Case Problem 5 DUKE ENERGY COAL ALLOCATION* Duke Energy manufactures and distributes electricity to customers in the United States and Latin America. Duke recently purchased Cinergy Corporation, which has generating facilites and energy customers in Todiana, Kentucky, and Ohio.For these customers Cin~ ergy has been spending $725 to $750 million each year for the fuel needed to operate its ceal-fired and gas-fired power plants; 92% to 95% of the fuel usd is coal. Inthis region, Duke Energy uses 10 coal-buming generating plants: five located inland and five located on the Ohio River. Some plants have more than one generating unit. Duke Energy uses 28-29 million tons of coal per yearata cost of approximately $2 million every day in this region. ‘The company purchases coal using ixed-tomnage or variable-tonnage contracts from ‘mines in Indiana (49%), West Virginia 20%), Ohio (12%), Kentucky (11%), Hinois (5%), and Pennsylvania (3%). The company must purchase al ofthe coal contracted for on fixed-tonnage contracts, but on variable-tomnage contracts it can purchase varying amounts up to the limit specified in the contract. The coal is shipped from the mines to Duke Energy's generating facilities in Ohio, Kentucky, and Indiana. The cost of coal ‘aries from $19 to $35 per ton and transportation/detivery charges range fram $1.50 to $5.00 per ton ‘A moda is used to determine the megawatt-hours (mWh) of electricity that each gen- crating unitis expected to produce and to provide a measure of cach generating unit's eff- ciency, refered to as the heat rate. The heat rate is the total BTUs required to roduce 1 kilowatt-hour (kWh) of electrical power. Coal Allocation Model Duke Eneray uses a linear prosramming model, called the coalallocation model, t0 allo- cate coal to its generating facilities. The objective ofthe ccal allocation model isto deter- mine the lowest cost method for purchising and distrbuting coal to the generating unis ‘The supplylavailabilty ofthe coal is determined by the contracs with the various mines, and the demand for coal atthe generating units is determined indiretly by the megawatt” hours of electricity each nit must proce. ‘The costto process cou called te add-on cost depends upon the characteristics of the coal (moisture content, ash Content, BTU content, sulfur content, and grindabiity) and the ficiency ofthe generating unt. The adi-on cost plus the transfortation cost are added to the purchase cos of the eva to determine the total cost to purchase and use the ccalCurrent Problem Duke Energy signed three fixed-tomrage contracts and four variable-teanage contracts. The ‘company Would like to determine the least-cost way to allocate the cnal available through these contracts to five genersting units. The relevant dita for the three fixed tonnage con- tracts are asfollows: Number of Tons Cost Supplier Contracted For (Sion) BrUsIb RAG 350,000 2 13,000 Peabody Coal Sales 300,000 26 13,300 “American Coal Sales 275,000 2 1290 For example, the contract signed with RAG requires Duke Energy to purchase 350,000 tons of eoalat aprice of $22 per ton; each pound of this particular coal provides 13,000 BTUs. ‘The data for the four variable-tonnage contracts follow: Number of Tons Cost Supplier ‘Available (Siton) BTUs Consol, ne. 200,000 32 12.250 Cyprus Amax 175,000 35 12/000 ‘Addington Mining 200,000 31 12,900 Waterloo 180,000 B 11,300 For example, the contract with Consol, Inc., enables Duke Energy to purchase up to 200.000 tons of coal at a cost of $32 per ton; each pound of this coal provides 12,250 BTUs, ‘The number of megawat-hours of electricity that each generating unit must produce sand the heat rate provided are ar follows: Electricity Heat Rate Generating Unit Produced (mWh) (BTUs per kWh) Miami Fart Unit 5 550.000 10.500 Miami Fort Unit 7 $00,000 10.200 Beckjord Unit 1 650,000 10,100 East Bond Unit 2 750,000 10,000 Zimmer Unit | 1,100,000 10.000 For example, Miami Fort Unit S must produce $50,000 megawatt hous of electricity, and 10,500 BTUs are needed to produce each kilowatt-hour.‘The transportation cost and the aeid-on cost in dollars per ten are shown here: ‘Transportation Cost (Siton) Miami Fort Miami Fort Beckjord East Bend Supplier Unit 5 Unit 7 Unit! Unit 2 RAG 5.0 500) 415 5.00, Peabody 35 375 3.50 375 ‘American 3.0, 3.00. 275 3.00, Consol 325 325 285 3.25 Cyprus 5.0 5.0, 415 5.00, Addington 2.25 225 2.00 2.25 Waterloo, 2.00 200 1.60 200 Add-On Cost (S/ton) Miami Fort Miami Fort Beckjord East Bend Zimmer Supplier Unit 5 Unit 7 Uniti = Unit? Unit 1 RAG 1000 10.00, 10.00 5.00, 600 Peabouy 1000 10.00 11.00 6.00 700 ‘American 1300 1300, 15.00 9.00 9.00 Consol 100 10.00 11.00 7.00, 700 Cyprus 1000 10,00, 10.00 5.00, 600. Addington 500 5.00, 6.00 4.00 400. Waterloo, 1100 1100 11.00 7.00 9.00 Managerial Report Prepare a report that summarizes your recommendations regarding Duke Energy's coal allocation problem. Be sure to include information and analys® for the following | Determine how much cos! to purchase iromeach ofthe mining companies and how it should be allocated to the generating units. What is the cost to purchase, deliver, ‘and process the coal?” Compute the average cost of coal in cents per million BTUs for each generating unit (a messure of the cost of fuel for the generating units). 