A REVIEW
OF THE ECONOMIC
COST OF POWER
IN ONTARIO
for
Independent Power Producers' Society of Ontario (IPPSO)
163-C Eastbourne Ave.
Toronto, Ontario
M5P 2G5
Telephone: (416) 322-6549
Telecopier: (416) 481-5785
e-mail: ippso@web.net
May, 1997
Prepared by:
David Argue Consulting
357 Roehampton Ave.
Toronto, Ontario
M4P 1S3Telephone: (416) 932-0324
Telecopier: (416) 932-0324
e-mail: david.argue@sympatico.ca
Please note that the content of this study represents the analysis and views of its author, and
IPPSO does not necessarily endorse any information presented herein.
INTRODUCTION
David Argue Consulting was engaged by IPPSO to review a number of
secondary studies
dealing with the cost of various generation technologies in Ontario. While these studies are now
over three years old, they represent the broadest and most recent possible survey of financial
arrangements and technologies, sufficient for such a comparative analysis. The objective is to
compare all-in costs, on a consistent per kWh basis with due consideration for environmental
costs.
This study has been undertaken because the choice of generation technologies produce
impacts which are long term, irreversible and have extensive economic and environmental
consequences. In addition, the debate about the "real" costs and advantages of generation
options continues. While there is some movement in Ontario towards a more market based and
contractual method of selecting generation resources, Ontario Hydro continues to assert its
monopoly rights in acting as the gatekeeper and rule maker, largely controlling both short and
long term decision making. Our review of the cost of power provides a perspective on
generation
costs that is different than that offered by Ontario Hydro.
Before turning to discussions of our methodology and the conclusions of this study, we
place the discussion in a historical context. The historical context is important because Ontario
Hydro's views on its competitive advantages in generation have undergone dramatic changes,
with far reaching effects over the last number of years.
HISTORICAL CONTEXT
In 1987, Ontario Hydro, proceeding with its planning for meeting the electricity needs of
Ontario's consumers, prepared a number of cases which examined the costs of various plans and
technologies that could be expected to contribute to Ontario's electricity system. These were
heady days. Hydro's System Planners postulated that the benefit from the province's massive
nuclear investment program was about to pay-off with real declines in electricity prices. In fact,
the System Planners adjusted the load forecast upward resulting in more electricity demand, to
address their conclusion that electricity prices would fall over the next decade. And while
recognizing an enormous technical potential for various dispersed technologies --- cogeneration,
small hydro, wind etc. --- the System Planners concluded that only a small portion of this
potential
was economic against Hydro's "low costs".
Figure 1 plots the Revenue Requirements Hydro saw as being necessary to service
existing
costs, and the beginnings of a large construction program for this plan, the "1987
Plan", against
actual revenues and the last major expansion plan we've seen from Hydro, the "1992 Plan".
Comparing the planned and actual revenues up to 1995 reveals Hydro's unanticipated cost
increases. In 1987 Hydro was projecting a 1995 revenue requirement of $6.464 billion. By
1992, with cost pressures mounting particularly in the nuclear portfolio, the projected 1995
revenue requirement increased to $9.993 billion, $3.529 more
than what had been projected just
five years earlier.
And until Ontario Hydro recognized the competitive threat from other generators, the
System Planners had been counting on a further 10% increase in electricity prices in 1993 and
1994. The saving to ratepayers, amounting to almost $1.3 billion in 1995, can be directly
connected to the competition offered by Non-Utility Generation.
The primary reason the 1992 Plan, including more rate increases and revenue, was
abandoned was because of the emerging competition from non-utility generation. Hydro's "low
cost" forecasts turned out to be very wrong, and the competitive threat from non-utility
generation was leading several large customers to contemplate abandoning purchases from
Ontario Hydro. In a pivotal speech to employees on March 10, 1993, Don Anderson, Ontario
Hydro's Vice President for Engineering & Construction Services offered this explanation for
the
dramatic reductions in budgets and staff Hydro's Management determined was necessary to meet
the competition:
"Our 30 percent rate increases over the last 3 years have been more than
double inflation. This has customers --- big and small --- angry. What we
have told them up to now is ... sorry but there's nothing we can do ---
you'll just have to live with it ...
What we all need to be aware of is that more and more people see Ontario Hydro as a company they can do without. In many cases they have tried to do just that. Whether it be the municipal utility in Kingston or Toronto or a mining operation near Sudbury, our customers are looking for somewhere else to go for their electricity --- and some are actually doing something about it."
The debate about the most cost effective sources of electricity supply has undergone
dramatic changes over the last decade. Forecasts have widely varied. Importantly, forecasts are
directly linked to the reasonableness of the assumptions.
HISTORICAL SUPPLY COSTS
Ontario Hydro's average generation costs are a blend of older and newer resources, and
supplies from hydraulic, nuclear and fossil stations. Figure 2 provides a breakdown of Ontario
Hydro's generation portfolio based on historical costs, as described in Ontario Hydro's 1995
Annual Report.
The "Historical +" bar, makes adjustments for costs not included in the Ontario Hydro
figures relating to net income (profit), generation-specific transmission, and corporate overhead.
