Trading is dead. At least that’s what some analysts are saying about the electricity markets. “Trading died with Enron on Dec. 2, 2001,” says Mark Williams, an energy risk management expert at...
Business & Money
is very expensive to most merchants that generally must allocate it across several plants located in different regions in the United States (and even several countries) where each plant's competitive position varies according to its market. PA's experience indicates that the capital allocation process followed by many merchant generators is flawed.
In many cases, proposed capital projects were not linked to the corporate or plant strategy. Examples include painting, parking lot improvements, floor sweeper replacement, purchase of special tools, and large contingent amounts for undefined projects. Additionally, many had weak business cases, and for those with business cases, alternate technical or business options for accomplishing the same goal were not often analyzed. Examples include overly frequent major inspections (4-year cycles that could be delayed), rail upgrades, controls upgrades, and significant capital spare part purchases in maintenance budgets.
Furthermore, there often was a lack of risk assessment (e.g., risks of late delivery; not achieving the performance improvement anticipated, or negative system impacts resulting from an isolated project; and cost overruns). These risks are not negligible. For example, a major unit inspection-an action that was often recommended in the plans that we reviewed-is in reality a collection of many smaller projects (e.g., inspections of boilers, turbines, plant controls, fuel delivery systems), each with its own performance risk and with the potential to delay the unit's return to service. Of course, within each of these smaller projects are still smaller projects, each with its own risks, rewards, and potential to result in cost overruns, or delaying the unit's return to service.
Plant expenditures designated for individual projects should be managed as a portfolio. This ensures not only that risks are fully understood, but also that capital is efficiently invested. While always important, this is especially critical during the current generation oversupply. Many assets may not perform as anticipated, and O&M plans need to take that into account.
Finally, the PA study revealed a disturbing lack of portfolio performance assessment and feedback. Project managers generally track performance during their project, but firms rarely monitor portfolio performance. Even more uncommon is the merchant generator that looks back at performance with a critical eye, searching for opportunities to improve.
In conclusion, each O&M cost re-duction or capital expenditure project should:
- Drive some strategic objective;
- Be selected from many options to accomplish a goal based on rigorous analysis;
- Be evaluated based on its impact on the entire capital portfolio of programs and projects; and
- Be managed to ensure the intended benefits are realized and the risks mitigated.
By following these basic principles, electricity generators can conserve cash, manage risk, and thereby increase value.
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