Tuesday, April 26, 2011

LEC - the accountant's view

A reader with a background in accountancy would be so horrified by the way I calculate the cost of electricity that I might be accused of mental decrepitude.  But, as Shakespeare would say, there is method in my madness; I am only looking to compare different methods of generation, not to present a bulletproof document to the Taxation Office.

And, as I’ll show in this post, my conclusions about the cost of power are robust even if I do the calculations according to accounting standards, provided any tax applied to carbon emissions is modest.  Let me illustrate by making a continuation of my last post – “Real Cost of Coal-Fired Power”.

Recall that I was looking at the Levelised Electricity Cost (LEC) for production from a Rankine-cycle steam plant with the following attributes:
·         specific capital cost: AUD 1,500,000/MW
·         thermodynamic efficiency: 0.39
·         cost of coal: AUD 120/t
·         fraction of coal that is carbon: 0.8
·         energy content of coal: 27.9 GJ/t
In addition, let me make my usual assumptions
·         interest rate is 8%
·         non-fuel operations and maintenance costs are 3% of the project cost
·         nominally the payback period for loans is 25 years, which in this case I take to mean the generation equipment is depreciated over 25 years
and the following specific additional assumptions
·         the plant has capacity 1,000 MW
·         the project is 50% funded by debt
·         the rate of taxation is 30%
·         the Social Cost of Carbon (SCC) varies between AUD 0 and AUD 100
·         the Capacity Factor (CF) varies between 0.70 and 1.00
·         the required after-tax rate of return on capital is 5%

The LEC is selected so that the required after-tax rate of return is achieved.  In the case where the plant is used 100% of the time (CF = 1) and the social cost of carbon is ignored (SCC = 0), this in fact requires the LEC to be AUD 64.65/MWhr, and the Profit and Loss statement for the year is given in the table below (all figures in AUD millions):

sales
566.3
less fuel costs
347.8
less non-fuel O&M
45.0
EBITDA
173.5
less depreciation
60.0
earnings before interest and taxation
113.5
less interest payments
60.0
pre-tax profit
53.5
less taxation
16.1
less SCC
0.0
nett profit after tax
37.5


On those figures, the after-tax rate of return is 37.5/750, or 5.00%, as required.

The various acronyms used are:
·         CF is the capacity factor, the fraction of time the generator is active
·         EBITDA is earnings before interest, taxation, depreciation and allowances
·         LEC is levelised electricity cost
·         O&M is operations and maintenance
·         SCC is the social cost of carbon expressed in AUD/ t CO2 emitted

Thus, on these assumptions, the conventionally accounted LEC is AUD 65/MWhr, which is close to the figure AUD 61/MWhr obtained with my usual methodology (see previous post).

I can now repeat the calculations for the range of SCC and CF values to give the Figure below (click to see original).  The dotted lines are LEC values based on the conventional accounting methodology, as above, and the full lines are the results from my last post (i.e. using a simplified set of assumptions).

If the Social Cost of Carbon is zero, then it does not matter much which method is used to assess the LEC.  As the Social Cost of Carbon is increased, then my simplified method underestimates the LEC as calculated by conventional accounting.

These LEC calculations involve a large number of parameters, more so under the conventional accounting treatment, less so under my simplified method.  By tweaking important parameters downwards (particularly the interest rate, the capital cost and the O&M costs), it is possible to strongly affect the calculated LEC.  That is why the UMPNER review’s LEC for nuclear power needs to be treated with suspicion (see post “Cost of Nuclear Power”, 14 March 2011).

My conclusions from this exercise:
·         For comparison purposes, I’m happy with the simplified methodology I have been using to estimate the LEC.
·         A tax for the Social Cost of Carbon increases the LEC substantially, particularly under conventional accounting methodology.

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