Economic Evaluation of Projects in the Electricity Supply Industry (3rd Edition)
In the highly capital-intensive electricity supply industry, it is essential that both engineers and managers understand the methodologies of project evaluation in order to comprehend and analyse investment proposals and decisions. This updated and expanded edition of Economic Evaluation of Projects in the Electricity Supply Industry takes a broad introductory approach, covering planning and investment, financial analysis and evaluation, risk management, electricity trading, and strategies, technologies, national requirements and global agreements for electricity generation in a carbon-constrained world. Developments covered by this new edition include the changing mix of fuels in the power generation sector, greater involvement of the private sector in power generation investments through independent power producers, the important role of regulations, the growing interest in clean electricity generation, the economics of investing in renewables, the introduction of smart grids and intelligent meters and networks, and cyber security. Economic Evaluation of Projects in the Electricity Supply Industry, 3rd Edition is essential reading for academic and industrial engineers and economists concerned with energy supply, students of energy economics and planning, industry planners and project managers, and government and regulatory officials.
Inspec keywords: environmental factors; power system reliability; project management; investment; power markets
Other keywords: electrical power projects; investment projects analysis; global electrical power planning; risk management; cost estimation; electricity generation in a carbon-constrained world; projects financial evaluation; discounting; environmental considerations; electricity sector; power supply reliability; electricity markets; projects economic evaluation; electrical power investments; electricity trading
Subjects: Environmental factors; Reliability; Power system management, operation and economics
- Book DOI: 10.1049/PBPO070E
- Chapter DOI: 10.1049/PBPO070E
- ISBN: 9781849197472
- e-ISBN: 9781849197489
- Page count: 304
- Format: PDF
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Front Matter
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1 Global electrical power planning, investments and projects
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Electricity is versatile, clean to use, easy to distribute and supreme to control. Just as important, it is now established that electricity has better productivity in many applications than other energy forms. All this led to the wider utilisation of electricity and its replacement with other forms of energy in many uses. Demand for electricity, although slowed down in Organisation for Economic Co-operation and Development (OECD) economies, is still growing globally at a rate near that of economic growth and, in many countries, at almost 1.5 times that of the demand for primary energy sources. This chapter presents the global electrical power planning, investment and projects.
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2 Considerations in project evaluation
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Project analysis is a method of presenting the choice between competing uses of resources, and is done through analysis of information and data. Project evaluation studies are meant to assist in the selection and design of new viable projects. A study will evaluate the extent to which the project produces the intended results, the proper technology, the least-cost alternative process as well as the cost-effectiveness of the project. It will also consider the engineering as well as the financial risk and evaluate the economic (social) cost.
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3 Time value of money (discounting)
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Projects in the electricity supply industry live for a long time. As already mentioned, 25-30 years is a normal useful life for a conventional power station. Operational cost (mostly fuel, maintenance and salaries) can vary significantly over time and from one region to another. Therefore, in this chapter we shall be only concerned with financial discount rates relevant to financial flows. Welfare economics have a different social discount rate, which is introduced in Chapters 4 and 8. Operational cost (mostly fuel, maintenance and salaries) can vary significantly over time and from one region to another. Therefore, it is not possible to assess long-term costs and performance with great certainty or to accurately compare different generation facilities. What is important is to understand the underlying procedures for analysis and apply them in an intelligent way.
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4 Choice of the discount rate
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It needs to be explained that there are two discount rates. The first is discount rate for investment (or goods). This is a concept that measures the relative price of goods at different points of time. This is also called the real return on capital, the real return and the opportunity cost of capital. This is what we shall be dealing with in this chapter. The second is the discount rate that involves long-term environmental considerations. This measures the relative weight of the economic welfare of different generations over time. This is usually called the 'pure rate of social time preference'. This will be utilised in Chapter 8 for evaluating environmental and global warming considerations.
