NORMAN, Okla., July 11, 2003 — In a newly published report, R.J. Rudden Associates, Inc. emphasized the importance of accurate and rigorous approaches for generation asset and portfolio valuation.
“With most of the largest independent generation companies facing the need to restructure the debt that underlies their projects (or sell certain assets outright), less than rigorous valuation approaches could lead to a repeat of history on the debt side or a surrender of too much value on the equity side,” the report stated. “Failure to apply more sophisticated analytical methodologies to the valuation of generation portfolios and assets will likely lead to inappropriate valuations and less than optimal decisions.”
The cornerstone of Rudden’s new valuation methodology is the GenTraderâ„- simulation model from Power Costs, Inc. (PCI). With GenTraderâ„-, Rudden is able to capture and model the operation of a portfolio or single asset, the uncertainty in prices, the quantity of full-service contracts and real world operating conditions.
The process uses hourly market price curves for energy, ancillary services, and fuel as inputs. It commits and dispatches generation units, and exercises long and short positions in forward and option contracts. The optimization is accomplished under fuel, emission and transmission constraints.
“At Rudden, we believe that determining the true value of an asset, or portfolio of assets, requires a simulation-based analysis capable of capturing both the intrinsic and extrinsic (optional) values while taking into account all operational constraints,” stated Stephen A. Stolze, Managing Director at Rudden. “Generation plants and power grids have operational constraints that restrict the plant’s ability to respond to market changes; therefore, traditional Black-Scholes models, which assume an instant on/off capability in an unconstrained grid, are inappropriate tools,” he said.
“When traditional Black-Scholes models are used and depending on the constraints, mix and location of individual plants, the value of portfolios or individual assets can be overstated by as much as 10 to 30 percent,” stated Dr. Douglas M. Logan, Vice President at PCI. “In addition, the Rudden methodology also uses PCI’s Monte Carlo-based tool to simulate a wide range of possible price trajectories and other variables. This will yield a distribution of profits, rather than a point estimate, that can be used to assess earnings at risk and calculate an appropriate asset or portfolio value under real world conditions,” he said.
Traditional valuation methodologies are not as comprehensive and exhibit a number of shortcomings that can lead to over-valuations, such as:
— High-level financial pro formas do not capture the effects that dynamic, physical asset limitations have on generation asset value (e.g., costs to achieve optionality); and, hence, they do not represent real asset value.
— The level of precision and functionality afforded by spreadsheet environments limits flexibility in the analysis of the physical characteristics of generation assets.
— Some financial models do not capture real-world optimization of plant operations in response to multiple market opportunities and constraints.
— Traditional Black-Scholes models must unrealistically assume an instant on/off capability for an asset in an unconstrained grid.
The Rudden Valuation Methodology requires in-depth industry knowledge covering a broad array of factors, the most important of which include:
— Understanding sector and plant economics and their interrelation with sector and market regulations.
— Assessing the alternatives at the project level and how they might positively or negatively impact the revenues that feed into the company.
— Reviewing the engineering performance criteria (e.g., heat rates and forced outage rates) and output flexibility for a variety of electric generation assets.
— Determining the plant’s optionality (the ability to respond to market dynamics).
— Analyzing electric power, reserve and ancillary services markets, contracts, and uncertainties.
— Evaluating fuel supply contracts and associated alternatives.
— Developing correlations between power costs and fuel prices.
— Identifying the location and extent of physical (e.g., transmission) constraints.
— Integrating environmental restrictions.
Stolze and Dr. Logan have authored the report along with Kevin M. Harper and Buck Feng from their respective firms. Titled Valuing Distressed Generation Assets, the report features GenTraderâ„- in specific case examples. The report is available on the PCI web site at www.PowerCosts.com .
About R.J. Rudden Associates, Inc.
R.J. Rudden Associates, Inc. is a strategic, economic and management consulting firm specializing in energy matters. Additional information is available on Rudden’s web site a www.rjrudden.com .
About Power Costs, Inc.
Power Costs, Inc. is a privately held company headquartered in Norman, Oklahoma, with clients throughout the United States. PCI has grown steadily since its incorporation in 1992. Its mission is to provide software and consulting services to help asset owners, traders and investors optimize asset value. PCI’s flagship product, GenTraderâ„-, is complemented with the enterprise scalability of PCI Enterprise Platform and PCI Bid Manager. For additional information regarding PCI, visit the company’s web site at www.PowerCosts.com or call 405.447.6933.