ECONOMICS OF ELECTRICITY GENERATION dr. Péter Kaderják Director, REKK NARUC Training on Tariff Development and Utility Regulation May 7-11, 2007, Baku, Azerbaijan
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 2
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 $/MWh 3
COSTS OF GENERATION Total cost (TC) = Fixed cost (FC) + Variable cost (VC) FC: related mostly to investment and economic profits to be earned; in the short run O&M, wages, depreciation social fund and other obligations are also fixed; independent of the level of production VC: fuel cost; depends on the level of production Marginal cost (MC): the change of TC when output is increased by 1 unit MC = constant, when VC is linear (we assume) 4
EXAMPLE: MARGINAL COST BY TECHNOLOGY AND MERIT ORDER Technology Installed capacity (MW) Marginal production cost ($/MWh) Life-time years Nuclear 1000 4 40 Coal 800 20 40 OCGT 400 60 40 CCGT 700 26 30 5
MARGINAL COST ESTIMATION Costing fuel conversion into electricity: short run marginal cost of generation Cost of fuel ($/m 3 ) Heat content of the fuel (GJ/ m 3 ) 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 6
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) 7
EXAMPLE: GAS PRICING FORMULA IN A TYPICAL EARLY TOP s i =96,8*(0,5*A/A o +0,5*B/B o ) A: average of last 9 months diesel price B: average of last 9 months heavy fuel oil price A o: diesel price on January 1, 1996 (147,95 $/t) B o: heavy fuel oil price on January 1, 1996 (135 $/t) 96,8 $/1000 m 3 : agreed starting price by January 1, 1996 Estimated gas import price / oil price link: S i =4,9+4,4*brent 8
CONVERSION TABLES Costing fuel conversion into electricity: 9
HEAT RATE ESTIMATES Gas/Oil ST Coal ST N uclear STCCGT GasG as/oil GT 1960 37,0% 35,0% 25,0% 1970 39,0% 37,0% 27,0% 1980 41,0% 39,0% 29,0% 30,0% 1990 43,0% 41,0% 31,0% 50,0% 34,0% 2000 45,0% 43,0% 33,0% 55,0% 36,0% 2010 46,0% 36,0% 58,0% 38,0% 2020 49,0% 39,0% 60,0% 40,0% 2030 52,0% 42,0% 62,0% 41,0% 2040 55,0% 45,0% 64,0% 42,0% Gross fuel efficiency parameters assumed in the KEMA study for power plants com missioned in the indicated years. For years in between, fuel efficiency can be linearly extrapolated. ST: C C G T : steam turbine com bined-cycle gas turbine 10
ESTIMATION: INDIVIDUAL GENERATION UNIT 1. Generating plant 2. Number and type of units 3. Unit capacity Total plant capacity Available capacity 4. Year of commissioning Gross efficiency (e) 5. Fuel type 6. Fuel cost (cent/gj) (C) 7. Marginal cost: C*0,036/e 8. Correction for self consumption 11
LOAD DURATION (SUPPLY) CURVE: EXAMPLE $/MWh 60 26 20 1000 1800 2500 2900 MW 12
SHORT RUN MERIT ORDER AND MARKET PRICES Prices are set by the marginal plant Price formation on competitive short-term electricity markets Marginal Cost Demand Supply Market price GT CCGT coal hydro nuclear lignite Capacity Source: EU Energy Sector Inquiry Report 13
PRICE FORMATION BY CHANGES IN DEMAND AND SUPPLY Price Preis Preis Price P 2 P 2 S 2 S 1 D 1 D 2 P 1 P 1 S D Q 1 Q 2 Menge Volume Q Menge Volume 14
APPLICATION BASED ON PUBLIC DATA estimated merit order for SEE markets 60.00 50.00 UNMIK MK HR RS 40.00 ME BG RO /MWh 30.00 AL BA 20.00 10.00-0 2,000 4,000 6,000 8,000 10,000 12,000 14,000 16,000 18,000 MW 15
APPLICATION BASED ON PUBLIC DATA estimated aggregate merit order for SEE 60.00 50.00 40.00 /MWh 30.00 20.00 10.00-0 5,000 10,000 15,000 20,000 25,000 30,000 35,000 40,000 MW 16
APPLICATION BASED ON PUBLIC DATA peak demand, January 2006; source: UCTE 9,000 8,000 7,000 6,000 MW 5,000 4,000 3,000 2,000 1,000 0 AL BA BG HR ME MK RO RS UNMIK 17
APPLICATION BASED ON PUBLIC DATA estimated equilibrium in peak and off-peak periods 60.00 50.00 40.00 /MWh 30.00 Off-peak demand Supply 20.00 Peak demand 10.00-0 5,000 10,000 15,000 20,000 25,000 30,000 35,000 40,000 MW 18
EFFICIENT INVESTMENTS: ACCOUNTING FOR FIXED COSTS Coal vs. gas based generation unit: which is the better investment option? Additional information is needed: Price of capacity ($/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 19
LONG RUN: ACCOUNTING FOR FIXED COSTS Converting overnight cost into fixed cost: FC r OC = rt 1 e 1 1/(1 + r OC r) T Technology VC (/MWh) VC (/kwy) OC (/kw) FC (/kwy) FC (/MWh) Gas turbine $35 $306.6 $350 $40.48 $4,62 Coal plant $10 $87.6 $1050 $106,96 $12,21 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 20
SCREENING CURVES (OR TOTAL COST CURVES) ARR $/MWh $/kwy gas turbine coal $12.21 $106.96 $40.48 0.3 Capacity factor Annual Revenue Requirement: ARR = FC + cf x VC 1 21
LOAD DURATION CURVE MW 8500 gas turbine 6000 coal 0.3 Capacity factor 1 Efficient generation park (only coal and gas): 6000 MW coal, 2500 MW gas 22
GENERATION PRICE REGULATION Objective: Total Revenue (TR) = ARR Price*electricity sold = FC + VC Price = (FC + VC) / electricity sold 23
COSTS: FIXED OR VARIABLE? 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? 24
COSTS: FIXED OR VARIABLE? Depreciation Operating & Maintanence Wages Social obligations (if any) Taxes Fines Fuel cost Is pass-through efficient? + Production projection Uncertainties? 25
GENERATION PRICE REGULATION Follow the example of Azeri wholesale revenue requirement worksheets 26
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 27