Electricity supply: Cost structure and decision making in ... · G2 unit, SIE94.2 GT based...

6th ERRA Training: Principles of Electricity Markets

May 7-11,2018 Budapest, Hungary

Electricity supply: Cost structure and

decision making in plant operation and

investmentPéter Horváth

9th May 2018 – Budapest – ERRA training


May 7-11,2018 Budapest, Hungary2

1. Microeconomics

2. Cost structure of different power plant technologies

3. Short run (production) decisions

4. Long term market impacts

5. Long term investment decisions

AGENDA

0. Introduction



MET Group is a unique international multi-commodity wholesale

and trading company with a significant European presence

MET Group introduction

Countries via subsidiaries13 UNIQUE POSITION

IN CEE19 Internationaltrading hubs 27 National gas

markets

KEY FACTS• Diversified commodity structure - natural gas, power, oil, oil products, LNG, LPG

• Track record in successful expansion to international markets

• Excellent understanding of CEE and CIS political and economic environment

• Stable and significant financing facilities and credit lines

• Ability to capture real option value through physical asset ownership

• Highly motivated and competent management and employees

• Proven track record of high profitability and fast growth

• Headquarters in Zug, Switzerland

500+e

mployees

d3Number of newly opened country

offices in 2016 and 2017

LEADERIN THE CEE

GAS MARKETSubsidiaries of MET Group

Trading regions for MET Group

24+ BCM

Gas turnover volume in 2016



Oil storage tanks (95% idle)

Feedwater canal for cooling water

Dismantling site – LOT1

G3 unit, AEN94.3 GT based multi-shaft 403 MW CCGT

unit

Dismantling site – LOT2 (former 5 steam cycle)

Demin water plant – LOT2

G2 unit, SIE94.2 GT based multi-shaft 220 MW CCGT unit

G1 unit, SIE94.2 GT based 150 MW OCGT unit

TSO 220 kV and 120 kV substation

Gas receiving station

Helicopter view of Dunamenti PP

Dunamenti is the largest gas fired power plant in Hungary with

794 MW of installed capacity on three combined cycle units



1960

Oil based BEADC blocks of Dunamenti start their commercial

operation

„Glorious history under plan-economy”

„Golden ages”

„Turbulent times”

1994

1973

2009q1

2014q1

2011

G1 gas turbine unit starts commercial operation1995 Privatization by Tractabel, long term PPA with state

power utility

1998 G2 CCGT unit starts commercial operation, to serve PPA

Repowering program: G3 CCGT unit starts commercial

operation

Due to EU pressure, termination of LTPPAs in Hungary,

including Dunamenti’s

1968

Decision about power plant investment at Százhalombatta

„F” blocks of Dunamenti start commercial operation

1980s Natural gas becomes the main fuel of the PP

• Initial objective was the support of the Danube Refinery

with energy (electricity, heat) and other resources (water)

• Oil tar was the main fuel of the units at the beginning

• Until the late ´80s the units were used for baseload power

production

• The main blocks were the up-to-date natural gas based

CCGT units

• As a result of the long-term PPAs (LTPPA) the G1, G2

and F units operated with high utilization

• Due to the act of the European Commission MVM breaks

up the LTPPAs

Dunamenti loses market share as a result of the termination

of LTPPAs, regional generation capacity oversupply and

collapsing clean-spark spreadHeadcount reduction, cost improvement program, efficiency

capex program, halt of power generation from 2014Q42013

Threatening insolvency, ownership change

2015-16 Full restructuring and corporate turnaround program

(business/revenue model, costs, organization, assets, liabilities)

2017-18 Consolidation, new investments (HGPI, Solar)

„Corporate turnaround”

• Through comprehensive restructuring program creating a‚

lean and compact’ power plant, given legacy constraints

• Elaboration of a new business model that revolves around

the capacity and not the energy generation capability of

the plant

The almost six decades of operation of Dunamenti provides plenty

of illustrative examples for the subject of today’s course

History of Dunamenti in a nutshell



1. Microeconomics


3. Short run production decisions



AGENDA

0. Introduction



Cost curves of a firm

To

tal

co

st

[EU

R]

Output [unit]

Total fixed costs

Un

it c

os

t

[EU

R/u

nit]

Output [unit]