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5 Financial evaluation of projects
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6 Considerations in project evaluation
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7 Economic evaluation of projects
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A lot of work has already been done during the past three decades to establish the techniques for the economic and social evaluation of projects. Most of this work was done in the past by the international lending agencies like the World Bank, Organisation for Economic Co-operation and Development (OECD), Overseas Development Administration (ODA) and various UN agencies. Handling detailed mechanics of economic and social evaluation requires a skilled economist. These are briefly explained below. An important issue, which project planners need to be aware of, is the existence of distortions and the general techniques of dealing with them. Four issues are important: transfer payments, border and shadow pricing, externalities and system linkages. Two other related issues are also important: integrated resource planning (this has been dealt with briefly in Chapter 1) and environmental and health issues. The environmental impact of the ESI (electricity supply industry) is significant. This is an externality that needs thorough evaluation and understanding and is dealt with separately in later chapters.
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8 Environmental considerations, cost estimation and long term discounting in project evaluation
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Because of the nature of fuels utilised in the electricity supply industry (ESI) and the rapidly growing utilisation of energy in the form of electricity, the environmental impacts of electricity production are gaining more importance than those of other forms of energy, and this demands a thorough understanding of their nature.This chapter tries to record the environmental detrimental effects of electricity, methods of quantifying them (where possible), and analyses technologies, investments and other means of control.
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9 Electricity generation in a carbon-constrained world: Part I - The strategies, national requirements and global agreements
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Simultaneously, the world is gradually increasingly electrifying. In the not so far future, carbon emissions from the electricity sector are likely to surpass that of the other sectors combined. By the mid-century half of global anthropogenic emissions are likely to be shared by power generation. Correspondingly any attempt to curb global emissions will need to have power generation at its centre of interest, without that it will be missing the right target. Therefore, decarbonising the power sector is becoming a focus of interest. Such strategy is demonstrated in the UK Electricity White Paper 2011, and US Climate Action Plan 2013, as well as all climate conventions. It also aims at encouraging generation of non-fossil fuels and phasing out harmful subsidies.
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10 Electricity generation in a carbon-constrained world: Part II - The technologies
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The technology of the electricity supply industry which suffered from low efficiency and stagnation in the last century is now in the process of evolution through the introduction of more efficient generation and smart grids. Smart grids rely on two-way AMI that will give consumers more control over their energy use and create new opportunities for energy retail services, infrastructure management and renewable energy generation. Beside improved technologies for energy storage, the smart grid will provide an alternative through demand management of consumer's appliances and possible PHEV energy exchange with the grid. At the core of the smart grid lies the development of the intelligent micro-grid. Such micro-grid will enhance distributed generation and will be incorporated to a smart grid through dedicated highways for command data and power exchange. The ultimate results will hopefully be more efficient supply that better serve consumer needs and lowers costs and help mitigate undue harmful emissions.
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11 Economics of reliability of the power supply
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Reliability of the power system is generally defined as the overall ability of the system to perform its function. It can also be defined as the ability of the power system to meet its load requirements at any time. Two distinct aspects of system reliability are identifiable: system security and system adequacy. System security involves the ability of the system to respond to disturbances arising internally, whereas system adequacy relates to the existence of sufficient facilities within the system to satisfy the customer-load demand. The function of the power system is to provide electrical energy as economically as possible and with an acceptable degree of reliability and quality. Economics of reliability tries to strike a reasonable balance between cost and quality of service. Such balance varies from one country to another, just as from one category of consumers to another. Most developing countries cannot afford the high costs of ensuring the high reliability of supply, taken for granted in industrialised countries. Gradually, however, quality of supply is improving worldwide.
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12 Economics of new renewables: is there viable energy at the end of the renewables tunnel?
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This chapter is presented in two parts. The first part details the debate about new renewables, particularly wind and solar, and the value of these technologies to the power system. The second part presents in simple terms examples and financial and economic methodologies for evaluating them.
