Weighing Coal Power Plant Assets is No Simple Task

by | Apr 13, 2019 | Due Diligence, Energy sectors to watch

Coal consumption in the United States is on a steep decline, with significant changes unlikely to be reversed. According to the Energy Information Administration (EIA), consumption by residential, industrial, and commercial sectors declined from more than 1 billion tons in 2010 to 691 million tons in 2018.

These declines were mostly the result of changing preferences toward natural gas and renewables, though state and federal regulations and tax incentives played a role too. In particular, state policies have pushed many coal plants into early retirement prompting questions of asset allocation and transfers. As coal plant retirements near an all-time high, it’s crucial for plant owners to develop a concrete strategy to deal with outstanding cash flow and investments.

2018 saw the closure of 20 coal-fired plants, most notably the retirement of four Vistra plants in the ERCOT (Texas) market. For many of these plant owners, the cost of adding pollution control equipment exceeds any return on invested assets. Older plants tend to have less market value and less pollution-control equipment, making continued operating costs high and benefits to continued operation low.

But regardless of age or underlying market capitalization, no owner wants “stranded assets” valued in the tens (or even hundreds) of millions of dollars. PacifiCorp, one of the Western United States’ largest utilities and owners of power plant, recently faced this situation at the conclusion of a lengthy regulatory case before the Oregon Public Utilities Commission in which the owner tried to recoup a fraction of more than $660 million spent on anti-pollution controls on seven plants.

The owner used a “present value revenue requirement differential” analysis to argue that, although continued operating costs were high, the inefficiency of stranded capital due to premature plant closings and the costs of finding alternative power sources were far greater. PacifiCorp estimated the value of its net depreciation to be $3.38 billion, yet the cost of environmental improvements totalled $4.2 billion.

Making the decision to keep a plant running is difficult enough, even if stakeholders have the relevant financial figures to assess options and weigh trade-offs. Often, though, owners aren’t properly accounting for their assets and plant costs. According to an analysis by EnergyQuants, “Traditional net present value (NPV) analysis disregards the flexibility to adjust production decisions to market developments, and thus underestimate true plant value. On the other hand, methods treating power plants as a series of spread options ignore technical and contractual restrictions, and thus overestimate true plant value.”

Owners, for instance, may use hourly and daily forward curves to predict future price and demand levels, which are key to any plant valuation. Yet these factors alone have proven insufficient to make reliable forecasts, resulting in models having high error rates and overly broad high/medium/low price or spread scenarios. Relying on cointegration instead, financial analysts can use regression analysis to learn from the accuracy of previous modeling and use the results to create a more accurate forecast going forward. In other words, any realistic valuation relies on accurate demand projects, which in turn rely on “smart” analysis that learns from previous errors.

Once owners have a reasonable idea of the assets at stake from closure, they can make a truly informed decision on how to weigh operation costs and benefits. Coal plant operators finding that costs exceed benefits may opt for closure, and depending on the locality, governments may offer to assist in minimizing closure costs. In New Mexico, for instance, the state senate recently approved Energy Transition Bonds to finance retirements and lower costs for participating project owners.

Regardless of state and local assistance, many project owners will still find the retirement process difficult and may wish to find alternative ways to measure/assess stranded assets at stake. Ensight Energy offers comprehensive financial and technical advisory services to evaluate current and potential plant assets to determine the best path forward.  For expert advisory services during every stage of your energy project’s lifecycle, feel free to contact us via email at info@ensightenergyllc.com or by phone at 720.648.6554.