Economic Feasibility and Investment Decisions of Coal and Biomass

Oleg Kucher and Jerald J. Fletcher

West Virginia University

30th USAEE/IAEE North American Conference,

October 9-12, 2011, Washington, DC

Economic Feasibility and Investment Decisions of Coal and Biomass to Liquids

Acknowledgment: “This material is based upon work supported by the Department of Energy under Award Number DE-FC26-06NT42804. Disclaimer: “This report was prepared as an account of work sponsored by an agency of the United States Government. Neither the United States Government nor any agency thereof, nor any of their employees, makes any warranty, express or implied, or assumes any legal liability or responsibility for the accuracy, completeness, or usefulness of any information, apparatus, product, or process disclosed, or represents that its use would not infringe privately owned rights. Reference herein to any specific commercial product, process, or service by trade name, trademark, manufacturer, or otherwise does not necessarily constitute or imply its endorsement, recommendation, or favoring by the United States Government or any agency thereof. The views and opinions of authors expressed herein do not necessarily state or reflect those of the United States Government or any agency thereof.”

3

We provide micro-economic analysis of commercial

CBTL 50,000 bpd projected plant with 7.7% by weight biomass

based on NETL(2009)* techno-economic design

Conclusions: Despite the technical feasibility of CBTL

processes, there is little evidence of strong commercial

viability of CBTL development in the U.S. under present

energy prices and projected costs. In the presence of

uncertainty over the payoff from investing, the high capital

cost of CBTL plant is the main barrier to the construction

of a large-scale CBTL plant in the U.S.

Upfront conclusion

Source: *National Energy Technology Laboratory. 2009. "Affordable Low-Carbon Diesel Fuel from Domestic Coal and Biomass." DOE/NETL-2009/1349.

4

Oil

Alternatives:

Costs and

Emissions Vary

Widely

High and low range of

costs and emissions

Assumed range of

crude oil prices

Midpoint of cost and

emission range

PERCENT OF GREENHOUSE GAS EMISSIONS RELATIVE TO CONVENTIONAL OIL

PR

OD

UC

TIO

N C

OS

T (

US

DO

LL

AR

S P

ER

BA

RR

EL

OF

OIL

EQ

UIV

AL

EN

T)

Figure 1: Cost and emissions data for 2008–2009

1. Introduction 2. Research methods and model 3. CBTL project evaluation 4. Summary and policy implications

Oil Alternatives Overview: Costs and Emissions

Coal-Biomass to

Liquids, NETL(2009)

$

$

$

$

$

$

$

$

-20%

Source: Adapted from Darmstadter, Joel. 2010. "The Prospective Role of Unconventional Liquid Fuels." Resources for the Future, 1-31 based on Newell. 2006. “What’s the Big Deal about Oil?” Resources.

NETL study*: CBTL could produce“affordable & low-carbon diesel”

Feasibility of CBTL 50k bpd plant with 8%wt at $80-$100 bbl

In U.S. 3 CBTL projects with capacity over 110k bpd:

American Clean Coal Fuels, IL; Baard Energy, Wellsville, OH;

Rentech, Natchez, MS

None of the CBTL projects have been completed

Reasons:

Financing issues, Environmental concern, Costs, Uncertainty

Feasible Solution to the Carbon Problem?

5



Motivation and Objectives

6

CBTL economic feasibility and investment decisions:

• Is the CBTL project commercially viable in the U.S.?

• If yes, than why are CBTL projects delayed so far? Risks?

Research objectives:

• economic assessment of the CBTL cash flows and NPV;

• assess the value option to invest into the CBTL plant

• draw insights on investments for the CBTL plant in the U.S.