This alternative is presented here because the basis for our comparative analysis is customer
cost.
However, our analysis of customer cost does not include any measure of the effect of corporate
writedowns by drawing down customer equity. For example, the price of nuclear fuel from
Hydro's figures is reported after taking a writedown on long term fuel contracts, amounting to
some $595 Million in 1993. From an economic perspective, writedowns are still costs incurred
by
customers, however from an accounting perspective they are no longer carried on the operating
statement. We unfortunately are unable to fully model the extent of the costs that have been
moved off the operating statement and balance sheet because of internal accounting decisions at
Hydro, so all the numbers presented in Figure 2 are somewhat conservative.
These figures are heavily weighted by the historical role of each of these portfolios. For
example, it would not be fair to conclude that nuclear is far more cost effective than Hydro's
fossil portfolio, owing to the fact that the bulk of Hydro's fossil portfolio provides intermediate
and peaking energy. In other words, fossil's fixed costs are assigned to fewer units of energy
production, and its higher unit costs are indicative of its special role. If the fossil and nuclear
portfolios were compared under similar operating circumstances with comparable capacity
factors, the results would be much closer, with a slight advantage to fossil due to the fact that
most of the fossil stations were incorporated before Hydro's nuclear stations, and therefore have
lower depreciated values.
Total Unit Energy Costs provide a snapshot of what occurred, or is planned to occur in a
single given year. No allowance is included for what future costs and performance might look
like, to the end of a station's useful life.
Figure 2 does indicate that Ontario Hydro does have the most cost effective 7,146
megawatts in Ontario --- that being the hydraulic portfolio. In 1995 this capacity provided
baseload and peaking energy for an average cost of slightly more than 1 cent/kWh. Even with
this
significant competitive advantage, adding higher cost nuclear and fossil to the Ontario Hydro
generation portfolio has left the utility vulnerable to competitive threat. Remove the hydraulic
portfolio, and its significant moderating impact on Ontario Hydro's total generating costs,
Ontario
Hydro's vulnerability to lower-cost alternatives increases dramatically.
In fact, a number of Hydro's accounting assumptions are holdovers from the days when Hydro was planning on adding many new generating stations, principally nuclear.
ACCOUNTING, MARKET and ECONOMIC COSTS
There are many ways to analyze the cost of power, and no method is absolutely perfect.
In fact, when forecasting, the one certainty is that actual costs will be different than those which
have been forecasted. Good forecasts result from knowledgeable assumptions and methods.
Whether looking at accounting, market or economic costs, assumptions concerning
lifetime, capital, operating, fueling and performance provide the key variables to any assessment
of the cost of power. And each of these input assumptions can have a significant impact on the
resulting forecast of cost.
In addition, whether a facility is public or private can have a significant impact on the
analysis, depending on financing vehicles and capital structure. Our analysis looks at these costs
from a true economic perspective --- without making assumptions about ownership, capital
structure or other market conditions, that may, or may not endure for the complete life of any
facility.
Before turning to the core of our analysis, some measure of the differences between our
forecast of the cost of power, and Ontario Hydro's accounting treatment is necessary. While
Ontario Hydro has taken write downs of more than $7 billion between 1993 and 1996, there are
many accounting provisions that continue to defer costs to future periods. To cite but a few
examples:
These accounting measures and others have the effect of deferring to future years part of
Ontario Hydro's costs of generation, thereby understating what generation costs would be in a
more competitive marketplace.
METHODOLOGY FOR COMPARING COST OF NEW
GENERATION
In order to make the comparison fair and true, core assumptions on discount rates,
performance and lifetime must be held consistent. And in any planning exercise, it is important
to
make sure that tax treatment, ownership, and financing issues do not obscure what are ultimately
technical and primary cost questions. Inclusion of tax treatment, present market conditions, and
varying capacity factors can introduce bias into the investigation that will make any comparison
of the technologies meaningless. Inconsistent assumptions for the individual technologies makes
fair comparisons impossible, however we do look at the sensitivity of core variables and the
significant results are summarized in the report.
The figures we have developed attempt to remove these biases. However, real world
conditions will vary dramatically around the central values we have calculated, and we provide
some measure of this in our sensitivity investigations. The market and history indicate that the
dispersed technologies perform better than a 65% capacity factor, and demonstrate lifetimes of
longer than twenty years. Entrepreneurs have employed financing mechanisms that can lower
costs considerably from those used in our comparative study, and IPPSO has
documented these
real world examples.
Since nuclear energy is the dominant technology in the Ontario Hydro electricity system,
the historical experience of this technology as been chosen as the primary input value for our
analysis. We believe that given the extensive experience and problems with Ontario's nuclear
portfolio, that a fairer assumption on lifetime is twenty years, rather than the forty that Hydro
employs. The historical performance has been closer to 65% rather than the "challenging target"
estimates that are replete in Ontario Hydro's assessments of future costs.
Looking at generation technologies on a comparative and consistent basis, does involve
the selection of various assumptions concerning price, site characteristics, escalation, cost of
capital and technology performance. Adjustments have been made to the secondary sources
cited,
in order to determine levelized costs in $ 1997 on a consistent basis.
