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Business & Money

Some independent power producers failed to contain capital and O&M costs, adding to financial pressures.
Fortnightly Magazine - April 2004

special projects. Although the merchant generators that we studied in our sample did eliminate their special projects and clamped down on certain capital expense categories, they generally increased their O&M capital expenditures.

Capital Expenditures

PA estimated that the average plant in this study was allocated $2 to $3/MWh in capital improvements, which raised the real cost of production by as much as 20 percent, further eroding an already tenuous competitive position for most of these plants. One would have expected a pattern showing an increase in capital investment to reduce rising operating and maintenance expenses (see Figure 2).

To preserve cash, merchant generators slashed their 2002 capital budgets. Significant projects were delayed or canceled, and operating strategies were reconsidered. Keep in mind that plant level capital budgets can be segmented into five generic expense categories:

  • Revenue Enhancing: greenfield or brownfield development, or uprates to existing equipment;
  • Environmental: generally required by law;
  • Major Maintenance: major inspections of existing equipment required to ensure efficiency and availability;
  • Reliability: generally significant balance of plant projects intended to ensure plant availability; and
  • Other: a variety of plant projects from information technology system enhancements to new plant vehicles.

PA's review of the planned capital expenditures of the merchants showed that peak outlays in 2002, largely driven by the need to meet increasingly stringent environmental limits, were reduced for 2003. We also found that the amount of capital allocated to revenue-enhancing items also dropped due to the over-supplied generation market.

Yet the analysis shows that the capital planned for major maintenance and reliability related projects is expected to grow. Between 2002 and 2005, major maintenance expenditures are planned to increase 30 percent per year, while reliability expenditures are planned to grow some 108 percent (see Figure 3).

Upon further review, PA estimates that 25 to 30 percent of these planned and approved projects were unnecessary. Close examination of each planned project revealed considerable waste. Examples include:

  • A $48 million chimney replacement that engineers admitted caused no operational, maintenance, or safety issues. It just needed to be replaced;
  • A $17 million low-pressure turbine rebuild that had no negative impact on operations and showed no signs of imminent danger;
  • A $7.5 million spare turbine rotor for a rotor not in need of replacement; and
  • A $4 million rail-yard upgrade that offered some improved efficiency after several years of construction.

Current Capital Allocation Process

No doubt engineers considered each of these projects necessary and justified, but the examples above and many more were not necessary. Many of these projects fall into the "nice to have" or the "this is the latest technology" categories.

Certainly many retained projects were intended to improve the plant, but the rationale behind the decision was not always explicit. For example, when asked for the reason behind a specific approved project, one engineer explained that the components were old, maintenance was difficult, and that better technology existed. However, there was no explanation whether, or how, he had evaluated the cost and returns of possible replacement options to ensure a maximum return on invested capital.

Yet access to capital