Combined Heat and Power Projects: An Opportunity But Know the Risks

February 2011

• The Ontario Power Authority is moving toward the implementation of a Combined Heat and Power Standard Offer Program (CHPSOP) to elicit new CHP projects up to 20 MW in capacity in certain areas of Ontario where distributed generation can meet a need for new generating capacity on the system.
• The CHPSOP will offer projects a standard contract with the OPA, designed to mitigate the risks developers face. The terms of the contract are based on the performance characteristics and economics of a reference or "virtual" plant.
• The CHPSOP is an opportunity worth evaluating for organizations with an available thermal load. However, the opportunity is not risk-free, and it is important to understand the inherent risks and how to manage them.

"Combined heat and power" is the name given to a class of power generation projects that are designed to produce useful thermal output as well as electrical output. A fuel such as natural gas is burned in an engine or turbine which runs a generator to produce electricity. The heat produced by the engine or turbine, heat which might otherwise be wasted in the exhaust gases or cooling water, is captured and used to heat water or produce steam to meet the thermal needs of a space heating or industrial heat load.

Usually, the key to a successful CHP project is the availability of a stable, well-suited thermal load.

In concept, CHP projects have a lot going for them. Engine and turbine technology is well-developed so engineering and executing a project is relatively straightforward and low-risk. The projects can be sized from under a MegaWatt up to 20 MW or more. Usually, the project can take fuel, such as natural gas, from the existing pipeline network, and the generator can be within an electrical load centre. This kind of "distributed generation" avoids the need for new transmission capacity to move power from generator to load, which helps to reduce the likelihood of opposition from landowners and others in the area.

The Ontario Power Authority is moving toward the implementation of a Combined Heat and Power Standard Offer Program (CHPSOP) to elicit new CHP projects up to 20 MW in capacity in certain areas of Ontario where distributed generation can meet a need for new generating capacity on the system. This includes the Greater Toronto Area, the Kitchener-Waterloo-Cambridge triangle, and Kingston.

The CHPSOP will offer projects a standard contract with the OPA, designed to mitigate the risks developers face. The terms of the contract are based on the performance characteristics and economics of a reference or "virtual" plant. If proponents can develop a project within the prescribed regions with better performance and better economics than the virtual plant, then they may find the CHPSOP program profitable.

The CHPSOP contract provides developers with a fixed monthly payment per MW of capacity. This payment is designed to cover the cost of capital and other fixed costs associated with the project. Inherent to the contract is the assumption that when the marginal revenue from generating and selling electricity exceeds the marginal cost of natural gas fuel and other variable operating expenses, the generator will choose to run and make money. The revenue deemed to be earned in these hours is deducted from the fixed monthly payment made by the OPA. In other words, if the generator can meet some of its revenue requirements from actually selling electricity, then the OPA can reduce the amount of support it has to provide the generator. On the other hand, if gas prices are very high and electricity prices are very low so that operation is not economic, the project operator knows it will receive a monthly payment that will cover its fixed costs. This is the risk-reduction philosophy behind the program.

The CHPSOP contract seems to insulate project proponents from some of the potential risks of CHP projects, however - as always - the devil is in the details!

Proponents considering a CHP project have only one chance to make sure they have identified all the risks in their project and to ensure that the CHP contract, or other measures, enable them to manage those risks. The only chance to do that is before the contract is executed. The CHP contract is built on a number of assumptions about gas pricing, utility distribution rates, and gas supply availability, and these assumptions will not always hold true for every project. In fact, for some projects, they will never hold true! That means there is some residual risk that the project must bear, risk that the project backers will need to understand and quantify before they sign off.

The CHPSOP is an opportunity worth evaluating for organizations with an available thermal load. However, the opportunity is not risk-free, and it is important to understand the inherent risks and how to manage them.

OPA's Combined Heat and Power Standard Offer Program Read more »