Modelling Two Power Plants James Henderson March 2024 The Economics of Energy Corporations (2) Revision Change the WACC in the model •Corporate borrowing rate – 6.5% •Company Beta – 1.47 •Debt:Equity – 40:60 • •What is the new WACC? • Change the model Oil price 25% lower Capex 50% higher Production 25% higher What are the results? What is the breakeven oil price? Increasing interaction between prices of hydrocarbons Outline of the course Overall objective – understand how senior management use economic models to make investment decisions 1.Introduction to key themes in the global energy market 2.Introduction to financial modelling as a management tool 1.Understanding some key concepts 3.Starting a model for a shale oil and gas field – revenues and prices 4.Inputting the costs – capital expenditure, operating costs and taxes 5.Calculating a discounted cashflow 1.Why is it important 2.How is it used to make decisions 6.Power plants – a gas-fired CCGT and a wind farm 7.Testing the investment decisions: running some numbers under different assumptions 8.Answering your questions Increasing interaction between prices of hydrocarbons A Combined Cycle Gas Turbine •Power sector accounts for a huge share of gas demand in many regions • •Provides base load power on which other demand is built • •Combined-cycle gas turbines (CCGT) are relatively cheap and efficient, and also provide vital flexibility • •The economics are based on low capital and operating costs and the price of the key input – gas supply • •It is also very important to consider how much the plants run – the more they operate the better their commercial outcome • • Electricity consumption is set to rise •Electricity demand is likely to rise as part of a decarbonisation strategy •As a result, the focus of the energy economy will be on how power stations are fuelled, with the assumption that renewables will grow •Key question for fossil fuels – how fast will the decline be? US electricity consumption forecast •Covid-19 impact and recovery followed by steady growth The Electricity Sector Value Chain •Electricity sector is a mixture of regulated and unregulated segments •As renewable energy is introduced, and as demand patterns change, the complexity for energy companies in all parts of the chain increases Generation - Competition End-User Supply - Competition Transmission and Distribution – Regulated Renewables will increasingly dominate the power sector Outlook for costs based on auctions •The cost of renewable energy is falling fast, and is now inside the range of fossil fuel generation •Once subsidies are no longer required, a tipping point will be reached •Key question revolves around the cost of intermittency and the need to provide back-up capacity Breakdown of levelised costs for different power technologies •The cost breakdown of renewables is very different from most fossil-fuel and nuclear technologies •High capital costs necessitate government support via subsidies to ensure a rate of return for the developer •Low operating costs mean that short run marginal costs are very low, so that a low price can be bid for dispatch •Effectively, when the wind blows strongly or the sun shines brightly the price of excess renewable energy can be zero or even negative Capex Stylised merit order for power generation •Historically generating companies have competed on the basis of a merit order of generating costs •The market price is set at the marginal price, which is paid to all power producers who are called upon to dispatch electricity Renewables and the merit order effect •Renewable energy has guaranteed dispatch, and so moves all higher cost supply out •The wholesale price declines as demand is satisfied at a lower level Introduction of renewables alters supply curve Renewables create over-generation risk •Net load (total electricity demand less generation from wind and solar PV) varies dramatically according to weather •As renewable generation increases, so low point gets lower, increasing the risk of having too much base load capacity •In a worst case scenario curtailment is required, undermining project economics The California “Duck Chart” The impact of renewables on fuel inputs for power generation •Dramatic difference in fossil fuel use between seasons •What incentives are needed to keep a fossil fuel plant open? Hours of effective operation by Gas-Fired Plants in Spain •The Spanish market provides a good example of the impact of renewables of fossil fuel generation •Gas-fired plant utilisation has fallen to below 20% on average, and many station have been mothballed of shut down •Low coal prices have also encouraged a renewables-coal mix, which has also been seen in Germany Key Economic Concerns •Capital and operating