Financing Fossil Fuel Power Plants:

The Environmental Rubik’s Cube

Environmental Banker Association
San Antonio, Texas
January 20-22, 2008
Aditya Sharma, MS, PE
Environmental Resources Management

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 Presentation Overview

• US Power Sector Overview

• M&A Drivers
• Environmental Risk: Conventional Vs Business
• Evaluating Multi-facets of Business Risks
• Speedy Due Diligence: How to get info within 72 hrs!
• Working System to your advantage (positive cash flow)

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 US Power Sector Overview
• Traditional fossil fuels would continue to
meet the bulk of energy requirements.
• U.S. energy demand is projected to grow
at an average annual rate of 1.1 %
• The energy efficiency of the economy is
projected to increase at an average annual
rate of 1.8 %
• U.S. natural gas use is projected to be level
off over in the next couple of decades
• Future growth in U.S. natural gas supplies
depends on unconventional domestic Total= 4,055 Billion KWh
production, natural gas from Alaska, and Electric Utility Plants=63%
liquefied natural gas imports Independent Power Producers
& Combined Heat and Power Plants: 37%
Electric Power Annual with data for 2005 by EIA

“Carbon dioxide emissions from energy sources projected to grow at an

average annual rate of 1.2%”

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 U.S. Electricity Generation by Fuel, 1980-2030
(billion kilowatt hours)
Annual Energy Outlook 2007 by EIA

Projections

Coal

Natural Gas

Nuclear
Renewables Petroleum

“Fossil Fuel is going to be the primary source in the immediate future,

despite our desire to move to a non carbon future”

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 M&A in the Power Sector

Acquirer Target
Drivers: Alstom Power Power Systems
Manufacturing, USA
• To expand into a regional Alstom Power Qingdao Sizhou, China
or niche market
Alstom Power RMG-Yhtiöt, Finland
• To gain engineering &
Alstom Power Thomassen Turbine
technical capabilities & Systems, Netherlands

expand offerings on a Siemens Power Thomassen Turbine

Systems, Netherlands
new business platform
Ansaldo Energia Thomassen Turbine
• To guarantee future Systems, Netherlands

revenue streams. Ansaldo Energia Energy Services Group,

Switzerland

“M&A an effective tool to expand quickly to gain the competitive advantage“

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 Conventional Environmental Issues
(Recognized Environmental Conditions)
• Sub-surface Contamination: bulk
chemical storage (unlined coal piles,
ash management facilities, oil
storage); legacy issues; etc.
• Liability Limiting Provision:
Indemnifications, Insurance policies,
deed restrictions, and activity use
limitation (AUL), pre-transaction
covenants and releases to parties who
commit to defined remediation
undertakings prior to the
consummation of a transaction.
The risk can be quantified and managed using technical,
regulatory, legal or financial means-”the tool box”

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 Business Risk: Regulatory and Market Drivers

• Regulatory/legislative obligations
which have significant
operational and compliance
implications.
• Potential “DEAL BREAKERS”: can
be orders of magnitude higher
than all RECs combined.

Given the uncertainties, due diligence likened to solving a

Rubik’s cube- six sided puzzle with multiple iterative solutions

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 Side 1: US GHG Regulation Conundrum?
• Regional Initiatives

Northeast – RGGI (10 Northeast states)

Western Regional Climate Action RGGI states
Initiative (signed 2/26/07)

NW, SW, Great Lakes states have met
to discuss initiatives
• Individual State Initiatives

California: GWSA (AB 32) mandatory
GHG emission reduction (Most Watched)

Oregon, New Mexico, others close to
promulgating rules
RGGI: Ten States

Many states have developed GHG 53 million people
emission reduction “goals” with 8th largest emitter in the world
2.4+ trillion dollar economy
possible legislation to follow

“No effective “end-of-pipe” technology to control/remove CO2”

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 “A US National/Federal Program is in the Pipe Line”

9
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 The “RGGI” program: Salient features

• The region has a single cap

• Each RGGI source must “cover” its emissions with
allowances every three years
• Price Modulators/Offsets: Price sensitive limit to use.

Initially, limited offsets use to 3.3% of total CO2
emissions.

If $7/ton price trigger, expands the use to 5%;

If $10/ton trigger, expands the use to 10%

At $10/ton trigger, allowances from non-US projects

“Power plant CO2 emissions capped at 121.3 MM. tons through 2014;
reduced by 10% by 2018”

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 Allocation VS Auctions: The big question?

• Each state has an emissions

budget – in tons of CO2
• Model Rule requires
minimum of 25% of
allowances to be auctioned,
proceeds used for
Consumer Benefit and/or
Strategic Energy Purpose
• Most likely no free
allocations!
“Auctions: Could result in Millions of dollars annual
operating liability (depending on 25 % - 100 % requirement)”

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 Leakage: The Wild Card

• “Leakage”: A problem with the auction program is that it may make it

more economical to import electricity from unregulated states, resulting
in MORE CO2 emissions (losses during transport) and greater costs.
• RGGI’s Model Rule does not specifically address this issue.
• Various states evaluating options/mechanisms to address “leakage” :

California (SB 1368), adopted a GHG Emissions Performance
Standard (EPS), for other states supplying electricity to California.

