3. Introduction
In a typical consumer bill in most
European countries, generation
costs (investment and operation)
make up about 60% while
transmission and distribution
network costs are in the order of
10% and 30% respectively. Annual
electricity losses in transmission and
distribution networks in the majority
of industrialized countries are
around 1–3% and 4–7%
respectively.
3
Key drivers of system operation and planning are economy and security. More recently
these concerns have been supplemented by sustainability considerations aimed at
limiting the CO2 emissions that accompany the use of fossil fuel in power stations.
4. Introduction
4
The subject of economics is quite vast. We are not, here, to investigate its principles.
We do not want to be involved in those aspects of economics which, somehow,
interact with electric markets, too.
Instead, we want to, shortly, review the definitions of some basic terms used in power
system planning field and especially in this course. The terms defined are not,
necessarily, related to each other. Later on, they will be used throughout the course,
once needed. The cash-flow concept is reviewed and the methods for economic
analysis are covered in this presentation.
5. Definition of Terms
5
Revenue
Revenue is the money that a
company earns by providing services
in a given period such as a year.
Investment cost
Investment cost is the cost incurred in
investing on machinery equipment and
buildings used in providing the services.
Cost
Cost is the expense incurred in
providing the services during a
period.
Profit
Profit is the excess of revenue over
the cost.
Operational cost
Operational cost is the cost incurred on
running a system to provide the services.
Wages, resources (fuel, water, etc.), taxes
are such typical costs.
Depreciation
Depreciation is the loss in value resulting
from the use of machinery and equipment
during the period. During a specific period,
the cost of using a capital good is the
depreciation or loss of the value of that
good, not its purchase price. Depreciation
rate is the rate of such a loss in value.
Salvage value
It is the estimated resale value of an
asset at the end of its useful life.
6. Definition of Terms
6
Nominal interest rate
Nominal interest rate is the annual
percentage increase in the nominal
value of a financial asset. If a lender
makes a loan to a borrower, at the
outset, the borrower agrees to pay
the initial sum (the principal) with
interest (at the rate determined by
interest rate) at some future date.
Inflation rate
Inflation rate is the percentage
increase per a specific period
(typically a year) in the average
price of goods and services.
Real interest rate
Real interest rate is the nominal
interest rate minus the inflation rate.
Present value of some money at some future date is
the sum that if lent out today, would accumulate to x
by that future date. If this present value is represented
by P and the annual interest rate is termed i, after N
years we would have (F)
or
Here, 1/ (1 + i)N is called discount factor.
Time value of money.
7. Definition of Terms
7
Example: What's the salvage value of Bridget's
high-end car if it's five years old, she bought it
for $27,500 and it depreciates 22% annually?
• P = 27,500 (original price)
• i = 22% (depreciation rate)
• y = 5 (age in years)
S=P(1 - i)N
Where, P = original price
i = depreciation rate
N = age in years
S = salvage value
8. Cash Flow Concept
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The flow of money,
both the inputs and
the outputs, resulting
from a project is
called cash-flow. In
order to understand
this concept, we
should first define
the time value of
money.
11. Economic Analysis
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From various solutions available for a problem, a planner should select the best, in
terms of both technical and economic considerations. Here we are going to discuss
the economic aspect of a problem.
Three methods may be used for economic appraisal of a project, namely as
• Present worth method
• Annual cost method
• Rate of return method
In evaluating a project, we should note that various plans may be different in
terms of effective economic life. Sometimes, it is assumed that the economic life
of a plan is infinite (n→∞).
12. Present worth method
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• Alternatives are developed from project proposals to accomplish a stated purpose.
• Some projects are economically and technologically viable, and others are not. Once
the viable projects are defined, it is possible to formulate the alternatives.
• Alternatives are one of two types:
a) Mutually exclusive – Only one of the viable projects can be selected. The viable
projects compete against one another.
b) Independent - More than one can be selected; compete only against DN.
Formulating Alternatives
Do Nothing Alternative: – If none of the mutually exclusive alternatives are
considered economically viable the “Do Nothing” alternative is accepted by default.
The do-nothing option is often low-cost but has low returns as well, making it a great
way to avoid choosing the best of a bad lot, but a lousy choice for a firm seeking
growth.
New alternatives should be developed and the analysis should continue until an
economically viable alternative is available.
14. Present worth method
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Present Worth Analysis of Equal-Life Alternatives
One alternative:
Calculate the PW. If PW > or = 0, the alternative is financially viable. Precede costs
by minus sign; receipts by plus sign.
Two or more alternatives:
Calculate the PW of each alternative. Select the alternative with the PW value that is
numerically largest, that is, less negative and more positive, indicating a lower PW of
cost cash flows or larger PW of net cash flows of receipts minus disbursements.
For mutually exclusive alternatives, select one with numerically largest PW
For independent projects, select all with PW > 0
18. Present worth method
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Present worth analysis requires an equal service comparison of alternatives, that is,
the number of years considered must be the same for all alternatives. If equal service
is not present, shorter-lived alternatives will be favored based on lower PW of total
costs, even though they may not be economically favorable.
Fundamentally, there are two ways to use PW analysis to compare alternatives with
unequal life estimates;
• Least common multiple of lives for each pair of alternatives- Compare the
alternatives over a period of time equal to the least common multiple (LCM) of their
lives.
• Study period (planning horizon)- Compare the alternatives using a study period
of length n years, which does not necessarily take into consideration the useful lives of
the alternatives. This is also called the planning horizon approach.
In both cases, the PW is calculated, and the selection guidelines of the previous
section are applied. The LCM procedure is used unless otherwise specified.
PW of Different-Life Alternatives
24. Discussions
24
Economies of scale:
when average cost of production, $/MWhr decreases as generation plant gets larger. And
this drove all thinking in the electric industry from 1900 until the early 1960’s. And then what
happened?
25. Discussions
25
Smaller plants began to look more economic. Why?
a) Large plants takes years to build, often must be located far away, and create havoc when
they outage. Smaller plants
• are built more quickly and their construction costs are consequently subject to less
economic uncertainty;
• can be located more closely to load centers, an attribute that avoids transmission,
decreases system losses, & is advantageous for system security;
• are generally more reliable, and less consequential when they do outage.
b) Combined cycle units, attractive because of high efficiency, have to account for design
complexities due to coupling between CTs & HRSGs driven by waste heat from the CTs, and
so tend to be lower in rating.
c) Cogeneration facilities, attractive because of high efficiency, typically have lower ratings
as a result of their interdependency with the industrial steam processes supported by them.
d) Plants fueled by renewable energy sources (biomass, wind, solar, and independent hydro),
attractive because of their low operating expenses and environmental appeal, also tend to
have lower ratings.
e) Reaganomics –public approval of less tax, less government, less regulation and being
competitive.
