Year 4 onward)Average Availability Over Project Life

90% 88%

Environmental Performance Net Emissions SOx 0.0321 lb/MMBTU Net Emissions NOx 0.0621 lb/MMBTU Net Emissions Mercury 0.84 lb/Trjllion BTU Net Emissions Carbon Dioxide 203 lb/MMBTU

$839 = $1400600 per KWe

$980 = $1885520 per KWe

28

Financing Assumptions

Financing Assumptions: Investor Owned Utility

Merchant Power Producer

Independent Power Producer Public Power

Capital Structure: 45% Equity, 55% Debt 40% Equity, 60% Debt 30% Equity, 70% Debt 10% Equity, 90% Debt

Interest Rate: 6.5% 8% 8% 5%

Amortization: Level Principal Mortgage Style Mortgage Style Level Principal

Loan Term: 30 Years 20 Years 20 Years 30 Years

Reserves: No Reserves Specific to Project

No Reserves Specific to Project Debt Service Reserve No Reserves Specific

to ProjectAllowance for Funds Used During Construction:

Recovered in Rates N/A N/A N/A

After-Tax Equity Internal Rate of Return (Range):

N/A 13% - 15% 15% - 17% N/A

Return on Equity: 11.5% N/A N/A N/A

Weight Average Cost of Capital: 7.3% 8.1% 7.9% 5%

Marginal Income Tax Rate: 39.2% 39.2% 39.2% N/A

Tax Loss Benefits: Utilized Currently Utilized Currently Utilized Currently N/A

29

Range of Benefits in LCOE ($/MWh)

• IOU results track well with EPRI findings.• MPPs and IPPs exhibit more LCOE sensitivity than IOUs.

– Reflects “price taker” status and dynamic tax effects.• IOUs less sensitive due to normalization process embodied in rate making.• The “juice” in the 3 Party Covenant is tied to a “leverage return” assumption.

IOUBenefits: $ / MWh 55 / 45 60 / 40 60 / 40 70 / 30 70 / 30

Equity at 11.5%

Low IRR 13%

High IRR 15%

Low IRR 15%

High IRR 17%

Structural IncentiveLoan Guarantee $0.58 $0.31 $4.40 $7.96 $10.27Direct Loan $1.71 $1.38 $5.42 $9.41 $11.683-Party covenant (no leverage) $0.32 $3.58 $6.77 Not done Not done3-Party covenant (with leverage) $10.52 $15.48 $16.95 $15.77 $17.31

Tax IncentiveProduction Tax Credit (0.9 c / KWh) $4.04 $6.38 $9.57 $5.08 $8.90Investment Tax Credit (20% on Gasifie $3.14 $1.18 $4.90 $2.68 $5.67Tax Credit Bonds N / A N / A N / A N / A N / A

Merchant IPP

30

Incentive Benefit/Cost Ratio and Rank

• Despite modest benefits for IOUs, credit incentives tend to be cost efficient relative to tax incentives.

• Accelerated Depreciation stands out among tax-based incentives.• 3 P Covenant efficiency is tied to leverage and initial credit rating

assumption.

Ratio Rank Ratio Rank Ratio Rank Ratio Rank

Loan Guarantee 4.23 4 3.05 6 11.65 2 N/A N/ADirect Loan 12.50 2 4.49 4 13.88 1 N/A N/A3Party Covenant w Leverage 230.00 1 7.83 1 6.97 3 N/A N/A

3Party Covenant w/o Leverage 10.67 3 3.07 5 N/A N/A N/A N/A

Production Tax Credit (0.9¢/KWh) 1.18 10 2.05 9 2.05 8 N/A N/A

Production Tax Credit (1.80¢/KWh) 1.19 9 2.38 7 2.61 7 N/A N/A

Accelerated Depreciation 3.04 5 4.76 2 6.41 4 N/A N/AInvestment Tax Credit (20% on Gasification Portion) 2.34 7 2.28 8 3.12 6 N/A N/A

Tax Exempt Bonds 1.96 8 N/A N/A N/A N/A N/A N/ATax Credit Bonds N/A N/A N/A N/A N/A N/A 1.77 1ITC and AD 2.95 6 4.73 3 5.88 5 N/A N/A

Credit-Based Incentives

Tax-Based Incentives

Public Power

Incentive

Investor Owned Utility

Merchant Power Producer

Independent Power Producer

31

Risks & Responses: Observations for 2005 • Top concerns remain constant: high capital cost and excessive

downtime. Will performance wraps be adequate? No signed deals yet leaving some uncertainty about price, terms.

• If federal government accepts significant technology (downtime) risk, then adequate EPC wrap probably could be negotiated with lower total cost.

• Concern about lack of clarity of state regulatory policies on conventional coal is rising, which adds risk for competitiveness of IGCC plants. This risk jumped the most since last year.

• Risk of natural gas prices dropping was rated lower than 2004, but carries big impact. Even with Eastern coal prices rising, IGCC can compete.

• Owners remain skeptical that carbon capture advantages will materialize by 2010. IGCCs have edge on mercury; but, CAMR is in litigation.

• Concerns about coal transport constraints doubled, but are not high yet.

• Lack of clarity that PUCs will accept high capital costs to gain long-term emissions and rate stability remains of concern.

• Workforce issues (for construction and operation) rate low.