ATC Average total cost

AVC Average Variable Cost

TC Total Costs

FC Fixed Costs

VC Variable Costs

Microeconomics 101: Total Costs, Fixed Cost, Variable Costs,

Marginal Costs… We’ve probably all heard it all…

MC Marginal cost

FR-ATC Full reinvest-ment marginal cost

FC Full investment cost

Cost

structure

of a firm

Unit cost

structure

of a firm



Competitive industry with price taking firms and industry market dynamics

Un

it c

os

t

[EU

R/u

nit]

Firm’s output [unit]

Microeconomics of a competitive industry, assuming price taking

firms with commoditized provide a good conceptual framework for

power generation

Industry output [unit]

D = Industry demand

S = Industry supply

Pri

ce

[EU

R/u

nit]

P1

D1

P2

P3

P1

P2

P3

ATC Average

total cost

AVC Average

Variable

Cost

MC Marginal

cost

FR-ATC Full reinvest-

ment marginal

cost

P2 (D2; S1) Inefficient or financially weak suppliers have shut down lost making production, thereby supply is industry curtailed

(S2S1). Hype is over, those firms that have survived the storm are back producing operating profits.

D2S1 S2

P1 (D1; S1) Market prices are above FR-ATC levels, it makes sense for the firm investing into production capacity (just like for

others with similar cost structures).

P2 (D1; S2) New production capacities increased supply (S1S2), new equilibrium market prices are above ATC levels, but below

FR-ATC. It makes no sense to enter the industry, but industry incumbents are making profit.

P3 (D2; S2) Industry demand decreased (D1D2), new market prices are below ATC levels. Firm (and other similar suppliers with

similar cost structures) are bleeding cash and are considering to exit the industry, shut down production. Survival of the

fittest.



1. Microeconomics





AGENDA

0. Introduction



Power plants can be depicted with very simple cost curves

Costs curves applied to conventional power generation

Long-run marginal cost

On top of SRMC it includes unit cost of fixed cost items,

typically :

- Fix part of fuel costs (e.g. mine)

- Fix operational costs

- Fix maintenance costs

- Labour costs

- Other (e.g. insurance)

Short run marginal cost is usually a linear rate at

which the plants total cost changes as output changes.

It typically includes:

- Linear unit fuel cost of production and rampup

- Unit cost of auxiliary materials (raw water,

chemicals etc.)

- Unit cost of waste (e.g. ash) disposal/depose

- Variable maintenance costs

Generation

capacity

[MW]

Unit cost

[EUR/MWh]

SRMC = AVC

ATC = LRMC

FR-ATC

Capacity

of the

unit

Full reinvestment average total cost

On top of LRMC includes unit cost of annual capital

charge of investments, such as:

- Initial investment

- Repowering investment

- Regular maintenance works (Major overhaul, HGPI)



Main peculiarity of renewable power plant is the unusually low

variable cost component

Cost curves applied to renewable power generation

Long-run marginal cost

On top of SRMC it includes unit cost of fixed cost items,

typically :

- Fix operational costs

- Fix maintenance costs

- Labour costs

- Other (e.g. insurance)

Short run marginal cost is the rate at which the plants

total cost changes as output changes. It typically

includes:

- Unit cost of expected imbalance charges

- Unit cost of grid access fees

- Unit cost of variable-type O&M price components

- (Note: no fuel cost)Generation

capacity

[MW]

Unit cost

[EUR/MWh]

SRMC = AVC

ATC = LRMC

FR-ATC

Capacity

of the

unit

Full reinvestment average total cost

On top of LRMC includes unit cost of annual capital

charge of investments, such as:

- Initial investment

- Repowering investment

- Regular maintenance works (Major overhaul)



Levelized cost overview for different techonologies

LCOE1) for different techonologies [GBP/MWh]

63 7352 4435

52

7219

28

20

240

13

00

0

0

0

0

50

100

150

200

Biomass

86

5 6

0

OCGT 600MW

(500hrs)

168

5

173

CCGT H Class

66

7 2

Onshore Wind

63

4

10 5

Large Scale Solar

67

6

9 0

Offshore Wind

105

5

3

1) LCOE sums up all accumulated costs for building and operating a plant and compares this figure to the sum of the annual power generation.

