By Jason Makansi, Pearl Street Inc.
Making strategic operating decisions at the plant means translating technical performance into dynamic financial and risk management. The imperative is driven by this reality: Under private investment scenarios, the litmus test is less the “obligation to serve” and more the right to seek the highest return.
Readers of the January issue of Electric Light & Power surely gained respect for the challenges that plant managers like Danny Morton and Rick Deese face in balancing profitability with maintenance expenditures (see EL&P, January 2002, page 23). Our nation’s fleet of coal-fired power stations has been starved of investment for many years. And the environmental investments required by new regulations imposed over the last decade have often impaired the efficiency and flexibility of many of the industry’s flagship coal units.
Both Deese and Morton emphasized their people/plant cultures and the application of new technologies, like predictive maintenance, in managing O&M expenses. These are certainly two pillars of a competitive plant.
But there is a third. That is translating the plant’s technical performance into dynamic financial and risk management. Generating companies (Gencos) need to begin understanding their plant operating costs in ways that allow front-line management to make strategic operating, and ultimately business, decisions. This is a relatively new activity for the vast majority of the nation’s coal-fired fleet although plants in the UK were forced to work through these challenges earlier.
Gencos go home
In some cases, these Gencos need look no further than the unregulated subsidiaries of their parent companies. New gas-fired combined cycles that have come on-line generally operate as independent power producers or as merchant capacity serving the wholesale market. As such, there must be greater day-to-day alignment of the plant’s operations and the trading environment. Most everyone concedes that aligning a new combined cycle plant with the market is a lot easier than for an older coal-fired station.
In both cases, there is generally no standard for calculating the true dynamic costs, regardless of which markets the plant participates in. Such standards do not exist today across all markets, and, therefore, bidding into the market is not a uniform process.
It may be easier for the latest fleet of combined cycle plants to do this because they are highly modularized and relatively young in age. However, the coal plants are far more variable-the fuel is more heterogeneous, the equipment is aged, the modifications and retrofits over the years are non-uniform, and therefore the impact from thermal and mechanical damage mechanisms are diverse. If these costs are not appropriately accounted for, there are critical impacts on the system. For one thing, the primary goal of deregulation-economic optimization of the nation’s electric system-cannot occur because the marginal costs are not measured to a uniform standard.
Even the so-called design efficiency or heat rate curves may not be adequate. Some reports suggest that some deregulated plants have stopped or greatly reduced turbine efficiency testing. Today’s plant performance monitoring systems can provide some indication of efficiency but again, each one uses different techniques and assumptions. But these still haven’t been accepted for widespread use as an operating tool. Because many plants are trying to avoid planned outages, there is less time today to conduct these tests or instrument the units properly for them.
What can be done?
The solution in a broad sense involves revamping the business process-the performance measures, the plant culture, the way in which performance is perceived and rewarded, the means by which the plant staff approaches operations and maintenance, the tools with which the staff monitors the plant, organizes the O&M activity, and gets the work done, and so on. The Genco must look at performance and costs through a different prism, one based on understanding what the value of a particular mode of operation will be to the market. In financial parlance, this is called the value of an option.
The idea is to capitalize on the market, and not be a victim of it. Plants that are always “price-takers,” may make money. But the question isn’t whether the asset is making money; it’s whether it is maximizing its value and its profit-making potential.
Maximizing profit can’t be done in a vacuum, of course. Otherwise, the plant would likely be pushed past the catastrophic risk boundaries. Therefore, the concept here is to push the profitability and value envelope while incrementally understanding and quantifying the risks taken. Again, technical risk, something that once was managed through the regulated, cost-plus environment, now has to be viewed as financial risk.
The technical performance of the plant has to be converted into financial performance. Commercial availability is what’s important, not availability per se. Was all the plant or unit capacity available when the prices were the highest in the marketplace? Having a very low heat rate, and, therefore, an efficient unit, is most important when the plant operates base load. Having a flexible plant, despite potential sacrifice in efficiency while cycling, is more important to profitability than efficiency per se or capacity factor. Being able to burn a variety of fuels as they become available is perhaps the most important driver of profitability. After all, 60-80 percent of fossil-plant operating costs are fuel. Flexibility must be delivered in terms of financial measures, mostly having to do with providing options to the marketplace.
Plant condition is another measure of technical performance or technical risk that has to be translated into financial risk and performance. Under cost-plus regulation, plants had to avoid risk by overbuilding and underutilizing assets. Under profit = revenues-costs regimes, plants have to embrace risk but carefully manage it. Different operating modes result in differing rates of equipment deterioration. The point isn’t to stay away from deteriorating condition. The point is to understand what the plant gains from the operating mode in terms of revenue and profit, with respect to the plant life usage costs. This takes operating experience interpreted through financial management.
Makansi is president of Pearl Street Inc, a technology deployment services consulting firm. He can be reached at JMakansi@pearlstreetinc.com.
Innogy significantly contributed to this article. Innogy, the former National Power, has now packaged a program called “Optionality” that is available to U.S. clients through Innogy America LLC, Chicago, IL. They are a client of Pearl Street Inc. You can get more information at their Web site www.innogy.com.