• Valuing NPV • Uncertainty estimation • Valuing investment opportunity

• Valuation of cash flows discounted at the end of the year

• Sensitivity analysis

• The probability occurrence technique

• Monte Carlo simulation

• Dynamic programming

• NPV, IRR

• Sensitivity results

• Distribution parameters

• Volatility estimates

• Value of options to invest

1. DCF 2. Risk analysis 3. Real options

Research Methods and Model O

bje

ctiv

es

Tech

niq

ues

R

esu

lts

Figure 2: Research framework for the CBTL evaluation

7


Real Options Model

𝐹 𝑉 = max 𝜀 (VT − 𝐼)𝑒−𝜌𝑇

𝑑𝑉 = 𝛼 𝑉 𝑑𝑡 + 𝜎𝑉𝑑𝑧

The basic continuous-time model after Dixit and Pindyck (1994)

Investor’s problem:

Maximize a payoff 𝑉𝑇−𝐼, discounted at 𝜌

s.t. change in NCF, 𝑑𝑉 that follows GBM,

with 𝛼 growth rate, 𝜌-discount, 𝜎- st.dev.

F V = 𝐴𝑉𝛽1

𝑉 − 𝐼

V ≤ V∗ V > V∗

𝛽1 = 1/2 − ρ − δ 𝜎2 + [ ρ − δ /𝜎2 − 1/2]2+2𝜌/𝜎2

𝐴 = (V∗−I)𝑉𝛽1 = 𝛽1 − 1 𝛽1−1/[𝛽1𝛽1𝐼 𝛽1−1]

V∗ = 𝛽1/(𝛽1 − 1)𝐼

Solution by Dynamic Programming:

Source: Dixit, Avinash K. and Robert S. Pindyck. 1994. Investment under Uncertainty. Princeton University Press.

8

Constants

Trigger value

Value of options to wait

Value of options to invest


CBTL Project Evaluation

Parameters Values

Pla

nt

bas

is Plant type designed by NETL(2009)* CBTL 50k bpd, 7.7wt% biomass

Life of project & construction period 30 & 4 years

Operating capacity 0.89 Coal & biomass input 19948 tpd & 1657 tpd

ULSD & naphtha output 34292 bpd & 15708 bpd

Eco

no

mic

s Startup prices & Inflation 2010 year & 2%

Investments (total as-spent capital) $5.6 billion

Discount rate 8% Tax rate 38%

Fin

anci

ng Ownership: debt/equity, % 60%/40%

Debt: senior/subordinated, % 80%/20%

Senior & Subordinated interest rates 5.5% & 9%

Table 1: Main parameters and assumptions in DCF analysis

9



Discount Cash Flow Analysis (DCF)

Free Cash Flow to Firm (FCFF):

FCFF=EBIT(1-Tax Rate)+Depreciation-CapEx Δ Working Capital

$0.0

$0.5

$1.0

$1.5

$2.0

$2.5

$3.0

2012 2019 2026 2033 2040Year

Product revenue

Billions of dollars

$(2.0)

$(1.5)

$(1.0)

$(0.5)

$-

$0.5

$1.0

$1.5

2012 2019 2026 2033 2040Year

Free cash flow to firm

Billions of dollars

Payback 13 years 78% of revenue from ULSD 22% revenue from naphtha

Cash intensive : revenue$1.87 billion, FCFF$191 million per year

Figure 3: Product revenue Figure 4: Free Cash Flow to Firm

10


DCF, Cont.

12.9% -$4,000

$0

$4,000

$8,000

$12,000

1.0% 4.2% 8.4% 12.6%

NP

V

Cost of Equity, %

Millions of dollars

IRR on Equity

9.2% -$4,000

$0

$4,000

$8,000

$12,000

1.0% 4.2% 8.4% 12.6%

NP

V

Cost of Capital, %

Millions of dollars

IRR

Free Cash Flow to Equity Free cash flow to Firm

• NPV>0 accept the CBTL project

• But IRRs are low for high risky project

• The cost of capital indicates high sensitivity of NPV

Figure 5: NPV (FCFF) at discount Figure 6: NPV (FCFE) at discount

11


Sensitivity Analysis (1) for NPV, FCFF

Top sensitive variables for NPV (FCFF):

