2005 Integrated Electricity Plan. Provincial IEP Committee Meeting #2 Economic Analysis February 22/23, 2005

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1 2005 Integrated Electricity Plan Provincial IEP Committee Meeting #2 Economic Analysis February 22/23, 2005

2 Presentation Overview Economic Analysis Economic vs Financial Analysis Unit Costs vs Portfolio Analysis Unit Costs Examples Portfolio Analysis Key questions in this section: Is the Committee sufficiently briefed on the financial analysis to be comfortable in reviewing the results? Does the Committee have the right data to make the trade-offs between portfolios? February 22/23, 2005 Page 2

3 Economic Analysis Objective to recommend a preferred portfolio Least cost with appropriate environmental and social consideration For each Portfolio: Determine costs and impacts of potential resource Based upon Supply / Demand balance, add sufficient resources Determine dispatch - which resources operate & how long? Determine total costs and impacts for portfolio Costs include Capital/ Fixed Operating/ Variable Operating/ Fuel/ Net Trade Revenue/ Transmission Impacts include GHG, air quality, land impact, water impacts Then compare Portfolios Including sensitivity analysis to assess uncertainties February 22/23, 2005 Page 3

4 Economic Analysis - High Level In least technical language: Determine types of resources available Including Demand Side Management Develop resource cost profile for each type Determine how big a basket of resources we need Fill basket with resources for each portfolio Determine total cost for each basket of resources Ultimately BC Hydro will run competitive acquisition processes in which various projects will be offered to BC Hydro based on proponents project/ structure/ financing. For the IEP, we need to understand the various resource costs and impacts to the extent required to structure obtain regulatory approval for resource calls. February 22/23, 2005 Page 4

5 Economic Analysis Objectives for 2005 IEP Ensure Consistent Representation of Projects IPP #1 vs IPP#2 IPP Technology #1 vs. IPP Technology #2 Ensure Level Playing Field: IPP Projects vs. BC Hydro Projects BCH projects include large hydro, resource smart, power smart Issues include discount rates, taxation, project life Compare resources based on their cost Consider merit of resources irrespective of who is assumed to develop them in the future Simplify the Economic Analysis From detailed corporate financial analysis to project comparison analysis February 22/23, 2005 Page 5

6 Simplification of Economic Analysis Within IEP Context - to determine the Net Present Value (NPV) costs of a portfolio and be able to compare portfolios Net Present Value - captures time value of money At the right level of detail to be able to understand impacts (not too detailed) but at a level that ensures we have done due diligence (i.e. enough detail to capture major impacts) What are the uncertainty bands around our data? Consider project pricing accuracy BCUC - planning estimates of +/- 35% Gas Price Forecast variability $US 3-5/MMBTU Electricity Price Forecast $US 30-52/ MWh February 22/23, 2005 Page 6

7 Typical Company/ IPP Cashflow Revenues Fixed costs Variable costs Taxes Capital expenditures Cost of Capital Changes in Working Capital Changes in Deferred Income Taxes February 22/23, 2005 Page 7

8 Different IPP Factors Capital structure Tax rate Tax shelter opportunities Risk factors Accuracy in estimates Credit worthiness In order to provide level playing field to all participants and to evaluate projects based on opportunity cost, not who develops them, all projects should be analyzed using the simplified method with consistent assumptions. February 22/23, 2005 Page 8

9 Economic Versus Financial IEP assesses resource preferences based on Economic Analysis of individual resource options and portfolios: Net Present Value Analysis (time value of money) Focuses on relative costs/benefits of alternative resource options/portfolios Can be done from BCH cost perspective (ratepayers) or from provincial perspective (i.e. shareholder s) Provincial cost perspective is net of provincial transfer payments Analysis done in real dollars (net of inflation) IEP assesses Rate Impact of portfolios using Financial Analysis: Estimates BC Hydro s year by year revenue requirements: what BC Hydro pays annually for IPP purchases and DSM reflects how BC Hydro recovers costs of BC Hydro/BCTC projects Preferably done in nominal dollars (with inflation included) February 22/23, 2005 Page 9