costs – but these are largely known • •Electricity prices • •Input price of gas (for a CCGT) • •Carbon price • •Capacity utilisation/load factor/availability (for renewables) • • • • • Capital cost comparison •Gas looks very cheap compared to alternatives on a capital cost basis • • Source: EIA Breakdown of costs for CCGT •Different contractors for each element, can costs will vary by region and level of competition Operating cost comparison •Note difference between fixed and variable costs – renewables have no variable opex • • European electricity price •European electricity prices were relatively stable until end of 2021 •Impact of Ukraine war on gas prices fed straight through to power market •How do we model electricity prices going forward? 66.2 42.4 US electricity price already quite volatile •Electricity prices in USA vary by region and source of power •West Coast impacted by brown outs in 2022 – lack of renewable supply led to switch to high priced gas •Elsewhere weather plays a key role in setting prices European gas price •History of European gas prices has been driven by availability of Russian gas and LNG •That all changed in 2022 – now competing with the rest of the world for LNG •Is historic range now irrelevant, or will we return to past range of prices? 9.83 7.38 US gas price has driven industrial and power sector growth •Discovery of shale gas has been a key factor in US industrial re-generation •Also sparked a move away from coal on the power sector •Can the shale “miracle” continue? •Will the demand for LNG exports impact US domestic prices? Carbon output by fuel •Coal emits roughly twice as much carbon as natural gas Carbon prices vary widely across global markets Global carbon price comparison EU ETS price history California carbon price history Key Questions •What is electricity demand likely to be? • •How much of it will be satisfied by renewable energy? • •What will this do to the electricity price? • •What will this do to utilisation of hydrocarbon-fuelled power stations? Let’s build a model •Capacity – 750MW, efficiency 54% – •Capital Cost – US$978/kW (construction time 3 years) – •Fixed Cost – US$11/kW – •Variable Costs – US$3.5/MWh – •Assumed utilisation – 85% for 20 years production life – •Gas price – US$4/mcf; carbon price $30 per tonne – •Electricity price - $66/MWh – •Project life – 20 years – straight line depreciation – •Tax rate – 20% • • • • WACC assumptions •Risk-free rate – 4.6% • •Equity market return – 10.57% • •Company Beta - 0.49 • •Company interest rate – 5.19% • •Tax rate – 20% • •Debt:Equity split – 77:23 • • A Wind Farm – near where I live! Key Questions for Wind Farm Economics •Wind availability and speed •If offshore, water depth and sea-bed conditions •Cost of equipment – supply chain issues •Power price •Cost of finance •Environmental impact Global wind availability (metres/sec) •Offshore in major oceans ideal – if possible •Sea-bed conditions as important as wind speed though Impact of sea-bed, tides, water content Impact on environment also critical Sea birds, but also fish and other micro-organisms on sea-bed Presence of wind farms will alter bio-diversity in the area Investment in global wind capacity •Wind power is becoming a major source of renewable electricity •Offshore wind has huge potential, although fixed platform is limited by geography – floating will be the ultimate answer Offshore Wind Investment Hit All-Time High in 2023 | BloombergNEF Increasing interaction between prices of hydrocarbons Offshore Wind Capex in €/MWh Increasing interaction between prices of hydrocarbons The North Sea has been the big growth area in Europe •Auctions in the UK and Germany have generated huge interest in the past 3-5 years •$13 billion bid for licences offshore Germany in 2023 by BP and Total THE VIEW | Will Northern Europe's offshore wind build gear-up in time to meet high energy transition ambitions? - Aegir Offshore Wind Energy Market Size, Growth, Report 2023-2032 Increasing interaction between prices of hydrocarbons Let’s look at a wind farm •Capacity – 4000MW, efficiency 100% – •Capital Cost – US$3617/kW (construction time 4 years) – •Fixed Cost – US$92.7/kW – •Variable Costs – US$??/MWh – •Assumed load factor (availability) – 40% for 30 years life – •Gas & Carbon price – ?? – •Electricity price - €??/MWh – •Project life – 30 years – straight line depreciation – •Tax rate – 20% • • • • WACC assumptions •Risk-free rate – 4.61% • •Equity market return – 10.57% • •Company Beta – 0.73 • •Company interest rate – 5.19% • •Tax rate – 20% • •Debt:Equity split – 77:23 • • Let’s make some forecasts! •Base case • •Upside case • •Downside case • •Disaster (worst) case • •Does the investment need to work in all of these scenarios?