Source: Department for Business, Energy & Industrial Strategy: Electricity Generation Costs, Nov 2016

Variable O&M

Fuel Costs Construction Costs

Carbon Costs Fixed O&M

Pre Development Costs



Wind and solar PV LCOE’s have decreased with 67% and 85%

in the last eight years

Unsubsidised Levelised Cost of Energy (Wind & Solar PV)

(1) Represents average percentage decrease of high end and low end of LCOE range.

(2) Low end represents crystalline utility-scale solar with single-axis tracking in high insolation jurisdictions (e.g., Southwest U.S.), while high end represents

crystalline utility-scale solar with fixed-tilt design.

(3) Lazard’s LCOE initiated reporting of rooftop C&I solar in 2010.

Source: Lazard’s Levelized Cost of Energy Analysis – Version 11.0



The market supply curve is build up of the marginal cost curves of

each individual plant

Short run merit-order curve

Short-run

marginal cost

[EUR/MWh]

Generation capacities

[MW]

Power generation types, with lower

SRMCs (e.g. RES (Hydro), Nuclear)

are at the beginning of the curve,

while OCGTs are ending it

RES & CHP mustrun

Nuke Lignite & Coal

CBC imports

CCGT OCGT



1. Microeconomics





AGENDA

0. Introduction



Typical short run decision of a plant is a simple production

decision, which in competitive markets are set by market prices

Type of business decisions along price curves - SRMC

SRMC time horizon: From hour ahead to within

year

• Shall the plant generate power the next hour,

tomorrow, next week/month?

• If yes at what capacity?

Generation

capacity

[MW]

Unit cost

[EUR/MWh]

SRMC

LRMC

FR-ATC

Capacity

of the

unit



Example: What is the day-ahead supply decision of an

individual price-taking CCGT?

Price taker power plant (1/3)

Generation

capacity

Unit cost

[EUR/MWh]

SRMC = AVC

ATC = LRMC

FR-ATC

Capacity

of the

unit

RES &

CHP

Nuke Lignite CBC

imports

CCGT OCGT Market

generation

capacity

Unit price

[EUR/MWh]

Typical CCGT Supply curve / Merit order



Example: What is the day-ahead supply decision of an individual

price-taking CCGT?


Generation

capacity

Unit cost

[EUR/MWh]

SRMC

Capacity

of the

unit

RES CBC

imports

CCGT OCGT Market

generation

capacity

Unit price

[EUR/MWh]

Short-run

DA BL

demand

curve

Typical CCGT Day-ahead power market landscape

Market price

Minload of

the unit

Remarks

• Baseloader nuke and coal plants

are usually contracted on a year or

quarter ahead basis, therefore not

present in a short term supply

• Even some of the CCGTs

capacities have already been

contracted, therefore missing

• Weather dependent renewables

are present, as their loads can be

best forecasted on a day-ahead

and intra-day basis

• Only DA CBC capacity is available,

not the full amount

• Both the short term demand and

supply curves is very steep

(inelasticity)

Remarks

• FR-ATC and LRMC are irrelevant

decision points

• Plant is „out of the money”, will

not be dispatched



Example cont’d: What happens in case demand suddenly shifts

the next day because of an unplanned plant outage elsewhere?


Generation

capacity

Unit cost

[EUR/MWh]

SRMC

Capacity

of the

unit

RES CBC

imports

CCGT OCGT Market

generation

capacity

Unit price

[EUR/MWh]

DA demand

increases

Typical CCGT Day-ahead power market landscape

Market price

Minload of

the unit

Remarks

• Plant is „in the money”, will be

dispatched

Remarks

• The plant effected with the outage

have already sold its production,

and therefore now is short in

power. This creates short term

demand for replacement power

until the unit is back in production



Breakeven calculation for baseload product [EUR/MWh] (1/2)

SRMC example of a CCGT: beyond gas and carbon credit there

are plenty of other relevant marginal cost drivers

2,8

2,6

1,0

1,0 1,00,7

Gas

logistics

costs

43,5

Gas cost

(incl. entry)

EUA Cost Water

costs

Revenue

tax

0,3

Rampup

/ down

revenue

Maintenance

0,5

Outage

provision

TSO

balancing

revenue

SRMC

49,9

48,3

Market

price



R1

Stop the frequency drop

Activation time up to 30 sec

Automatic operation

Continental cooperation

Operating reserves

R2

Restore frequency

Activation time from 0,5 to 5 minutes

Automatic / manual op.

