UMS Group Europe

Joop Geesinkweg 901-999

P.O. Box 94013
1090 GA Amsterdam
The Netherlands
www.umsgroup.com

Asset Management of Fossil-Fueled Power Plants in a Renewable

Energy-Driven World
This paper describes how renewables are fundamentally changing the role of Fossil-Fueled
Power Plants and how Generation asset management can be used to deliver the highest
potential value to the asset owner.
By Remco Frenken (Managing Partner, UMS Group Europe) and Jan Schipper (Managing
Director, UMS Group Europe)

Introduction
Many fossil power plant operators are struggling at the moment trying to operate profitably in
a challenging market. In Europe, relatively high gas prices and low carbon prices make life
difficult for gas plants, while in the USA, low gas prices pose challenges for coal plants,
despite the current absence of a carbon cap or tax. At the same time, in Australia, with its
high gas prices and high carbon prices, things are tough for all fossil-fueled plants. These
challenges have led many fossil-fueled power plant operators to report lower earnings,
blaming them on atypical fuel prices combined with reduced demand driven by the financial
crisis.
In order to bolster earnings, many power plant operators are reducing costs in the belief that
they can wait out the economic crisis and will see a return to higher profitability when demand
recovers. The truth is that there is no guarantee that the market for fossil-fueled power will
recover.
In this paper, we explore the underlying trends driving the power market and the impact they
will have on fossil-fueled generation. We then illustrate how power plant asset management
strategies can be modified to deal with the coming changes in the market.
The European, Australian and American Electricity Markets
Electricity is mainly generated by a mixture of natural gas, coal, nuclear, hydro, wind, solar
and biomass powered stations. In developed countries, the installed capacity is higher than
the maximum demand (i.e., there is reserve capacity) in order to cope with plant outages
(planned and unplanned) and transmission capacity constraints. On a typical day, only 60 or
70% of the available power plant capacity is used. As capacity typically exceeds demand, a
merit order is determined whereby the cheapest plant to operate is scheduled first and plant
capacity is added until the demand is covered.
This merit order principle is the core of every energy market, whether it is single supplier or
free market. In a single supplier system, the system operator calculates the merit order and
schedules the plant; in a free market system, the result of all the traders contracts is the
merit order. Although there will be some differences between the two models, due to market
strategies or peculiarities, approximately the same merit order is achieved in both systems.
2012 UMS Group Inc., All Rights Reserved

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UMS Group Europe

Joop Geesinkweg 901-999
P.O. Box 94013
1090 GA Amsterdam
The Netherlands
www.umsgroup.com

So in order for a particular plant to run at any given time, it must be in the merit order. This is
determined by the cost of the plant as defined by the cost of fuel plus the costs of CO2 (in
markets with Carbon trading) plus variable O&M costs in other words the plants Short Run
Marginal Cost.
Typically,
hydro has zero marginal cost
nuclears marginal cost is approximately 5-10 /MWh (mostly cost of Uranium)
lignite is 10-20 /MWh (cost of lignite plus CO2 allowance)
coal is 30-40 /MWh (cost of coal plus CO2 allowance)
gas is 30-80 /MWh (cost of gas plus some CO2 allowance). The large spread is due
to large price difference in different markets
So on a normal day, the plants scheduled are hydro (and solar and wind if available) and
nuclear, then lignite, coal and gas (in the USA, current prices would see gas scheduled
ahead of coal). The higher the demand, the more plants that need to be scheduled, so many
plant operators make their money during the peak hours (working days during daytime, when
demand is the highest).
Trends Driving Change in the Market
Historically, hydro, nuclear and lignite together could cover 50% of peak demand and 70100% of the off peak demand. The remaining gap was filled with gas and coal stations. Solar
and wind generation have historically provided an insignificant amount of capacity and
generally did not impact the operation of fossil-fueled power plants. In addition, demand
increased continuously (until 2009) and depending on gas and coal prices, either coal or gas
stations had significant capacity factors.
Recently, two fundamental trends have cropped up which are moving us away from the
traditional power market - a minor one and a major one. The minor trend is that load is not
rising anymore. Load growth was initially stifled by the economic crisis, but the drive for
greater efficiency (e.g., LED lighting, more energy efficient buildings etc.) now seems to be a
factor that is likely to inhibit load growth even when the economy recovers.
The major trend is that significant zero marginal cost renewable capacity (wind and solar) is
being installed. Wind and solar have historically been roughly twice as expensive as fossil
fuel-fired generation. However, 95-99% of their costs is fixed and only 5- 1% is variable (in
contrast to coal and gas stations, which have a roughly 50/50 split). This means that once a
wind park or solar panel is installed, it generates energy at virtually zero cost. These
technologies will always run when there is wind or sun (at no cost), pushing coal and gas
stations out of the merit order.
To illustrate this effect, it is useful to look at Germany, Europes largest energy market. While
the Chinese are building a new coal station every month, the Germans are installing solar
panels with the capacity of a coal station every month. Currently, Germany has 30 GW of
2012 UMS Group Inc., All Rights Reserved

