This article presents the approach developed by Transactive Management, Inc. (TMI) to assess the impact of intervener issues on hydro production costs, which TMI studies concluded are not sufficient to make hydropower uneconomic and therefore should not be a barrier to attracting new investment in this critical renewable energy resource. It is organized into the following topics:

1. The TMI approach to determining the depreciable life of plants in a deregulated market

2. The unique characteristics of hydro plants identified by applying this approach

3. The steps necessary to quantify the impact of intervener issues on hydro production costs

4. Conclusion

The Life of Power Plants in a Deregulated Market

TMI depreciable life studies have demonstrated that deregulation induced changes and other long-term industry trends can be used to project the useful life and value of power plants as a basis for determining the period of time over which plants should be depreciated. Conclusions on broader industry trends are used in combination with research and analysis of company-specific generating assets and management practices. Research in the latter area includes gathering information on maintenance and accounting policies and practices, asset positioning plans and strategies, and planning and internal control processes.

Figure 1 depicts the eight-step—or double-loop—analysis developed by TMI to determine the depreciable life of each type of technology on a company-specific basis. The first loop shows the steps followed to project the service life of a prototype plant that is representative of each generating technology under study. We first estimate the service life of each component consistent with their design life, failure mechanisms, and mode of plant operation. Next client operations and maintenance (step 2) and accounting practices (step 3) are reviewed to determine if they are consistent with component service life estimates. Service life estimates take into account life extension based on the ongoing repair, replacement, and upgrade of components. These estimates are applied to calculate the service life of each system and the overall plant based on the percent of total plant construction cost represented by each component. The last step confirms that costs incurred in maintaining the plant are reflected in financial pro forma projections.

The second loop shows the steps necessary to validate plant economic viability by projecting financial performance over the estimated service life. Operating costs (step 5) and generating costs (step 6) are based on updating plant financial pro forma projections to reflect the results of the technological life assessment. Validating economic viability is accomplished by projecting income and cash using long-term projections of market clearing prices for merchant plant sales and power sales agreements or other long-term contracts prices for contract sales (step 7). Plants are economically viable if the cumulative undiscounted cash flow meets or exceeds total carrying costs consistent with applicable accounting standards (step 8).

The Unique Characteristics of Hydro Power

When this approach was initially used in 1999 to determine the depreciable life of hydro plants, TMI found that these plants differ significantly from their fossil-fired counterparts. Because hydro plants do not operate in a high temperature or pressure environment, creep, oxidation, thermal fatigue and other component failure mechanisms that limit the lives of fossil-fired plant components—and serve as the basis for estimating their depreciable life—do not apply. From a technological perspective, hydro plants, dams, and other facilities can, in fact, operate forever if maintained to a reasonable standard of care. Moreover, such a standard of care is assured because of FERC’s regulatory oversight role regarding hydro system safety. Due to the inherent public safety issues associated with hydro (from natural disasters or catastrophic dam failures), FERC mandates third party inspections every five years. These studies:

1. Verify the integrity of dams;

2. Identify needed maintenance and remedial modifications;

3. Ensure that facilities are being properly operated and maintained;

4. Verify that licensees comply with the terms and conditions of their license.

From an economic standpoint, we found that hydro generation consistently ranks amongst the low-cost generators in regional markets due to zero cost for fuel, relatively low O&M costs, and capital costs that can be spread over very long time periods. The total production costs of the large majority of plants assessed to date are under 2 cents/kWh and even smaller and less efficient plant costs are under 3 cents/kWh. Moreover, the prevailing economic advantage will continue to improve over the longer term as the cost of conventional gas- and coal-fired plants, which dominate unregulated generation and market prices, will continue to increase due to rising fuel costs that will not be fully offset by the introduction of more efficient plants. For example, market-clearing prices in the northeast are projected to increase from about 5.5 cents/kWh in 2005 to about 7.5 cents/kWh by 2030.

Both the technological and economic longevity of hydro systems are supported by our review of the historic record of plants put into service since 1900. Only 306 plants representing less than 1 percent of the total population of plants have been retired. A number of plants have already been in operation over 100 years and it is reasonable to expect all hydro plants to operate this long, which reflects one of hydro’s significant advantages over other power technologies—its longevity.

In the three studies of hydro plants conducted in 1999, 2003, and 2005, we found that the eight step, double loop analysis outlined above, which is sufficient to determine the depreciable life of fossil-fired plants, was not sufficient to find an end-of-life point for hydro plants. To do this, TMI introduced the following “externalities” study criterion—could reasonably foreseeable changes in government, regulatory, or other external factors, impair or enhance economic viability by impacting generating costs? Thus the main focus of our studies shifted from understanding the technological factors that physically limit component life of fossil-fired plants—the key to estimating their depreciable life—to the extent to which addressing non-energy related intervener issues could render plants uneconomic.

The Issues/Impact Analytical Steps

As discussed above, a 1986 amendment to the Federal Power Act requires that environmental interests be considered by FERC when licensing or relicensing hydro projects. The Commission is required to give "equal consideration" to: power and development; energy conservation; protection, mitigation of damage to, and enhancement of, fish and wildlife (including spawning grounds and habitat); protection of recreational opportunities; and preservation of other aspects of environmental quality. This allows external stakeholders to intervene in the FERC licensing approval process. Even though during the term of a plant license, the condition of the license may not be changed without the licensee’s consent, the license includes various open-ended conditions. These open-ended conditions reserve the FERC’s right—upon complaint by an intervener—to require changes in project structures and operations for environmental and safety purposes.