10 Economic Analysis Economic Cost Benefit: Assess Total Resource Cost which is the PV total costs vs PV benefits over economic life of project (with and without provincial transfers) Consistent assessment of BC Hydro/IPP/BCTC projects and DSM (includes customer costs) Ignores distribution of costs and benefits Intent: to select preferred portfolio irrespective of who develops the resources February 22/23, 2005 Page 10

11 Financial Analysis Rate Impact Analysis Determine BC Hydro s Annual Total Revenue Requirement Rate Surrogate: Annual Revenue Requirement Annual Energy Sales IPP Purchases: based on estimated purchase price (e.g. UEC based on contract life) BC Hydro Projects: annual financial cashflows as they would be recovered in revenue requirements Power Smart: Utility Cost only Intent: to reflect actual cost to acquire February 22/23, 2005 Page 11

12 Economic &Financial Analysis Direction to BC Hydro BC Hydro has been given direction at various points Most recently in the VIGP Decision and the 2004 RRA Decision the Commission directed BC Hydro to undertake both analyses Economic Analysis to decide amongst projects or portfolios Financial Analysis to assess rate impact of a selected project Consistent evaluation of BC Hydro and IPP projects (level playing field) In conclusion, the analysis for 2005 IEP is recommended to be: Economic Analysis to compare between Portfolios; Financial Analysis to undertake Rate Impact; Simplified Approach to analysis as being adequate within accuracy of the data. February 22/23, 2005 Page 12

13 Economic vs Financial Project Life Factor Eg: Small hydro project Service life - 40 years Expected contract life - 20 years To calculate UEC/ UCC amortize capital cost Over 40 or 20 years? After 20 years - remaining value accrues to owner For economic analysis - use 40 years independent of developer For financial cost - 20 years Based on what the developer needs to obtain financing February 22/23, 2005 Page 13

14 Economic vs Financial WACC Weighted Average Cost of Capital Corporate Tax rate BC Hydro = 0.0% Inflation assumption = 2.0% BC Hydro Capital Structure Nominal Pre-tax cost Debt 80% 5.0% 4.0% Equity 20% 13.5% 2.7% Pre-tax WACC 6.7% BC Hydro Capital Structure Real Pre-tax cost Debt 80% 2.9% 2.3% Equity 20% 11.3% 2.3% Pre-tax WACC 4.6% February 22/23, 2005 Page 14

15 Economic vs Financial IPP WACC Corporate Tax rate IPP= 35.0% Inflation assumption = 2.0% IPP Capital Structure Real Pre-tax cost Debt 60% 4.9% 3.0% Equity 40% 11.3% 4.5% Pre-tax WACC 7.5% IPP Capital Structure Real Post-tax cost Debt 60% 3.2% 1.9% Equity 40% 7.3% 2.9% Pre-tax WACC 4.8% February 22/23, 2005 Page 15

16 Economic vs Financial Pre-tax WACC Analysis Puts all participants on level ground income taxes impacts on tax deductible expenses and net income before income taxes are eliminated Discounting pre-tax cash flow with pre-tax WACC will yield similar results as discounting post-tax cash flow with post-tax WACC The different tax shelter opportunities of different participants can be ignored because evaluation is based on the pre-tax basis Recommendation: Use pre-tax WACC for analysis purpose Have not settled on what rates to use February 22/23, 2005 Page 16

17 Economic vs Financial Discount Rates BC Hydro Discount Rate: pretax WACC 5-7% long term IPP Discount Rates: pretax WACC may be higher than BCH s but not a given (ultimately they ll bid their projects) Common Discount Rate: Social discount rate or opportunity cost of capital is appropriate for use in economic benefit-cost analysis Rate is still under debate For long life assets, portfolio results can be sensitive to choice of discount rates: Sensitivity analysis is recommended - 6%, 8%, 10% suggested some indication SDR should be lower Recommendation: For the economic analysis, utilize the Social Discount Rate; For the Financial Analysis, utilize a range of Discount Rates to test impacts of various corporations WACCs. February 22/23, 2005 Page 17