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UMS Group Europe

Joop Geesinkweg 901-999
P.O. Box 94013
1090 GA Amsterdam
The Netherlands
www.umsgroup.com

wind and 31 GWs of solar capacity installed, compared with a minimum demand of ~30 GW
and peak of ~80 GW. This means that on most sunny and windy days, these renewable
resource generate enough energy to cover the entire German load. On the other hand, on
cloudy and foggy mornings, coal and gas units are needed. The problem for the fossil-fueled
power plants is that there are more sunny and windy days than there are foggy mornings.
The graph below demonstrates the impact of solar on a sunny Friday and Saturday (source:
Wikipedia). Three years ago, the load now supported by solar would have been supported
by peaking gas and coal plants. Now solar covers the complete peak demand and every
month a new coal plants worth of capacity in the form of solar panels is added.

Thanks to German subsidies and Chinese manufacturing, solar panel prices have decreased
to a level where minimal subsidies are needed to drive demand. In some areas with high
levels of insolation, they have reached grid parity where no subsidy is needed to incent
households to install solar panels. They have little investment risk, require limited
maintenance, and are in reach of many households and Small and Medium Enterprises
(SMEs).
To provide some relevant data points, at 2,000/kW (US$2,500/kW) installed, solar is roughly
the same price as a coal-fired generating station or an onshore wind turbine. Although still
twice as expensive to install as a gas-fired generating station, there is no fuel cost.
Installation can be performed in small increments, development risk is negligible, and once a
plant is up and running there are no fuel costs and only minor maintenance costs. With lots of
investors looking for low risk/medium return, we expect solar panel sales to grow rapidly in
the coming years; not only in Germany but throughout the sunnier parts of Europe, the USA
and Australia.
The implication is that the size of the generation pie for coal- and gas-fired stations will keep
shrinking. While these stations will still be needed as backup on foggy days, the market
premium paid for that back up will be minor in relation to the total cost of the station. In the
2012 UMS Group Inc., All Rights Reserved

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UMS Group Europe

Joop Geesinkweg 901-999
P.O. Box 94013
1090 GA Amsterdam
The Netherlands
www.umsgroup.com