The impact a variety of external stakeholders—that see the use of the watershed and generation structures as detracting from their particular interest be it endangered species, white water rafting, historic preservation, or a variety of other socially-beneficial causes—can increase costs or reduce production to the point of rendering plants uneconomic. Therefore TMI depreciable life studies have developed an approach to assess the impact of external stakeholders on the economics of hydro projects. This approach is made up of the following steps, each of which is described, in turn, below:

1. Develop a comprehensive issues list

2. Assess the potential impact of issues on each plant

3. Identify marginal plants

4. Complete a quantitative issues impact analysis of marginal plants

Develop a comprehensive issues list

The first step is to compile a comprehensive list of issues that could be the basis for stakeholder intervention. TMI has done this by attending hydro conferences, discussing dam safety issues with the Department of Reclamation, and working with hydro clients. Table 1 provides examples of some of these issues and their legal or regulatory basis.

Over the course of our studies, we have identified over 50 issues that can have either a positive or negative impact on the economics of hydro projects and grouped them into the seven categories depicted in Table 2, which also provides examples of issues in each category.

Assess the potential impact of issues on each plant

The next step is to systematically assess each issue by completing an Issues/Impact Assessment. The assessment must be done by responsible hydro management—i.e., officers and managers responsible for system planning and management including budget approval—consistent with accounting guidelines provided in the Statement of Financial Accounting Standards (SFAS) No. 144; “Accounting for the Impairment or Disposal of Long-Lived Assets”. This standard states that, in assessing the impact of externalities on the life of long-lived assets, only factors that have a level of likelihood greater than fifty percent, should be considered. It also states that such assessments are by their nature subjective and, in many situations, may be limited to management’s best judgment about the probabilities of the best, worst, and most-likely scenarios.

We prepare an Issues/Impact Assessment Matrix that lists the name of each plant—organized by river system—across the first row and issues—grouped by category—down the first column. Clients are asked to critically review issues we have initially identified and to keep, delete, modify, or add to what is listed based on their collective judgment regarding what could impact operations and costs.

Once this review is complete and the issues list validated or modified, clients consider each issue and determine if it could have a positive or negative impact on the economics of each plant over the next 50 years. If an issue is judged to have a negative impact, a minus is placed in the appropriate space on the matrix; if it is judged to have a positive impact, a plus is placed in the space. If an issue is not relevant, an “x” is entered to document that the issue was considered.

Identify marginal plants

Once the matrix is complete, it is reviewed to identify plants that are negatively affected by issues. Table 3 provides an example from a 2005 hydro study, which found that eight plants were negatively affected by the client-revised issues listed in the first column.

Management considers the impact of issues—both positive and negative—on each plant to identify plants that could be affected to the point of raising reasonable doubt regarding their long-term economic viability. The guideline for “reasonable doubt” is a greater than fifty percent probability that the plant: (1) will not be relicensed; (2) will not continue to operate through the remaining time under its existing license. In the Table 3 example, two plants were identified as “marginal plants” due to the costs that would be incurred to address external issues to the extent necessary to resolve stakeholder concerns.

Complete a quantitative issues impact analysis of marginal plants

The final step is to complete a quantitative analysis of marginal plants as identified in the prior step. The objective is to determine the extent to which addressing issues in a manner that satisfies concerned stakeholders will add to future operating costs or reduce production. For the two plants in Table 3 that were identified as marginal, we developed a cost estimate for building and operating fish ladders and flumes to allow for fish and eel passage. We also estimated production losses due to halting plant operations during certain hours and seasons to facilitate safe passage. The cents/kWh cost impact was estimated by spreading capital costs over the number of years plants were expected to be licensed and adding annual operating costs for operating fish passage facilities.

Taking any production losses into account, the adjusted cents/kWh production costs were calculated and compared to current and long-term projections of market clearing prices. Even though annual production costs increased by 28 percent for one plant and 75 percent for the other, the total adjusted operating costs for both were below current market clearing prices by about 50 percent or more. Moreover, this economic advantage would increase over time based on client projections of future market clearing prices. We concluded that even marginal plants would remain economically viable if costs were incurred to address external stakeholder issues.

Conclusion

The purpose of this article is to challenge the conventional wisdom that the cost and risk of addressing environmental and other issues raised by interveners makes it uneconomic to expand existing hydro systems or to develop new ones. I believe the time and cost of addressing intervener issues has proved a barrier to new investment because hydro owners fail to fully recognize the economic life of a hydro plant, which is generally treated as the remaining life under an existing license. What my studies recommend—and what TMI clients change the depreciable life of plants to as a result these studies—is the number of years under the existing license and an additional licensing period of at least 40 years.

The number of years over which the capital cost of non-production related facilities such as fish ladders are spread has a significant bearing on conclusions regarding the economics of such an investment. For example, investing $10 million to $15 million of non-productive capital on a 5 Megawatt plant, which earns less that $1 million a year in revenue, makes no sense if a company expects capital recovery over a remaining life under an existing plant license of 10 or 15 years. However, spreading the cost over an additional licensing period of 40 years would change the economics in favor of such an investment, particularly if future increases in market clearing prices are recognized.

The reason most often given for not investing in hydro is the length and complexity of the licensing and relicensing process. While progress is being made to remove this barrier, even with such a regulatory impediment, the time and cost necessary to develop a generating asset that will operate profitably for 80-to-100 years will likely justify such an investment.

Another factor that is overlooked in considering new investment in hydro is that it is the only generating asset that can actually be shown to increase in value over time based on the $/kW price at which these assets have been sold.

In sum, as we look increasingly to renewable energy to meet our future power needs, both regulated and unregulated generating companies with hydro systems should assess opportunities to expand rather than contract the production capability of these assets. Both should consider using the approach outlined above to systematically assess the production and cost impact of addressing issues raised by interveners in conjunction with assessing hydro expansion projects or relicensing efforts. In doing this, they should also take into account the longevity of hydro plants, which can reasonably operate for 100 years or more.

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