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The Growing Strategic Role of Fuels

Fortnightly Magazine - April 1 1995

to view dispatch of the company's own plants as part of a broader make or buy decision.

The only long-run choice open to many companies will be to restructure their plant mix or operations in such a way that fuel costs become competitive. Yet the incremental fixed costs of doing so must remain low enough that the utility still makes money.

Restructuring generation resources to meet fuel objectives and constraints is exactly the opposite of the way that fuels have traditionally been managed. In many companies the fuel function reported to the production department, and fuels were viewed as just one more commodity to keep the plants running. While this perspective has broadened, many companies still consider power production their core skill. Unfortunately, by itself, this skill provides little enduring competitive edge: Power plant operating skills are common; considerable excess capacity exists in many regions; and new plants can now be built by a broad range of potential competitors. Coordinating power production and fuels with power marketing and environmental activities, however, is the lifeblood of an effective corporate strategy.

Many companies can produce a greater impact on variable costs through innovative fuel management than by changing power plant operational practices. Heat rates and availabilities can only be improved a few percent at most plants. Furthermore, the technologies and practices that allow such improvements are usually available in the marketplace and can be replicated by competitors. Fuel management options, by contrast, are often much more diverse. Creative fuel strategies can have unique and continuing impacts on variable costs beyond just a few percentage points. Competitive fuel prices don't just happen.

Corporate Strategies

Companies will structure their strategies to improve fuel management in a variety of ways:

Explicitly linking power market transactions to fuel market transactions. Fuel market activities will be designed to meet the needs of specific power contracts. Relationships with producers and carriers will be structured to ensure that fuel prices support competitive power pricing. Utilities will develop innovative fuel contracts and establish relationships with fuel suppliers and carriers other than the traditional arm's-length relationships.

Acquiring and disposing of generation resources. Fuel considerations have long been key to technology choice and environmental compliance. Now they will take on added significance as utilities shuffle their generation mix. Plants that are poorly sited or structured to produce low fuel costs will be dropped; plants with favorable fuel-supply characteristics will be added. Evolving distributed generation concepts will also present significant fuel-supply challenges.

Increasing reliance on outside production capacity or energy. This strategy may include purchases (or leases) from neighboring utilities as well as independent power producers (IPPs), and perhaps even moving utility-owned plants outside the corporate structure (sale/leaseback). By adjusting contract terms, such shifts in reliance may convert generation assets from a fixed cost to assets with different degrees of cost variability. This option will increase operational and financial flexibility and reduce dependence on specific fuel suppliers.

Restructuring fixed costs. While variable costs may determine which companies are competitive in currently price-sensitive markets, coverage of total costs determines profitability. Companies will be seeking creative ways