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13 Electricity trading
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Trade in electricity can be local, inside the country, or regional- cross border. Cross-border trade faces many restrictions and challenges - geographical and interconnectivity of grids. In addition to this, regulatory and administrative issues can hinder such trade. With the liberalisation of electricity markets in many Organisation for Economic Co-operation and Development (OECD) countries, regulations and rules were created, which are country specific and none conducive to cross-border trade.
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14 Evolvement of the electricity sector - utility for the future
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During the last decade of the 20th century the electricity supply industry (ESI) underwent major evolvement and restructuring. Until very recently most network industries (mainly the ESI, and also gas, water and telecommunications) were considered to be natural monopolies. Their size, networks, capital-intensive nature and their sensitive services to the public meant, in most cases, exclusive government ownership and control. Recently, however, technological progress, particularly in information technologies and telecommunications as well as development of regulatory instruments, has enabled the introduction of a market mechanism into these traditional monopolies. One main consideration is that governments no more have the resources and intention in financing the capital-intensive projects like power stations. Governments are now more interested in financing social services rather than electricity services, which the private sector can more profitably handle. Developments vary from one country, or region, to another but a general pattern of five phases has developed.
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15 Investment projects analysis: evaluation of risk and uncertainty
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Risk taking is normal to entrepreneurs, to lending and funding agencies and also to government while making development plans. Such risks and their extent can be reflected in choosing the discount rate of the project, where investors expect higher returns to compensate them for risk taking. Because of the regulatory nature of the industry, the limited number of players and the unique nature of electricity and its continuous rise in demand, the average project in the electricity supply industry (ESI) is less risky than the average investment in the stock exchange. However, each project has its own risk; projects that involve new technologies (renewable and clean-coal technologies), or projects with lengthy lead times (nuclear and hydro-power), involve a lot of investment and have more than the average level of risk. Some of the risks are related to engineering and technology; however, market risks equally exist. Recently, two other risk factors are affecting the ESI. The first relates to carbon pricing and legislation - discussed in more details in earlier chapters. Long-term investments in carbon-intensive generation like coal firing plants are highly vulnerable to variations in possible carbon pricing and trading as well as future legislation. Another risk factor is that provided by the wider investments in renewables, particularly wind and solar energy. These as already explained provide distribution to the operation of the generating system and its economics, thus providing another risk to the system investors. Both these two risk elements as well as many others are discussed in detail below.
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16 Risk management - in electricity markets
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Risk is the hazard to which we are exposed because of uncertainty. Risk is also associated with decisions. Where there are no uncertainties and no alternatives, there is no risk. Decisions that we make can affect these uncertainties and can reduce hazards. Under regulated markets there were fewer uncertainties and risks because tariffs were almost fixed. With deregulation, electric power markets are volatile, prices change within a short time, and risks can be serious. In the deregulated market of electric power, electricity is a commodity and consumers have choices, correspondingly generators are competing among each other. This has created opportunities mainly for consumers and risks for producers, which need to be hedged. Trading refers to transactions that take place directly between two parties or through an organised exchange. Although commodities trading in agricultural products have been established since the middle of the 19th century, it was only in 1996 that electricity future started to be traded in the New Year Mercantile Exchange in the US. It is believed that the California electricity crises of 2000-2001 and its serious financial and economic consequences were due to inadequate proper hedging through long-term supply contracts. The last two or three decades of electricity market reforms have shifted most of the financial risks from consumers to producers. Such restructured electricity market can pose large financial risks to producers. Therefore, to limit these risks regulatory mechanisms were introduced, such as price caps and various capacity market mechanisms, through balancing risks between consumers and producers, limiting price volatility and ensuring investments recovery to producers.
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Appendix A: Levelised cost of electricity generation
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Appendices on electricity generation levelised cost; levelised cost calculation; levelised cost estimation; and load factor assumption.
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Appendix B: Social discount rate for climate change evaluation
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Appendix C: Calculating the economic benefit of renewables
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Appendices on wind energy-benefits, and solar energy benefits and cost.
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Appendix D: Glossary
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The following is a glossary of financial, economic and technical terms used in this book as well as few other terms that are of interest.
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Back Matter
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