County-wide cooperation

Operating reserves

Usually from flexible units

R3

Restore the required level of R2 to be prepared for a further

system imbalance

Activation time up to 15 minutes

Manual operation

County-wide cooperation

Usually from OCGTs or R2 providers

Overview of balancing markets

Spinning reserves for balancing are required by TSOs from a 5 sec

to a max 1 hr horizon



Breakeven calculation for baseload product [EUR/MWh] (2/2)

SRMC example of a CCGT: a change in a single component can

change the economics

2,8

2,6

1,0

1,0

6,0

0,7

SRMC

44,9

TSO

balancing

revenue

Outage

provision

Maintenance

0,5

Rampup

/ down

revenue

Revenue

tax

0,3

Water

costs

costs

EUA CostGas

logistics

costs

Gas cost

(incl. entry)

43,5

Market

price

48,3



1. Microeconomics





AGENDA

0. Introduction



Example: What is the year-ahead supply decision of an individual

price-taking coal plant?

Price taker coal plant year ahead decision

Generation

capacity

Unit cost

[EUR/MWh]

SRMC

Capacity

of the

unit

RES &

CHP

Nuke Lignite CBC

imports

CCGT OCGT Market

generation

capacity

Unit price

[EUR/MWh]


Implied

YAQ3 BL

demand

curve

Market price

LRMC

FR-ATC



Example: What is the year-ahead supply decision of an individual

price-taking CCGT?

Price taker CCGT year ahead decision (1/2)

Generation

capacity

Unit cost

[EUR/MWh]

SRMC

LRMC

FR-ATC

Capacity

of the

unit

RES &

CHP

Nuke Lignite CBC

imports

CCGT OCGT Market

generation

capacity

Unit price

[EUR/MWh]Typical CCGT Supply curve / Merit order

Year ahead

BL demand

curve

Market price



Example: What is the year-ahead supply decision of an

individual price-taking CCGT for Q3 next year?

Price taker CCGT year ahead decision (2/2)

Generation

capacity

Unit cost

[EUR/MWh]

SRMC

Capacity

of the

unit

RES &

CHP

Nuke Lignite CBC

imports

CCGT OCGT Market

generation

capacity

Unit price

[EUR/MWh]

Typical coal plant Supply curve / Merit order

Implied

YAQ3 BL

demand

curve

Market priceLRMC

FR-ATC



LRMC time horizon: typically year ahead, along corporate

business planning/budgeting cycles

Type of business decisions along price curves

LRMC time horizon: typically year ahead, along

corporate business planning/budgeting cycles

• Do unit prices cover the total fixed and variable

cost structure of the plant? Will the plant make

operating profit?

• If not, can the plant change the fixed and/or

variable cost structure, to improve profitability?

• Can unit prices (e.g. under a PPA) be

renegotiated to favourable terms?

• If not to all of the above, should the plant be

mothballed or decommissioned?

Generation

capacity

[MW]

Unit cost

[EUR/MWh]

SRMC = AVCATC = LRMC

FR-ATC

Capacity

of the

unit



Dunamenti case: the once grandiose Dunamenti’s corporate

restructuring, the benchmark plant was a competing compact 400

MW CCGT plant

Land: 110 ha vs 10 ha

FTE: 102 vs 28

Capacity:860 MW on 7 generators vs 400 MW on 2 gen.

Fix opex: HUF 4293 m vs HUF 1800 m

Dunamenti (2014) Benchmark plant



Dunamenti case: Decrasing the LRMC of the plant involved

measures both on the fix cost and the standby revenue side

Target

Opex

-49%

Strategic

projects

Admin

support

transform.

Fac.Man.

Impr.

O&M perf.

Impr.

