Coal power plants are more than just about selling electricity.

Coal power plants are more than just about selling electricity. (Vol.82)

The recent Finkel Review of the Australian national electricity policy may hold some insights for the Indonesian coal mining companies entering the power industry.

Introduction.

The national energy industry is an essential part of today’s society, industry and national well-being, along with an increasing public concern over the environment and lower energy prices. The industry is concerned about providing a reliable electricity supply to households and industry. The Australian electricity industry has a mix of public and private power producers, and a competitive commercial distribution system. This is different to the Indonesian electricity system that is dominated by state power producers (with some private) and a state monopoly on distribution and pricing. Both Australia and Indonesia have a strong coal fired power industry, a plan to continue to diversify the source of power, and further research. The governance of the power industry is of concern to all parties.

Vision of Australian power producers.

Dr Alan Finkel, Chief Scientist has produced on behalf of the Australian government the June 2017 report “Independent Review into the Future Security of the National Energy Market – Blueprint for the future.” (the Finkel Report).

The Finkel Report was largely prompted following a number of incidents that emphasized the national power grid was failing, and that renewable technology was changing the nature of the grid. Some major incidents included a break in the undersea power cable to Tasmania, the South Australia state wide black out, the interruption of power to aluminium smelters, the closure of aged low-cost coal power producers, and the short term lack of gas for some power producers. Large numbers of rooftop solar cells with new battery technology is reducing the power consumption patterns of homes, leaving less consumers to bear the burden of “poles & wires” ongoing maintenance costs. These, and other factors are now leading to massive increases (20%) in electricity prices that threaten a number of industries and burden Australian households. Indonesia is also facing strains on its electricity industry, particularly with inadequate power reliability on existing grids (brown outs, peak load reserve, etc), aging power plants & infrastructure, and an uncertain regulatory future to promote new power stations to meet national growth targets.

The Finkel Report’s vision is to be implemented through orderly transition, systems planning and stronger governance. The strategic plan is to provide a secure, reliable and affordable electricity supply, support investor confidence, contribute to reducing emissions and be innovative and responsive to change. The plan was developed through more than 120 meetings with market participants, technology experts, consumer and business representatives and the public, along with more than 390 submissions that were often published during the review process. A small delegation sought policy input from visiting a number of countries (Europe & America).

The Finkel Report is technology neutral, wherein the factors of the electricity output’s reliability, cost and emissions reduction are the principal factors. In line with Australian current political trends, the Finkel Report is clearly sensitive to not emphasizing coal, but as a science based report, allows for coal fired power stations. Indonesia recognizes coal’s lower cost options in the coal fields regions of Sumatra and Kalimantan, centralized large power plants in the densely populated Java, and that renewables may be the best option for some small remote communities in many parts of Indonesia.

Both Australia and Indonesia have ongoing reviews of the power sector, wherein Indonesia’s policies include a larger component of providing subsidized electricity and relying upon the State for financial support. Both countries look to the private sector to provide the larger contribution of capital for new power plants, including coal fired power plants.

The Finkel Report highlights that power output is more than just electricity.

Generators do not work in isolation, as there are grid management issues to be considered.

• All generators are required to meet acceptable levels of performance in respect of a number of technical requirements, including frequency control, voltage and reactive power control, active power control, and response to power system disturbances.
• Base load and peak load levels need to be planned and managed.
• Under some extreme load cases, load shedding relays are required to avoid main power station generators tripping. The grid needs to be managed well to avoid serious repercussions for the power station.
• Extreme events, including sudden shifts in power demand, can disrupt the power system and result in a significant part of the electricity grid suffering a total shutdown. This is known as a ‘black system’ To restore power to the system there is a need for generators that are capable of restarting without the need for an external electricity supply.
• There is the forecast power demand, plus a reserve margin (about 30%). Typically, PLN may want to pay only for power consumed, but should recognize there is a cost for providing a reserve margin. Indeed, some power districts may need the new coal fired power stations to take on a larger role for reserve margin to cover other power sources in the district (or interconnected districts) that do not contribute proportionally to the reserve margin.
• Scheduled power plant maintenance and upgrading is limited where power pricing is short term. Major refurbishments by coal-fired generators may be deferred indefinitely because of uncertainty of long-term returns, resulting in eventual declining efficiency and reducing possible lifetime.
• Any emissions reduction mechanism to be adopted by governments is to be agreed by the power plant operator such that investors can be confident the power plant will endure through many electoral cycles.