The "generic" numbers used in this report are representative of average conditions and
circumstances given present market development and studies. For the alternatives to Ontario
Hydro generation development, we have selected projects at the 10th percentile of
economic
potential, from more substantive market studies completed for IPPSO and the Ontario Ministry
of
Environment and Energy. They are not the best projects, but they do represent projects at better
sites than the average. Around these results there will be large variation in specific
circumstances.
For consistency, all of the calculations were based on a twenty year service life, with a
discount rate of 10%, and lifetime capacity factor of 65%. The only exception to this was wind
in
which we used a 21% capacity factor, and new large northern Ontario hydraulic development, in
which we used Ontario Hydro's estimation of a 23.5% capacity factor.
In addition, we also have adjusted the values on the basis of a consistent commissioning date, of January 1, 1997. If we did not, the comparison would be problematic.
As a result, we have understated the benefits of the alternatives to Ontario Hydro generation, which in many cases have demonstrated availability above 95%. The choice of 65% as discussed previously was based on our investigations of the lifetime capacity factor of CANDU nuclear stations in Ontario, which have been plagued by performance problems.
In addition, the choice of a 20 year lifetime is also driven by nuclear experience in
Ontario. Based on our review of performance and costs, the first time major capital additions are
necessary beyond the 20 year mark, the incremental costs of such capital additions exceed the
cost
of alternatives by a significant margin. As a result of the assumption of a 20 year lifetime, the
costs for Ontario Hydro hydraulic and fossil, and the alternatives to Ontario Hydro generation are
also likely overstated.
We have looked at the cost of generation from an economic perspective. Before turning to the results of our investigation, it is instructive to examine Ontario Hydro's "accounting" for the cost of power. Our economic analysis does not exclude the actual or planned writeoffs of $7 billion taken by Ontario Hydro as a charge to equity, nor do we include long term depreciation terms, both of which discount Ontario Hydro's calculation of the accounting cost of power.
CORE
RESULTS
Figure 3 schematically indicates the results of our investigation. The levelized $1997
value for each of the technologies is displayed for a complete twenty year life cycle.
Notes:
All of the dispersed generation technologies show better cost profiles than the central
generation options.
It is important to re-emphasize that in order to make comparisons between the
technologies consistent, all of the technologies with the exception of the resource-constrained
options, large hydro and wind, have been treated with a similar 65% capacity factor. This
assumption has a big impact on the bottom line.
SENSITIVITY TESTING
All of the key inputs were tested, in order to provide further analytical data for
considering
the choice of technology. In the following table we show how varying capacity factors, and the
cost of capital affect the core results.
As can be seen, the
capacity factor assumption has a significant impact on the core values.
Importantly, the ranking does not change significantly. However, also importantly, each of the
dispersed technologies cost profiles decrease as capacity factors closer to historical levels are
employed. While CANDU stations in Ontario have been plagued by a myriad of design and
performance problems, the availability and performance of cogeneration, waste wood, and small
hydro have generally been higher than the 65% capacity factor used in our core analysis.
For example, industrial cogeneration, including mid-range environmental externalities,
shows lifecyle unit costs of 5.951 cents/kWh when a 95% capacity factor is utilized. And a 95%
capacity factor is much closer to the experience of this technology in the energy marketplace.
Besides the varied capacity factors and cost of capital described in our Sensitivity Testing
table, we tested the impact of varying lifetimes, fuel price escalation, operations and
maintenance,
and capital additions. In all cases the ranking held constant with similar assumptions employed.
Before turning to the conclusions of this investigation, the consistency of assumptions
when comparing options is of crucial importance. To compare technologies with different costs
of capital, or varied capacity factors indicates more about the differences in these variables,
than it
does about the technologies' core economic profiles.
CONCLUSIONS
Based on our review of generation costs in Ontario, we conclude that:
Ontario Hydro's latest Business Plan, the 1997 Corporate Budget and 1997-1999
Business Plan, will make over $1.2 billion in capital expenditures in 1997. This is up over
$200
million from expenditures in 1996.
Unfortunately, the utility is not indicating its expectations for costs beyond 1999, which
doesn't make it possible for us to compare the dispersed technologies against further capital
commitments to existing generation. Since the decision to invest in Hydro's existing generation,
primarily refurbishment of its nuclear stations, directly impacts on the implementation of the
more
cost effective dispersed options, there is a real need for a thorough incremental cost analysis,
comparing the implementation of replacement facilities against the refurbishment plan Hydro has
embarked upon.
In addition, the secondary studies we have depended on for this investigation are now
approximately four years old. In order to keep the consideration of generation options current, a
thorough survey of manufacturing, installation and operating costs for each of the technologies is
warranted. The scope of this study did not include time or budget for surveying upwards of fifty
manufacturers, and a minimum hundred different end use profiles that are necessary to ensure
that
results are not biased by random projects, good or bad, that fall out of the core technology cost
profile. In order to further this work, IPPSO should conduct a rigorous survey of more current
technology information.
When compared on a consistent basis, the dispersed technologies all show advantages against the central generation options in Ontario.