O&M org

transform

OPEX

base caseTarget

standby revenues

Base case standby

revenues

Increase

Targeted OPEX improvements of power plant restructuring project

The cost of real option in 2017 is

expected to be 2 mEUR

High coverage of fixed costs enables

DERT to increase profit margins

and/or price more competitively



Dunamenti case: the program was achieved through 100+ measures

with different complexity, risk and implementation characteristics

High

Low

Low High

Medium

Medium

The size of the bubble is

proportionate with the

estimated potential

Chem.plant outsourcing

Kraft

Insurance

G1 withdrawal and sale

G1 withdrawal

Maintenance outsourcing

G2-3 common operation (4 shifts)

Oil station withdrawal

Real estate taxes

Downsizing the Asset team

G2-3 common operation (5 shifts)

Security service

Self-consumption reduction (power)

Implementation time / Complexity

Operational

and

business

risk

FacMan

O&M

Admin and

horizontal



Dunamenti case: the program lowered the LRMC of the plant and

redesigned commercial strategy refocused on select competitive

productsImpact of LRMC reduction of a price taker CCGT

Generation

capacity

Unit cost

[EUR/MWh]

SRMC

Capacity

of the

unit

RES &

CHP

Nuke Lignite CBC

imports

CCGT OCGT Market

generation

capacity

Unit price

[EUR/MWh]


Implied

YAQ3 BL

demand

curve

Market priceLRMC



A CCGT can also be regarded as a real option on the clean spark

spread

Option value of gas fired power generation

CSS

[EUR/MWh]

Option:

Out-of-the-money

Op

tio

nvalu

e [

EU

R/M

Wh

]

Peaker or standing

reserve

Peak loader,

occasional

spinning TSO

reserve

Baseloaer & constant

TSO spinning reserve

Option:

At-the-money

Option:

In-the-money

Option

premium

Strike

price of

option

Option premium is the price

to pay for the option. The

LRMC or the FR-ATC of the

unit can be considered as

the premium

Strike price is where the

plant turns in the money. The

higher the plant’s efficiency,

the lower the strike

CSS: Clean Spak spread is

the difference between the

market price of electricity

and its cost by way of gas

fired generation, which can

be negative or positive.



Trade #1:

Buy: ’18q3 CSS ( =

sell: power 18q3 CSS

buy: gas 18q3 CSS

buy: EUA Cal18 )

PnL: 0.5 EUR/MWh

Trade #2:

Sell: ’18q3 CSS ( =

buy: power 18q3 CSS

sell: gas 18q3 CSS

sell: EUA Cal18 )

PnL: 1.0 EUR/MWh

Trade #3:

Buy: ’18q3 CSS ( =


buy: gas 18q3 CSS

buy: EUA Cal18 )

PnL: 1.5 EUR/MWh

Trade #4:

Sell: ’18q3 CSS ( =

buy: power 18q3 CSS

sell: gas 18q3 CSS

sell: EUA Cal18 )

PnL: 2.0 EUR/MWh

Trade #4:

Buy: ’18q3 CSS ( =


buy: gas 18q3 CSS

buy: EUA Cal18 )

PnL: 2.2 EUR/MWh

Cal18 EUA

18q3 Gas

18q3 Power

18q3 CSS

Depending on the volatility of its components, the CSS of a specific

tenor can be traded in and out a number of times before delivery

CSS trading strategy (illustrative example)



0. Microeconomics




4. Long term (investment) decisions



FR-ATC time horizon involves capital allocation decisions from

five years to decades

Type of business decisions along price curves

Generation

capacity

[MW]

Unit cost

[EUR/MWh]

SRMC = AVC

ATC = LRMC

FR-ATC

Capacity

of the

unit

FR-ATC time horizon: from five years to decades

• Do long term market prices provide enough

stability to:

• new/greenfield investment?

• Lifetime extension investment?

• Repowering investment?

• If not, are there any creditworthy long term PPA

schemes available to provide price and volume

risk support?



The European energy transition of the past decade has been the

perfect storm for conventional power generators

Power market trends on the merit-order curve

A

B

C

D

Expansion of renewables

Decreasing power price

Lower CO2 cost

Decreasing demand

SR

MC

[E

UR

/kW

h]

Gas

Coal

Nuclear

RES Nuclear Gas Oil

D1D2

S1S2

Oil

Coal

Q1Q2

P1

P2

P

B

A

CP3

B

Available capacity [MW]

Weather dependent RES generators

have almost zero SRMC therefore they

push the supply curve to right

Low emission costs squeeze the

power prices with the switching from

gas based generation to coal

The competitiveness of larger

pollutants is raising with the low level

of emission costs

Decreasing (waving) demand pushes

the equilibrium price to left.