Security of power stations.

Since 2009, there have been several significant instances of cyber vulnerabilities being exploited in power systems globally. A disruption in the supply of electricity would impact the well-being of the society, and the security and resilience of other critical infrastructure sectors. Power plants need to constantly update their cyber security, as well as maintain a strong effort to protect against physical terrorist attacks.

There are typically only a few nationalities willing to invest in Indonesian coal power stations (China, Japan and South Korea). Allocating too much critical infrastructure to one country may have security and trade implications over the 25 to 30-year power plant life. For example; – At one point in Indonesia’s history, the American government stopped supplying spare parts for the Indonesia air forces planes, effectively grounding the nation’s air force for many years.

Reliance of off-taker (PLN).

Natural hazards cannot be averted. The draw-down of power from the power plant is vulnerable to direct impacts from hazards such as landslides, bushfires, floods, storms, geomagnetic storms and earthquakes. Each pose different challenges with the potential to damage electricity infrastructure and create bottlenecks, leading to security concerns and potential blackouts. Many of these power crises can be averted through robust and well-maintained power distribution infrastructure. For example, the collapse of the South Kalimantan power cable system due to theft of pylon metal may have been avoided through an appropriate maintenance inspection program. The coal fired power producer is reliant (for 30-50 years) on its off-taker (PLN) to maintain its power distribution system.

Generators need to trade off the benefits that are likely to accrue from locating near a quality coal resource, against the cost of connecting to the transmission network. PLN is endeavouring for some long connecting transmission lines to be part of the power producer’s costs. However, once a power line is established, then it is possible for PLN to engage several competitive power producers to develop and make use of the same power transmission line. There are other issues related to connecting to the PLN network. In one case, a coal power station was built in Sumatra, but PLN took nearly another year to build the connecting power cables and associated infrastructure. In another case of concern over reliability of power transmission agreements with PLN is seen in the case where a Sumatran gold mine agreed with PLN to construct a major power line from the grid to the remote mine so that PLN would provide state power. After construction, PLN declined to send electricity down the wire, opting instead to gain greater profits by charging the mine an excessive fee for producing its own power. The traditional coal exporter has a straightforward requirement to deliver coal to a ship (excluding new plans for CIF freight options). However, power plant producers may need to look more closely at the issue of connectivity to power transmission lines.

Regulations on power pricing.

The most recent amendment to the coal power pricing is ESDM 19/2017 – The use of coal power plant and the purchase of excess power. This regulation refers to mine mouth and non-mine mouth power plants. The regulation simply refers to obligations to the supply and purchase of electric power that is to be conducted through an “Electric sale and purchase agreement between the seller and PLN as the buyer”. The only technical specifications included in the regulation is the term “Grid Code that refers to a set of rules, requirements, and safety standard, dependability as well as efficient operating and development system in meeting the rise in demand for electric power….” The only reference to this Grid Code is that the power plant business “should refer to the Grid Code at the local system or electric power distribution rules”. Presumably this may provide more flexibility in negotiating a power sale and purchase agreement, but the emplacement of this code in a legal setting lower than a national implementing regulation may allow PLN to later adjust the Grid Code, and thus expose the power provider to greater business risk.

Previous power purchase regulations were based on a production cost plus scheme, with some limits on mining criteria and mining cost components. The associated bidding documents set out in some detail the technical requirements of the resource and reserve JORC code compliant reports, and that such reports were to be signed off by a reputable international geological / mining consultancy to assure PLN that the project could deliver reliable and reasonable priced coal to the power plant. However, this latest regulation ignores mining costs and sets the power price based upon existing PLN power production costs. The revised bid documents have greatly simplified the coal fuel definition to simply requiring a suitable resource & reserve report. This may allow for more flexibility of PLN in setting coal fuel supply criteria that may include multiple coal sources.

Essentially the new power purchase price is a maximum of 75% of a formula that combines the average existing local and national power generation cost over the previous year (known as PBB). The sales period for mine mouth power can be for 30 years. Contracts for excess power providers typically for up to, or more than 1 year at a rate of up to 90% of district power production cost. There are some variations in the regulations reflecting the size of the power plant.

Competitors and pricing.