18 Economic vs Financial Subsidies There are various subsidies for renewable energy deployment initiatives These subsidies reduces the overall costs of the project developer However, these subsidies are also a societal cost since they are paid by the taxpayers Technologies that attract subsidies include: wind, fuel cell, photovoltaic, biomass and others Recommendation: Exclude subsidies in economic analysis Include subsidies in financial analysis February 22/23, 2005 Page 18

19 Economic vs Financial Factors Factor Economic Financial Discount rate Social Discount Weighted Average Rate Cost of Capital Project Life Economic Contract Taxes Excluded Included Subsidies Excluded Included * Corporate Overhead and sunk costs excluded from both analyses February 22/23, 2005 Page 19

20 Unit Costs vs Portfolio Costs Two basic ways in which to consider resource costs. Unit Cost Cost for each resource type per unit of output $/MWh - Unit Energy Cost [UEC] $/kw - Unit Capacity Costs [UCC] Resources produce both energy and capacity Typically, use UEC vs UCC if mostly energy project Portfolio Analysis Models the BC Hydro existing system Including existing IPP contracts Add resources to model how well customers needs are met Capacity and energy February 22/23, 2005 Page 20

21 Unit Costs vs Portfolio Costs Unit costs - useful summary metric for initial ranking/screening Applicable to: Supply and DSM resources / BC Hydro and IPP resources Determines costs for full output Portfolio Analysis provides more comprehensive assessment of resource options costs/benefits. Determines how resources expected to perform as part of basket For non-dispatchable resources (most renewables) $/MWh UEC costs monthly energy capability Calculate total annual cost For dispatchable resources (storage hydro, most thermals): fixed costs are input separately in $/year Variable costs are used in model s economic dispatch February 22/23, 2005 Page 21

22 Sample UEC Small Hydro Project Annual Energy Capability 90 GWh Installed Capacity 20 MW Dependable Capacity 5 MW Direct Capital Cost 40,000 $k Construction annual cashflow: Uniform over 3 years Fixed Annual Operating Cost: 2% of direct capital (800$k/yr) Fixed Annual Provincial taxes: 1.9% of direct capital(760$k/yr) Variable Operating Cost: $0/MWh Variable Provincial taxes: $1/MWh Fuel cost: N/A Fuel tax: N/A Project Life: 20 year contract February 22/23, 2005 Page 22

23 Sample UEC Small Hydro Project Investment Cost = Direct Capital + Interest During Construction amortized over contract life using pre-tax Weighted Average Cost of Capital as discount rate February 22/23, 2005 Page 23

24 Sample UCC Simple Cycle Gas Turbine Expected Annual Energy 65 GWh (in Heavy Load Hours) Installed Capacity 50 MW Dependable Capacity 50 MW Direct Capital Cost 40,000 $k Construction annual cashflow: Uniform over 2 years Project Life: 20 year contract Fixed Annual Operating Cost: 2% of direct capital (800$k/yr) Fixed Annual Provincial taxes: 1.9% of direct capital(760$k/yr) Variable Operating Cost: $4/MWh Variable Provincial taxes: $0/MWh Heat Rate 9000 GJ/GWh Fuel cost: $5/GJ ($45/MWh before tax) Fuel tax: 7% February 22/23, 2005 Page 24

25 Sample UCC Simple Cycle Gas Turbine February 22/23, 2005 Page 25

26 Possible Adjustments to Unit Costs Resource alternatives technical characteristics vary which affect their relative cost/value: Capacity value/ dependability for energy projects Energy value of capacity projects Location - affects transmission costs and losses Impact on system storage: Seasonal variation in energy delivery Daily/hourly variation in energy delivery Dispatchable? Can use be shifted to peak hours? Fuel Cost uncertainty February 22/23, 2005 Page 26

27 Dependable Capacity Adjustment: Sample UEC - Small Hydro Assume Value of Dependable Capacity = $50/kW-yr February 22/23, 2005 Page 27