0

50

100

150

200

20302019201820172016 20242023202220212020 20292028202720262025

Small PV

Large PVOnshore wind

Offshore wind

Brown coal

Hard coal

CCGT

2013 2030

LCOE of technologies1) Baseload price forecast

MIN-MAX range

Source: Fraunhofer ISE, REKK

1) LCOE of technologies assuming German location, and typical load factors for each technology. LCOE sums up all accumulated costs for

building and operating a plant and compares this figure to the sum of the annual power generation.

Energy prices determined by SRMCs, no power plant is expected

to built in EU without non-market component or subsidy

Forecasted European BL power prices vs. LCOEs of technologies in 2013 and 2030 [EUR/MWh]



Just like on population demographics, the best proxy for future

power plant demographics are past birth rates

EU generation portfolio evolution

Large nuclear capacity

installations based on the

development of the nuclear

industry

The CCGT era:

more than 50%

efficiency, low

emissions

Golden age

of coal

investments

Economical crisis, strong

RES subsidies: end of

CCGT commissionings

Forrás: oilprice.com

Younger coal and nuclear generation is reaching the end of the lifecycle

Unfavorable market conditions: CCGTs are depressed. Second rounders (in early 2000’s) has

written-off the assets

No conventional investments since the beginning of the RES revolution



The focus turns to digitalisation, decentralisation and customers in

the energy industry

The new world requires a selective and tailored approach from market participants

Old world New world

Centralized

generation

Monopolistic setup,

high margins

Predictable demands and

physical grid connection

Hub-and-spoke

distribution design

Decentralized

generation

Increasing competition,

diminishing margins

Flexibility and

energy efficiency

Digital transformation,

smart technologies and

systems convergence



Majos risk of power plant construction

Source: Brennstoff-Wärme-Kraft, 64. k. 6. sz. 2012. p. 9.



Many EU countries have realised the importance of flexible back-up

capacities and introduced some kind of capacity market

Capacity market mechanisms in Europe (2018)

Source: Pöyry Management

Consulting, EURELECTRIC

Ireland

Ongoing price-based capacity

mechanism

Centralised ROs being developed

Portugal

Price-based capacity

mechanism for new units

Spain

Current price based

capacity mechanism being

re-developed

Italy

Replaces current mechanism with

market-wide solution

Poland

Capacity auctions to

be launched in 2018

Germany

Grid stability reserves

Discussions about

introduction of

national capacity

mechanisms

Sweden

Strategic reserve

Belgium

Targeted tender

Strategic reserve

France

Targeted tender

Capacity obligations

Great-Britain

Capacity auctions

Finland

Strategic reserve

Greece

Transitional price

based

Enduring capacity

obligations

Promoting demand

response

Capacity markets can

help to safeguard the

security of electricity

supply, while paying

capacity based fee to

generators.

The European

Commission has

already accepted

several assessed

mechanisms, recently

in February 2018 in

Belgium, France,

Germany, Greece, Italy

and Poland.

The aim is to create the

right investment

incentives and to

enable further

development.



Off-peak (evening) demands are 20-30% lower than peaks,

especially during the weekends

Weekly Hungarian load curve

Source: MAVIR website

3 000

3 200

3 400

3 600

3 800

4 000

4 200

4 400

4 600

4 800

5 000

5 200

5 400

5 600

5 800

25.04.24.04. 28.04.27.04. 29.04.26.04.23.04. 30.04.

-37,2%

Off-peak

(8pm-6am)

Peak

(8am-8pm)

Workdays Weekends

Fast ramp-up (20-30% of the overall

demand required in 1-2hours) and ramp-

down demand of the power system



Solar PV changes the conventional meaning of BL/PL

Source: Energiewirtschnaftliche Tagesfragen, 62. k. 1/2. sz. 2012. p. 97-100.



While addition of RES capacity constantly squeezes out

conventional plants, the intermittent nature will require fast cycling

conventional backupsImpact of solar development – in theory

Source: Energiawirtscheftliche Tagesfragen, 63. k. 1/2 sz. 2013.p.62-65 / Dr. Stróbl



The proliferation of solar farms in California has led to an oversupply

of power generation in the middle of the day (and steep drop-off in

the evening)The Duck Curve - Impact of solar development

Source: Californian ISO and Bloomberg



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Electricity supply: Cost structure and decision making in ... · G2 unit, SIE94.2 GT based...

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