Power supply into the local grid typically has a number of sources. PLN will be inclined to prioritize the lowest cost producer. So, an old hydro power plant may get a maximum allocation during good water storage times, but rely upon the coal power plant during dry season. The uncertainty of the weather, or other competitive local power systems may impact on the coal power plant business risk factor.

As the Indonesian National Grid develops further, then PLN may produce cheap coal power in one district, and sell it at a higher profit margin in another power district, while imposing the lower cost – price structure for the power plant. This situation may become even more tempting to PLN when Indonesia starts selling/importing power to and from the ASEAN power grid.

A coal fired power plant is a major investment with a long term pay-back period (typically 12-15 years for supercritical power plants). The present PLN pricing structure is adjusted each year, wherein PLN has an incentive to seek lower power costs. The coal producer will need to adjust their mine plan annually to match the profit margin of an annual electricity price change, and in doing so may not optimize the coal resource or optimize the mine business plan. In some other countries electricity price agreements are set several years ahead of the delivery year, to underpin the business risk of the power plant and the long-term mine plans. This longer term option may hopefully be possible in Indonesia, and may help PLN through improved performance from long term planning. A private power plant that is not making adequate financial returns may be closed, wherein PLN and the people of Indonesian may suffer. We have seen the example of a private diesel power plant in Sumatra that shut down and deprived the community of power, because PLN had not paid the power producer for an excessive period. There needs to be good will and a sound business environment for both PLN and the power producer.

The present pricing structure is set at 75% of the district & national cost of producing electricity. Unfortunately, in the ESDM sector the government has regulated an unusual method for determining a mining projects share value (for example to Freeport’s detriment). To ensure PLN does not unduly manipulate the cost structure in its favour, the PLN determination of the district & national price structure may need to be transparent and have clear agreeable rules for determining cost components. The PLN cost estimation should be subject to scrutiny and legal claims by the power producer.

The power pricing structure needs to incorporate the eventual plant closure costs. There also needs to be some resilience in the agreement to accommodate premature plant closure, or for the investor pulling out. Such closures may involve the coal mine being mothballed, or options for the coal to be sold on the open market.

Action should be taken with the aim of creating a market environment in which the electricity sector has the confidence to invest. The impact of a high degree of market uncertainty is ultimately borne by consumers in the form of a more costly, less reliable system. Governments and power producers should provide the sector with more transparency.

Conclusion

Exporters of coal have some leeway to negotiate with off-takers in a free market, where miners have the option to adjust production up and down, vary who to sell to, vary the target product, vary the mine life and profit margin (through adjusting Strip Ratio) or even shut down in periods of low price. The Indonesian coal power plant business has shifted from a cost-plus basis, where the margin and project risk factors were readily determined, to that of a power sale based on a single government (PLN) electricity off-taker that unilaterally determines the power price. PLN is a domestic monopoly with a clear political objective to lower the power price. The coal power producer has far less options to respond to lower prices, and has less upside prospect of higher prices.

It is understood that each proposed coal fired power plant is developing a separate contract with PLN. This may allow each contractor to negotiate a price structure that is not simply based on the supply of electricity, but also based upon the ability of the power plant to fulfil a number of needs that are essential in supporting a modern power grid. These fee components may include; –

1. The reliability of technology to support Grid Code (frequency control, voltage and reactive power control, active power control, etc).
2. The agreed conservative/ base load projected power needs
3. For providing more/ peak load.
4. Providing a reserve margin (unused – but available).
5. Plant closure.
6. Ensuring cyber and physical security.
7. Incentives for contributing to lowering national emissions.
8. Compensation in some Force Majeure situations (reflecting avoidable power interruptions from PLN’s management of the grid & distribution system).

 

The private power industry may require new levels of transparency and operational cooperation from PLN in a number of areas.

Traditional coal miners have been undergoing an expensive learning phase over several years to understand and participate in the private power sector. This action will help develop a greater Indonesian ownership and management of the power industry. This is also a timely opportunity for PLN to learn the realities about the coal mining industry, rather than simply receive coal on its dock site.

PLN is headed towards greater grid connectivity, including the ASEAN power grid, where some Indonesian mine mouth private power plants may be able to export power, and some power may be imported to Indonesia. The coal power companies and PLN will need to grow with the development of a more sophisticated grid, new technology, and evolving business sector.