Fuel prices, Operating Capacity, Discount, Investments

NPV= $767 million

Millions of dollars

Figure 7: Impacts of major sensitive parameters ( 10 %) on NPV8 (FCFF)

12


Sensitivity Analysis (2) for NPV, FCFE

Top sensitive variables for NPV (FCFE):

Investments, Operating Capacity, Discount, Debt ratio, Fuel prices

NPV= $207 million

Millions of dollars

Figure 8: Impacts of major sensitive parameters ( 10 %) on NPV12 (FCFE)

13


Risk Assessment

14

Fitting distributions of sensitive variables:

Capital expenditures: $5-$6.5 billion range for CBTL 50k bpd plant

Operating capacity: U.S. refinery utilization rate89%; st.dev. 6.3%

ULSD & coal prices st. dev. up to 30%; Oil price st. dev. 45%

Dividend rate: mean 6% & triangular distribution with ±10% change

Correlation of ULSD & oil prices 0.9; Corr. coal & fuel prices 0.6


Monte Carlo Simulation

The payoff of the CBTL project is lowered by 1/3:

Mean NPV8 $497 millions. It falls -$0.85 & $1.7 billion at 90% CI

Mean of NCF $185 millions, St. Dev. $25 millions (13%)

Figure 9: NPV8 and NCF forecast after 4000 simulations NPV NCF

15


497

Real Options Application

I

NPV

V

F(V)

V*

$3,468

-$5,000

-$3,000

-$1,000

$1,000

$3,000

$5,000

$0 $1,000 $2,000 $3,000 $4,000 $5,000 $6,000 $7,000 $8,000 $9,000 $10,000

NP

V

Present value of Net Free Cash Flow, millions of dollars

Linear NPV . . . .

Figure 10: Value of the investment opportunity

16

𝐹(𝑉)𝑤 𝐹(𝑉)𝑖𝑛𝑣


4.5 times

Summary

A CBTL project is feasible but in the near-term it cannot be

commercially viable under uncertainty in the energy market

• NPV8 from FCFF$767 million

• The biggest impact on NPV: fuel prices, discount, investments

• Uncertainties lower payoff by 1/3 with 25% chance of NPV<0

Real options yields high value to wait:

• The value of waiting could reach 2/3 value of capital costs

• The payoff needs to exceed the traditional NPV over 4 times

17


Policy Implications

In order to make the CBTL project viable:

• CBTL technology will need to be substantially more cost

effective, either through:

• reductions in capital costs,

• increased policy incentives, (i.e, carbon legislation),

• better project economics (i.e. optimized configuration),

increase in product demand and government support to

attract investment.

18


Backup: Risk Assessment Parameters

Variable Value Distributional Assumptions

U.S. Ultra low sulfur diesel price, $/gallon $2.31 Lognormal 3: St. Dev. 0.61

Coal price, $/t $44.6 Lognormal: St. Dev. 12.5

Crude oil price, $/oil barrel (bbl.)

$79.4

Lognormal: St. Dev. 35

Operating capacity 0.89 Gumbel Minimum: Beta 0.05

Dividend rate,% 6 Triangular: Min –10%, Max. +10%

Capital costs, millions of dollars

$5,595 Triangular: Min –10%, Max. +15%

Table 2: Fitted distribution parameters and distribution assumptions

19


Backup: Real Options Application

Parameter Value

δ, dividend (payout) rate 0.06

𝐼, present value of capital costs (TASC), $ millions $4,972.6

𝑉, present value of net cash flow to the firm, $ millions $5,739.6

𝑁𝑃𝑉, 𝑁𝑃𝑉 = 𝑉 − 𝐼, millions of dollars $767.01

NCF, millions of dollars per year $184.9

𝜎, volatility of average present value of net cash flow, % 13.49

Table 3: Real options model parameters

20

𝛽1 = 2.434, 𝐴 = 0.00000096486, V∗= $ 8,440.95 million.


Documents

Economic Feasibility and Investment Decisions of Coal and Biomass