28 Energy Value Adjustment : Sample UCC - Simple Cycle Gas Turbine Assume: Capacity Factor: 15% (65GWh/year during HLH) Variable OMA and Fuel: $4/MWh + $45/MWh +7% tax annual average HLH Market Value of energy: $55/MWh February 22/23, 2005 Page 28

29 Unit Cost Adjustments versus Portfolio Analysis TECHNICAL CHARACTERISTIC Capacity Dependable Energy Contribution of Capacity Resources Incremental Bulk Transmission System Costs Incremental Transmission Losses CAPTURE AS ADJUSTMENT TO UEC or UCC? include as cost adder with sensitivities credit energy value less variable production cost Depends on location and T assumptions Depends on location and T assumptions CAPTURED IN PORTFOLIO ANALYSIS? Yes, capacity scheduled based on dependability Yes, capacity resource energy reduces energy need Yes, major T projects are scheduled for projects and included in costs Limited to adder for large energy projects Impact on System Flexibility: Monthly energy delivery profile Daily/hourly energy delivery profile Dispatchable Complex adjustments Monthly energy delivery profile: YES Daily/hourly energy delivery profile: NO Dispatchable: PARTIAL Fuel Cost Uncertainty Sensitivity Analysis Economic dispatch and sensitivity analysis February 22/23, 2005 Page 29

30 UEC/ UCC & Portfolios Resource Options Database Resource Options Report IEP Portfolio Analysis Dispatchable Units Capital Cost Operating Cost Firm Energy Average Energy Dependable Capacity Dispatchable Units UEC $/MWh UCC $/kw-yr Dispatchable Units Capital Cost Operating Cost Calculate Dispatch Dependable Capacity Non-dispatchable units Capital Cost Operating Cost Monthly Energy Profile Firm Energy Average Energy Dependable Capacity Non-dispatchable Units UEC $/MWh UCC $/kw-yr Non-dispatchable Units UEC $/MWh Monthly Energy Profile Dependable Capacity February 22/23, 2005 Page 30

31 How UEC is used in Portfolios February 22/23, 2005 Page 31

32 Simple Portfolio Y (Resource D is Dispatchable) February 22/23, 2005 Page 32

33 Economic vs. Financial Analysis Economic Financial UEC/UCC X Portfolio X X * First portfolio analysis undertakes a least economic cost to acquire the resources. Then financial analysis determines the financial impact on rate payers (RIM). February 22/23, 2005 Page 33

34 Representation of Portfolio Costs At the last meeting - suggestion that portfolio costs should be shown as $/ MWh Large Net Present Value numbers were not meaningful Issues with isolating impacts and benefits of new resources New resources combined with existing resources for combined dispatch and variable/ fuel costs Benefits of all trade not be reflective of new resources Possible solution - select base portfolio to determine unit dispatch Incremental portfolios would be compared against base Costs become new resource capital, variable, fuel, and new trade revenue February 22/23, 2005 Page 34

35 Next Steps? Inclusion of potential future environmental liabilities in analysis Need for further briefing on economic and financial modeling? Do we have the right measures for the PIEPC to make trade-offs/ value portfolios? February 22/23, 2005 Page 35

36 Backup Slides February 22/23, 2005 Page 36

37 Calculation Examples FIGURE 1 EXAMPLE OF UNIT ENERGY COST CALCULATION Sample Energy Project In-service for 5 Years Starting in Year 4 dollars are 'real' which means net-of-inflation Assume discount rate is 6% (real) DISCOUNTED CASHFLOW CALCULATION OF UNIT COST: YEAR Capital Cost to Construct $225 $75 $75 $75 Annual Operating Cost $10 $10 $10 $10 $10 Total Cost $75 $75 $75 $10 $10 $10 $10 $10 Discount factor formula 1 1/(1.06) 1/(1.06)^2 1/(1.06)^3 1/(1.06)^4 1/(1.06)^5 1/(1.06)^6 1/(1.06)^7 Discounting factor Total Cost times discounting factor: $75 $70.8 $66.7 $8.4 $7.9 $7.5 $7.0 $6.7 Sum of Total discounted cost equals Present Value of total cost: $250 Annual Energy Benefit (Megawatt-hrs) Annual Energy times discount factor: Sum of discounted Annual Energy equals Present Value of Energy: 7.5 UNIT ENERGY COST = PV Total Cost/PV Energy Benefit= 33 $/MWh February 22/23, 2005 Page 37

