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Cracking the ROI Code

Raising generation returns in evolving power markets

The power generation business has been stable and reliable for over 100 years. Change has happened slowly and new technologies have been introduced at a measured pace. This evolutionary pace is accelerating as markets change across the globe.

Demand is skyrocketing in emerging economies while it’s leveling off in mature ones, making it more difficult to maintain margins in both situations. Increasing amounts of intermittent renewable power – wind and solar – are being added to the supply mix, causing dispatchable power plants to adjust their output – i.e., to cycle – more frequently, which can cause imbalances between supply and demand and prematurely degrade asset health. Power plants are aging and so are the workers who keep them running. Plus, one of the most reliable and cheapest sources of supply – coal-fired generation – faces increasing pressure to reduce CO2 and other emissions, which pushes costs upward. Nuclear power has been a preferred alternative, but it has its own challenges. And meanwhile, competition from non-utility owned generators, coupled with vibrant trading of wholesale electricity and emissions credits, are changing the face of the marketplace for traditional power generation companies.

The goal is to create an environment where everybody is measured on the performance of the portfolio as well as the individual asset.

As this change accelerates, the way a successful generating company views and manages its business also must change.

The Portfolio Manager Emerges

The new power generation business is about managing a portfolio. It’s about the assets owned, the risks taken, the capital invested and liquidity. This is similar to how any consumer would manage his or her own investment portfolio, or how a mutual fund manager buys and sells investments to achieve a certain profile of risk and return. Individual power plants – the major assets of the power generation business – will still be managed and optimized by engineers. But a new breed is emerging from this transformation: the portfolio manager.

This portfolio manager isn’t just one person; instead it’s a new way of thinking that must permeate the power generation business. Here are just a few examples of how a portfolio perspective can improve business performance:
· The entire operation of the power plant is integrated and optimized to achieve the most economical and profitable operation possible.
· Power plants are operated as a fleet – a portfolio – where each plant and fuel source contributes to the cost, revenue and the risk/return ratio of the entire portfolio.
· Besides selling electricity at a profit, the generation company expects to increase economic returns through contracts that define how it buys or sells emissions credits and fuel.
· Capital is invested based on a risk adjusted return on capital (RAROC), and all investments are evaluated by how they advance the portfolio strategy.

Pulling in the Same Direction

No power generator can change its business overnight. Rather, it’s a journey that must leverage the best of the current portfolio while constantly adjusting and investing in the future.

In this context, improving the performance within each power plant is the place to start. Even if you do this well (and most power generation companies do), consider tightly integrating operations and maintenance, standardizing processes, automating any and all routine activities, and developing predictive and proactive capabilities. Do anything that can make what is happening within the power plant more transparent. According to an ROI Study by IBM based on case studies and broad industry research, these actions can deliver as much as a 6 percent reduction in downtime and maintenance costs through better operational efficiency. They can similarly extend plant life, improving the return on investment and postponing capital expenses by augmenting ad hoc processes and rules of thumb with real visibility into plant conditions and automation.

The next step is to start managing assets as a fleet. Elevate the transparency introduced into each plant to the fleet level, and emphasize collaboration. Whether it’s the outage schedule, best practices, predicting demand, or managing electricity production, these actions should be evaluated across the portfolio and measured as a whole. The goal is to create an environment where everybody is measured on the performance of the portfolio as well as the performance of the individual asset for which they’re responsible. The same ROI study showed that managing the fleet in this way can result in even less downtime and production cost because everyone is engaged in overall portfolio performance. They pull in the same direction and see the same opportunities to trade-off for a larger gain. This approach raises the profit potential across the portfolio, a result any portfolio manager would be pleased to achieve.

Profit can be improved 5 percent by engaging markets with a wider lens and optimizing the business across markets.

Next, this portfolio thinking should be extended into the company’s approach to various markets – wholesale electricity, fuel and emissions. Every portfolio manager aims to increase returns while minimizing risk. This is easier to achieve when approaching multiple markets rather than just one. The process starts by varying contract terms, managing counterparty risk, and routinely back-testing risk models to help improve them based on the outcomes achieved. Additionally the portfolio manager will evaluate the emissions profile to make the most of incentives – and avoid penalties. Overall, the portfolio manager should be willing to trade maximizing profit in one market for a reduction of risk in another. It’s the overall portfolio outcome that matters. And, in the study noted above, profit can be improved by as much as 5 percent by engaging markets with a wider lens and optimizing business results across all these markets.

Finally, it’s important to build agility into the portfolio. To ensure that everybody is on the same page, the company should clearly define the business strategy and communicate it broadly. Risk and return should be evaluated in detail on every capital request, and if an investment doesn’t contribute to the strategy, it should be rejected. As time passes, market conditions will change, so the portfolio manager must be prepared to continually evaluate the strategy and to move investments into and out of the portfolio. This movement in and out of the portfolio makes many generating companies uncomfortable. Power plants take years to build and they’re expected to be in service for 30 to 60 years. Once a plant is approved and in construction, there’s often no turning back. But investment decisions can still be made across the portfolio, with the company diversifying as it invests in new assets, retires under-performing ones, and continually analyzes and manages risk.

Taking each of these actions, sequentially and together, can pay significant dividends to a generation company willing to make the journey. For just one hypothetical 10,000-MW generation company over 10 years, it could mean more than $800 million in quantifiable benefits and a short, 14-month payback. The potential for each company will depend on its unique situation.

Beyond Business as Usual

Success in the new power generation business hinges on the ability of a company to manage its investments and to maximize its return across the portfolio. Engineering will keep power plants running, but profitably growing the business is in the hands of those who can effectively balance risk and return – in short, those who can manage the portfolio. Information is the foundation in this new world, requiring transparency at every level. Thinking horizontally across traditional lines of business – in effect, integrating the operation – makes it possible to see opportunities and take action. And, a commitment to agility – making the best assessment and being willing to continually re-evaluate – is the way to sustain the business in transformative times. This is the antithesis of business-as-usual for the generating company.

ABOUT THE AUTHORS: Neil Gerber is IBM’s Global Power Generation Solution Executive. Bridget Meckley is the IBM Center for Applied Insights Industry Leader for Energy & Utilities.