9, Compute the average numberof BTUs per pound of coal received at each generat- ing unit (a measure of the energy efficiency of the coal received at each unit) 4. Suppose that Duke Energy can purchase an additional 80,000 tons of coal from “American Coal Sales as an “all or nothing deal” for $30 per ton. Should Duke Energy purchase the additional 80,000 tons of coal?” 5, Suppose that Duke Energy leas that the energy content of the coal from Cyprus ‘Amax is actually 13000 BTUs per pound. Should Duke Eneray revise its procure- ‘ment 6, Duke Energy has leaned from its trading group that Duke Energy can sell $0,000. ‘megawatt-hours of electricity overthe grid (to other electricity suppliers) ata price of $30 per megawat-hour. Stould Duke Energy sell the electricity? If so, which ‘generating units should produce the additional electricity?Case Problem 2 DISTRIBUTION SYSTEM DESIGN ‘The Darby Company manufsctures and distributes meters used to mecsure electric power consumption. The company started with a small production plant in EIPaso and gradually built a customer base throughout Texas. A distiibution center was established in For TABLE 6.10 SHIPPING COST PER UNIT FROM PRODUCTION PLANTS TO DISTRIBUTION CENTERS (IN S) Distribution Center Fort Santa Las Phot Worth Fe Vegas ELPaso 320 220 420 San Bernardino = 390 120 ‘Worth, Texas, and later, as business expanded, a second distribution center was established in Santa Fe. New Mexico. “The El Paso plant was expanded when the company began marketing its meters in Ari- zona, Califomia,Nevala, and Utah. With the growih of the West Coast business, the Darby ‘Company opened a third dstitution center in Las Vegss and just two years ago opened a second production plant in San Bernardino, Cilifomia. “Manufacturing cots differ between the company’s production plans. The cost of each ‘meter produced a the El Psso plant is $10.50. The San Bernardino plant utilizes newer and ‘more elficient equipment; asa result, manufacuring costs ae SO.50 per meter les than at the E1 Paso plant. ‘Due to the company’s rapid growth, not much attention kad been paid to the efficiency of the distritution system, but Darby's management decided tha it is time to address this issue. The cost of shipping a meter from each of the two plants to each ofthe three distri- bution centers is shown in Table 6.10. ‘The quarterly production capacity is 30.900 meters at the okler Fl Paso plant and ‘20,000 meters at the San Bernardino plant. Note that no shipments ae allowed from the ‘San Bemardino plant to the Fort West distribution center. “The company serves nine customer zones from the three distibution ceaters. The fore- cas of the number of meters needed in each custorer zone for the next quarter is shown in Table 611 ‘The cost per unit of shipping from each distribution center to each customer zone is, tiven in Table 6.12; note tha some distuitution centers cannot serve cerain customer zones. In the current distribution system, demand at the Dallas, San Antonio, Wichita, and Kansas ity customer zones is satisfied by shipmerts from the Fot Warth distitution cen- ter In asimilar manner, the Denver, Salt Lake City, and Phoenix customer zonesare served by the SantaFe distribution center, and the Los Angeles and San Diego customer zones areserved by the Las Vegas distibusion center. To determinehow many units toship romeach plant, the quarterly customer demand forceasts are aggregated atthe distribution ceuters, ‘and a transportation model is used to minimize the cos of shipping from the production plants to the distribution centers. Managerial Report ‘You are asked to make recommendations for improving the distribution system, Your re pot should address, but not be limited to, the following issues 1 Ifthe company does not change its current distritution strategy, what willits disti- ‘ution costs be forthe following quarter? ‘Suppose that the company is willing to consider dropping the distribution center ‘imitations; that is, customers could be served by any of the distribution centers for ‘which costs are available. Can costs be reduced? By bow much? The company wants to explore the posibility of satisfying some of the customer demand cirectly from the production plants. In particular, the shipping cost is 80,30 per unit from San Bemardino to Los Angeles and $0.70 fiom San Bernardino ‘@ San Diego. The cost for direst shipments from El Paso to San Antonio is ‘3.50 per unit-Can distribution costs be furtier reduced by considering these direct plantto-castomer shipments? Over the next five years, Dasby is anticipating moderate growth (5000 meters) to ‘he North and West. Would you recommend that they consider plant expansion at this time? TABLE 6.11 QUARTERLY DEMAND FORECAST Customer Zone ‘Demand (meters) atlas 600 ‘San Antonio 4880 Wichia 2130 Kansas City 1210 Denver 6120 Salt Lake Cty 4830 Phoenix 2750 Los Angetes #580 ‘San Dego 4460 TABLE 6.12. SHIPPING COST FROM THE DISTRIBUTION CENTERS TO THE CUSTOMER ZONES tribution Center Fort Worth Santa Fe Las Vegas Customer Zone San Kansas Salt Lake Los San Dallas Antonio Wichita City Denver City Phoenix Angeles Diego 03) 210 4k — 52 S40 4S a 34 — = = $4 33 24