38 Calculation Examples FIGURE 2 EXAMPLE OF UNIT ENERGY COST CALCULATION Sample Energy Project In-service for 5 Years Starting in Year 4 dollars are 'real' which means net-of-inflation Assume discount rate is 8% (real) DISCOUNTED CASHFLOW CALCULATION OF UNIT COST: YEAR Capital Cost to Construct $225 $75 $75 $75 Annual Operating Cost $10 $10 $10 $10 $10 Total Cost $75 $75 $75 $10 $10 $10 $10 $10 Discount factor formula 1 1/(1.08) 1/(1.08)^2 1/(1.08)^3 1/(1.08)^4 1/(1.08)^5 1/(1.08)^6 1/(1.08)^7 Discounting factor Total Cost times discounting factor: $75 $69.4 $64.3 $7.9 $7.4 $6.8 $6.3 $5.8 Sum of Total discounted cost equals Present Value of total cost: $243 Annual Energy Benefit (Megawatt-hrs) Annual Energy times discount factor: Sum of discounted Annual Energy equals Present Value of Energy: 6.8 UNIT ENERGY COST = PV Total Cost/PV Energy Benefit= 35 $/MWh February 22/23, 2005 Page 38

39 Calculation Examples Figure 4: Calculation of Levelized Cost Assume Discount rate = 6% year Example: Forecast Fuel Cost $/unit Levelizing is done over a specified period as per the following two examples: Present Fuel Cost levelized over years 1 to 8: year Forecast Fuel Cost $/unit (a) # of units of fuel (b) LEVELIZED FUEL COST Years 1-8 (a) divided by (b): 4.14 $/unit Fuel Cost levelized over years 4 to 8: year Forecast Fuel Cost $/unit (c) # of units of fuel (d) LEVELIZED FUEL COST Years 4-8 (c) divided by (d): 4.77 $/unit February 22/23, 2005 Page 39

40 Calculation Examples Figure 5: ANNUALIZED COST METHOD (applicable for projects that have same energy benefit every year) The Annualized Capital Cost is the Uniform Annual Payment over the project's 5 year life to repay the Capital Cost plus interest during construction based on 6 % YEARS to In-service: TOTAL: annual capital $75 $75 $75 0 $225 Interest during construction: (1.06)^2 (1.06)^1 1 Capital plus IDC $239 Total Capital + IDC 239 $ Annualized Capital Cost 57 $/year Annual Operating Cost 10 $/year Total Cost per year 67 Annual Energy 2 MWh Unit Energy Cost 33 $/MWh February 22/23, 2005 Page 40

41 Calculation Egs. February 22/23, 2005 Page 41

42 Portfolio Modeling vs UEC Cost line items include: Capital cashflow and fixed annual costs for BCH/BCTC projects (e.g. REV5, transmission lines) UEC times annual GWh for non-dispatched new IPP resources Fixed annual costs including annualized capital cost are included for dispatchable resources System simulation model predicts expected variable operating costs for existing dispatchable resources (like Burrard), dispatchable new resource options (like a CCGT), expected economic spot market imports costs and exports revenues All these line items of annual cost (revenues) for study period, typically 20 years, are discounted at opportunity cost of capital Includes estimate of residual value for BCH/BCTC projects added in last year February 22/23, 2005 Page 42

BC Hydro Provincial Integrated Electricity Planning Committee Meeting 5 (July 12-14, 2005)

BC Hydro Provincial Integrated Electricity Planning Committee Meeting 5 (July 12-14, 2005) Information Sheet #12 Financial Impacts Background The financial objective for the IEP is to minimize cost. Most