Key Considerations for CESOP

August 2008

The Ontario Power Authority's Clean Energy Standard Offer Program (CESOP) is designed to address smaller generation development projects with a "one-size fits all" contract methodology. The program might attract project proponents with small, one-off power generation opportunities. The CESOP contract will set out some parameters for a Net Revenue Guarantee that will be available to approved CESOP projects. The Net Revenue Guarantee is based on the value of small distributed generation to Ontario, and assumptions about the operating characteristics of a "virtual plant" specified by the OPA - a theoretical plant that has the operating characteristics that the OPA deems to be efficient and valuable in the marketplace. If a prospective project is expected to operate as economically as the "virtual plant" or better, then the CESOP contract could be attractive to the proponents.

Parties considering CESOP projects will need to look carefully at the CESOP contract underpinnings and compare their plant's performance against that of the virtual plant .

Program Summary

CESOP provides projects with a 2009 Net Revenue Guarantee (NRG) of $ 15.97/kW/month. This value will be indexed each year by 30% of the Canadian Consumer Price Index.

It is assumed that some of the revenue a project requires will be earned from market revenues from electricity sales. Therefore, each month a Net Market Revenue (NMR) value will be deducted from the Net Revenue Guarantee payment.

To determine the Net Market Revenue, the OPA starts with the Imputed Gross Energy Market Revenue, the amount that the virtual plant is deemed to have earned during on-peak (weekdays, 7 am - 11 pm) hours. The Net Market Revenue is then arrived at by discounting this imputed revenue amount by 10%, an adjustment that reflects assumed total downtime. The virtual plant has a base rate of 5.5 MMBtu/MWh, a variable maintenance cost of $ 5.50 / MWh, and a gas distribution charge (marginal cost to get gas from the Dawn reference location to the generator) of $1.30/MMBtu.

The Net Market Revenue is the amount of market revenue that would be earned by CESOP projects with parameters identical to the virtual plant.

Competitive Considerations

A prospective CESOP project developer needs to gauge its competitiveness against each of the program parameters in order to assess the viability of its project and the risks involved.

The most basic consideration is whether or not the Net Revenue Guarantee of $15.97/kW/month or about $192,000 /MW/year will pay for its capital and other fixed operating costs.

The total revenue a project receives will be determined by the Net Revenue Guarantee, less the virtual plant Net Market Revenue, plus the project's actual net market revenues. This means that each parameter in the Net Market Revenue calculation warrants close consideration, with actual performance of the prospective plant evaluated against each virtual plant parameter.

A project with parameters that are collectively more favourable than the virtual plant parameters would realize net market revenue above the virtual plant's Net Market Revenue, so it would realize total revenue greater than the Net Revenue Guarantee. A project with parameters that are collectively less favourable than the virtual plant parameters would realize net market revenue below the virtual plant's Net Market Revenue, so it would realize total revenue less than the Net Revenue Guarantee.

Let's look at each key parameter in turn.

Heat Rate

The virtual plant heat rate of 5.5 MMBtu/MWh is equivalent to what can be achieved by a reciprocating engine generator using about 75% of its easily-recoverable heat, which in turn displaces an alternative thermal efficiency of 75%. Over the course of a year, this could be equivalent to using 50% of recovered heat during the low (typically summer) thermal requirement season, 100% during the high (typically winter) season and something in between during shoulder seasons. The efficiency "bar" has then been set relatively high, pointing to the need to find efficient projects that are sized on thermal rather than electrical considerations.

Variable Operating and Maintenance

Levelized maintenance costs (minor and major, averaged over a number of years) for smaller combined heat and power plants often land closer to $10/MWh, so the virtual plant variable operating and maintenance of $5.50/MWh appears to be on the low side. This may be an implicit suggestion that earlier-year maintenance costs are lower, along with a general desire to attract only the most efficient projects possible.

Gas Distribution Charge

Comparing the virtual plant gas distribution charge of $1.30/MMBtu against a prospective plant's cost is not a trivial task.

The plant's location is a factor. Plants in the Union Gas southwestern Ontario service area will have an advantage as Union is directly connected to the Dawn pricing point. Plants in other service areas will incur additional costs.

The size of a CESOP project and whether it is a standalone facility or behind an existing gas meter would affect the project's distribution rates and variable gas costs.

Utility rate and service options are also key considerations. "Unbundled" distribution services generally involve higher fixed costs and lower variable costs, and impose on the plant operator a greater responsibility for matching gas supply to gas usage day-to-day. This sometimes means higher management costs must be considered as part of the fixed cost burden for the project. However, it can also mean lower variable gas costs, more dispatch hours, and greater market revenues.

"Bundled" distribution services can reduce direct management costs, but increase variable costs and could therefore reduce the number of dispatch hours. Importantly, bundled distribution services can also create gas price risks that may not be obvious to the operator, since the operator has less control over when and whether he or she buys gas.

The development of a cost effective and risk minimizing gas supply strategy is likely to be a custom solution for each project.

Dispatchable Hours

The virtual plant Net Market Revenue will be calculated assuming economic dispatch within the on-peak hours (16 hours per day, 5 days per week). A prospective plant that can economically dispatch during hours when the virtual plant was deemed to be not running will keep any incremental revenue earned during those periods, whether they are on- or off-peak hours.

Plant Reliability

The virtual plant total outage rate is 10%. The Imputed (all hours) Gross Energy Market Revenue is reduced by this amount to arrive at the reference Net Market Revenue. A prospective plant with a total outage rate less than 10% would then earn revenue greater than the virtual plant's and therefore realize greater revenue. This motivates project developers to choose reliable equipment and maintain it. The economics of scheduling planned maintenance during non-peak hours should also be evaluated.

Additional Considerations

Electricity Price Uncertainty

The virtual plant's deemed dispatch means it "dispatches" with 100% accuracy, since deemed dispatch is determined after the fact. An actual plant will experience uncertainty related to the revenue it will actually receive from the sale of electricity, relative to the deemed revenue. The reference Hourly Ontario Energy Price (HOEP) is only calculated after the fact, by averaging each of the twelve 5-minute prices determined by the Independent Electricity System Operator (IESO). HOEP is also forecast through the IESO's pre-dispatch prices, however there can be a wide divergence between these prices and HOEP. The IESO also offers a Day Ahead Forecast Price, but the uncertainty band attached to that forecast is too wide to be of much value.

An actual plant has to decide whether to run in an hour before the HOEP for that hour is known. After the fact, it might be determined that the plant ran uneconomically or that it did not run when it could have run economically. Both types of events would lower an actual plant's market revenue relative to the Net Market Revenue of the virtual plant.

Natural Gas Cost Uncertainty

Gas prices in the CESOP program are based on the Dawn Daily Index price. The Daily Index price is set a day ahead (trading on Monday sets Tuesday's gas price). However, dispatch of the power generator will depend on same day electricity prices (Tuesday's electricity price will determine whether gas will be needed on Tuesday). This disconnect between the two markets creates risk for the generator. (Read more »)

Behind-the-Meter Advantages

Behind-the-meter or load displacement projects have additional quantitative benefits, including avoiding wholesale market service charges and local line losses. These benefits impact economic dispatch and affect a plant's actual Net Market Revenue, so these potential advantages should also be considered.

In summary, the Ontario Power Authority has set the competitive bar fairly high with its Clean Energy Standard Offer Program parameters. When evaluating the viability of a prospective CESOP project there are a number of factors to consider, as part of a multi-dimensional analysis. If you have questions about assessing these factors or the analysis, contact Bruce Sharp at bsharp@aegent.ca or John Voss at jvoss@aegent.ca.