New Jersey is evaluating this issue.

“Un-addressed Leakage could make it economically

infeasible for RGGI-affected facilities to compete in the free
market”

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 Cost of Electricity Generation ($/MWH)
Cost of Energy Efficiency adjusted
Generation Cost Factor
Fuel Type ($/MWH) Efficiency ($/MWH)
Natural Gas 22.51 0.80 28.13
Fuel Oil 32.97 0.90 36.64
Coal 6.07 0.30 20.23
Source: EIA
Cost of Credit 18.00 per tCo2 equivalent
Total Cost adjusted for CO2 compliance
CO2 emission CO2 compliance
generation cost Total Cost
Fuel Type (tonne/MWH) ($/MWH) ($/MWH)
Natural Gas 0.44 7.92 36.05
Fuel Oil 0.72 13.01 49.65
Coal 0.94 16.98 37.21
“Depending on operating configuration, CO2 compliance cost could shift the balance
away from coal- need to evaluate this on a portfolio bases”

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 Quick Due Diligence: Data Sources & Key Parameters

• Data Sources:

Emissions: EPA Clean Air Markets (http://www.epa.gov/airmarkt/) ,
RGGI website, AP-42 factors,

Baseline/Allowance: RGGI published data; model rule
• Key Parameter/Sensitivity:

Allowances (allocation vs auction)

Operational conditions: capacity factors, unit types (Base loading,
Intermediate, & Peaking)

Combustion efficiency

Fuel type and price: type of coals (waste coal, peat, lignite, sub
bituminous, and bituminous); dual fired (natural gas and fuel oil)

“Using publicly available information as a supplement, we can effectively

estimate the liability (order of magnitude)”

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Illustrative Modeling Approach: different Regulatory Scenarios
Modelled Description Modelled Rule Case (MRC) Reasonable Worst Case (RWC)
Scenario
Allocation Offset Allocation Offset

Scenario 1 Addresses only those projects
which are currently located in
RGGI endorsing states.
Assumes 75% allocation of
baseline; 25% auction (cost
varies from $3 to $9 per ton
based on anticipated
decrease availability from
2009 to 2018)
3.3% to 5% when allowance
price reaches $7/ton.
Assumes offset cost at $6
per ton for all years.
Assumes 100% 5 to 10% when
auction of entire allowance price
baseline (auction reaches or exceeds
cost varies from $9 $10/ton. Assumes
to $20 per ton based offset cost at $10 per
on anticipated ton for all years.
decrease availability
from 2009 to 2018)

Scenario 2 Facilities assumed to be Assumes 75% allocation of
effected by RGGI type baseline; 25% auction (cost
programs varies from $3 to $9 per ton
based on anticipated
decrease availability from
2009 to 2018)
3.3% to 5% when allowance
price reaches $7/ton.
Assumed offset cost at $6
per ton for all years.
Assumes 100% 5 to 10% when
auction of entire allowance price
baseline (auction reaches or exceeds
cost varies from $9 $10/ton. Assumed
to $20 per ton based offset cost at $10 per
on anticipated ton for all years.
decrease availability
from 2009 to 2018)

Facilities affected by
California AB32 type
programs
Assumes 75% allocation of
baseline; 25% auction (cost
varies from $3 to $9 per ton
based on anticipated
decrease availability from
2009 to 2018)
Amount of offsets not
limited but assumes 10% of
emissions acquired via
offset (with cost at $6 per
ton for all years).
Assumes 100% Amount of offsets
auction of entire not limited but
baseline (auction assumes 10% of
cost varies from $9 emissions acquired
to $20 per ton based via offset (with cost
on anticipated at $10 per ton for all
decrease availability years).
from 2009 to 2018)

“The uncertainty regarding applicable regulatory framework could lead to

different operative scenarios: cost implications”

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Graphical Representation of Cash Flow (Order of Magnitude)

Scenario 1 RGGI CO2 Cost Implications 2009 Prorated Scenario 2 Total CO2 Cost Implications 2012 Prorated

Total: Total

Facility 3
Facilities

Facilities
RWC RWC
Total AB-32:
MRC MRC
Facility 2

Facility 1 Total RGGI:

$0 $5 $10 $15 $20 $25 $30 $35

$0 $20 $40 $60 $80 $100 $120 $140
Cost ($m m )
Cost ($m m )

Scenario 2 Total CO2 Cost Implications 2018 Prorated

Scenario 1 RGGI CO2 Cost Implications 2018 Prorated

Total: Total

Facility 3
Facilities

Facilities
RWC RWC
Total AB-32:
MRC MRC
Facility 2

Facility 1 Total RGGI:

$0 $10 $20 $30 $40 $50 $60 $70

$0 $50 $100 $150 $200 $250
Cost ($m m )
Cost ($m m )

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 SIDE 2: Don’t forget other Air Emissions
• Acid Rain Precursors:

SO2: Title IV (Acid Rain), CAIR, other state
initiatives (MHAA)

NOx: Title IV (Acid Rain), CAIR, other state
initiatives (MHAA, NOx budget program)
• Mercury: Clean Air Mercury Rule is coming !!
• Program Dependant Evaluation Matrix:

Net emission (Tons/yr) or emission limit
(lbs/MMBTU) or a permutation of both.

various “Interstate”, “Intra State” &
“Company” compliance framework

Season accountability for NOx compliance
(Ozone, non-Ozone)
“Depending on fuel source and the resulting emissions, this can significantly
increase the operating cost and may mandate additional Air Pollution
Controls (significant Cap-Ex)”

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 Quick Due Diligence: Data Sources & Key Parameters
• Data Sources:

Emissions: EPA Clean Air Markets
(http://www.epa.gov/airmarkt/)

Allowance: various legislative directives,
Federal Implementation Plan and State
Implementation Plan.

Other Legal Obligation: Consent Decree,
ordinances may have economic (penalties and
CAP-EX) and operational (limited operation)
• Sensitivity Parameters:

APC equipment efficiency: optimal
configuration for different pollutants (FGD
and SCR combined reduce Hg)

Fuel type and price: type of coals (waste coal,
peat, lignite, sub bituminous, and
bituminous); dual fired (natural gas and fuel
oil)

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 Case Study: 900 MW Coal Fired Power Plant
Emission/Allowance Balance Sheet
Introduction of CAIR & MHAA

Current

CAIR
Deficit

MHAA

MHAA

CAIR
“Reducing caps have significant cost implications”

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 Cash Flow: Implications of Upcoming Regulations
Trigger Years

X X
“System” Wide Compliance
X
No interstate/intrastate
trading allowed

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 Air Pollution Control Added:
Emission/Allowance Balance Sheet

FGD
Installed by
2010

Excess Allowances

(assumes flue-gas desulfurization system installed in 2010 (90% removal

efficiency))

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 Cost Flow: Implication of Air Pollution Control Added

FGD
(150 – 200 million)

“Over compliance from one program may result in “assets” in another.”-

[positive cash flow]

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 SIDE 3: Cooling Water Intake/Discharge
(Impingement/Entrainment)
• Major Programs: Clean Water Act: 316 (b); Clean Water
Act 316 (a); CESA
• Stringent design requirements, capital and operating
expenditure
• January 2007, the underlying federal statute was
suspended; however, the requirements maybe enforced
via state/local permitting program
• Cost: Depending on the technology: Screen ($1-10 MM) to
Cooling Towers ($100 MM)
“Cap-ex/Op-ex: EPA published estimates (Low
end estimates)”

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 SIDE 4: Long Term Reserves

• Asset Retirement Obligations (GAAP & IAS): Obligations arising from

requirements that relate to enacted laws, statutes and written or oral
contractions. (SFAS No. 143 and FIN 47)
• Primary Drivers include coal ash management facilities (CAMF); asbestos
management & abatement; tank removal etc
• Key Parameters/Uncertainties: Itemized undiscounted liability; inflation
rate; discount rate; time period; and Obligation expected maturity
• Closure/Post Closure Obligations: not specifically covered under AROs.

“Realization of certain obligations indirectly trigger additional

requirements. For ex. If the CAMF reaches end of life, additional or
alternate CAMF may be required”

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 Side 5 (PRP) and Side (Compliance)
• Potentially Responsible Parties
(Third party –off-Site liability):
The regulatory agencies have the
right to seek out PRPs: individuals,
companies or any other parties that
are potentially liable for payment of
cleanup costs.
M&A Tip: Independent “entity &
asset search(s)” can be done to
verify any outstanding • Spill Prevention Control
Countermeasure Plan: (SPCC) The
obligation.
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• Air Compliance: NSR/PSD, NSPS,
MACT, particularly in non-attainment
areas (often urban areas, where
electricity demand may be greatest).

The cost for permitting may or may
not be material; however, cost for
compliance (additional APCs, Op-
EX) and historical non-compliance is
more than likely to be material.
upcoming 2009 SPCC regulation, may
require secondary containment
upgrades, which could be material.
 In Summary

• Fossil Fuel power plants will continue to

be the primary source for electricity in the
foreseeable future.
• In addition to traditional environmental
issues, attention needs to be given to
various business risks from various
federal, state and local legislation.
• Need to assess as a “portfolio” rather an
“individual asset”
• Turn Liability into Assets is a realistic.

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 Questions?

Aditya Sharma, P.E.

ERM
235 Park Avenue South
New York, NY
212-679-0288

aditya.sharma@ERM.com

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