current environment of overcapacity, economic crisis, high grid expansion costs and good
reliability there is no burning platform for politicians to pay for back up. As most markets pay
for primary energy, rather than for capacity, the incentive for backup will be limited. It will take
many years to change this compensation system, although we are convinced that ultimately it
must be changed.
Adapting Your Generation Portfolio For Renewables
Inevitably, the running hours for gas and coal power plants will keep on shrinking and energy
prices will remain low, as more and more zero cost generation is added to the system.
Therefore, asset managers need to prepare their fossil portfolio for a dark decade; wherein
developments like changing fuel prices and variable carbon prices will only impact how the
pie between coal and gas is divided; it will not reverse the overall trend of a shrinking pie for
fossil generation. Your plants will only become profitable again when many of your
competitors have closed their plants, demand starts rising again and/or the market model is
adapted to support capacity-based compensation, rather than energy based. This will take a
decade or more to sort out, not 1 or 2 years. Therefore, you will have to assess how your
fleet will fit in a renewable-centered world.
For example, in case of a major overhaul, as a prudent asset manager you will try to lock in
your business case by selling forward the power and purchasing the fuel, plus a realistic
estimation of the optionality value (incl. backup) of your plant. At current prices in Europe,
this will only justify very low major overhaul costs. In Australia and USA, the renewables
boom has yet to come, but keep in mind the speed with which this can come; with the ability
of adding the capacity of a coal station per month.
This means that you must critically assess those plants with high major overhaul costs, trying
to variabilize these major costs as much as possible, investing only in those plants which are
on critical grid nodes, because if renewables keep on growing the system operator will be
more likely to pay for back up at those nodes, and variabilizing your other costs as much as
possible.
An old plant with low efficiency but low major overhaul costs may be more attractive than a
newer plant with higher efficiency, but higher major overhaul costs. Also, when it comes to
mothballing facilities, you will need to reassess the likelihood that the plant will ever be
restarted. In most cases it takes many weeks to restart and a major overhaul is then often
required and you may also have to deal with unit fuel conversion. In such cases, it may be
better to save the mothballing effort and just close the plant. For CCGT plants, if they will not
be running at nearly the capacity factor you had planned; it will be essential to maintain the
plants ability to operate in a cost efficient and flexible way, but also critical to conserve plant
operating hours to avoid or at least defer the major LTSA overhaul costs. You (and your
asset owner) will also have to prepare for extended periods where the plant will not be
running (over the summer months for example).

2012 UMS Group Inc., All Rights Reserved

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UMS Group Europe

Joop Geesinkweg 901-999
P.O. Box 94013
1090 GA Amsterdam
The Netherlands
www.umsgroup.com

Changing Your Asset Management Strategy From An Optimal Lifecycle Profile To

Fix On Failure
Within your asset management department the implication will be a major shift from the
traditional engineering profile (risk avoidance), or the optimal lifecycle cost profile to a profile
where your strategy moves to only do things when risks are not defensible.
This means that the overall
portfolio of programs, projects
and activities need to be reevaluated. For every single
project, management has a
choice to fund it or to defer it
(e.g. inspections) and accept
the risk of failure. Each of the
elements of the risk of deferral
must be evaluated.
The next hurdle is likely to be that funds available will be far less than the budget needed to
support all initiatives. So a further competence will need to be developed the selection of
projects within increasingly difficult budget constraints. Prioritizing the initiatives is not
sufficient to ensure maximum value and minimized risk from the investments. Herein lies the
second challenge for asset managers viewing overall value and risk from the perspective of
the entire fleet. To accomplish this, it is important to look at market dynamics, competition
and likely changes in regulation.
Conclusions & Recommendations
The growth of renewables will mean fundamental changes for coal- and gas-fired generation.
Owners and operators need to prepare for reduced running hours and much less predictable
scheduling (for example, they may be needed more during a warm night than on a warm
day). This will impact your asset management priorities and strategies.
As an asset manager, you will have to
acknowledge this fundamental change
and develop a vision for how your fleet
will fit into a renewable-centered world.
Your plants may be needed for back up,
but that fact by itself will not (financially)
justify keeping your fleet in the current
state.
The decisions you make as asset
manager will have a large impact on your
asset owner. His various stakeholders
will have many conflicting interests; so a good business value framework is needed to guide
you through the various options and interests and allow you to act decisively.
2012 UMS Group Inc., All Rights Reserved

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UMS Group Europe

Joop Geesinkweg 901-999
P.O. Box 94013
1090 GA Amsterdam
The Netherlands
www.umsgroup.com

Furthermore, the asset management function needs to be competent in the domains of

modeling market and political uncertainties, understanding and being able to minimize risks
of deferral and portfolio optimization against variable but ever tightening budget constraints.
For more information on our viewpoints, case studies, etc. please contact us at:
info@umsgroup.com

2012 UMS Group Inc., All Rights Reserved

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