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: ECONOMIC FEASIBILITY AND INVESTMENT DECISIONS OF COAL AND BIOMASS TO LIQUIDS
Oleg A. Kucher, West Virginia University, Phone 304 293 5429, HYPERLINK "mailto:okucher@mail.wvu.edu" okucher@mail.wvu.edu
Jerald J. Fletcher, West Virginia University, Phone 304 293 5499, HYPERLINK "mailto:jjfletcher@mail.wvu.edu" jjfletcher@mail.wvu.edu
Overview
Coal and biomass to liquids (CBTL) technologies can produce synthetic fuel with lower CO2 emissions than petroleum-based fuel (NETL, 2009). However, the economic feasibility of CBTL production depends on technological, economic and policy factors that may not be favourable in the U.S.; high capital costs of CBTL plant development is of particular concern. CBTL is an emerging technology, no CBTL plants have been constructed. This paper focuses on economic factors that determine the long-term economic feasibility of developing CBTL fuel in the U.S. We apply a micro-economic analysis to the projected CBTL plant operation by providing a discounted cash flow (DCF) and real options valuation to assess the economic feasibility and investment decisions for a CBTL plant.
After a brief introduction, the first section reviews techniques and the real options model for the evaluation of a CBTL plant. The next section describes an assessment of economic feasibility of CBTL fuel production from an investment perspecitve. The final section includes conclusions and policy implications.
Methods
We apply a micro-economic research framework to evaluate the economic viability of a CBTL plant and examine investment decision flexibility under uncertainty. We construct a dataset of technological, economic, financial parameters and measures for a projected CBTL plant. The dataset incorporates the best available information from the Energy Information Administration, the National Energy Technology Laboratory (NETL) and investor data sources The CBTL technology scenario draws upon a 50,000 barrels per day (bpd) CBTL plant with a biomass input of 7.7% by weight as designed by HYPERLINK \l "_ENREF_15" \o "NETL, 2009 #2" NETL (2009). We develop a DCF analysis based on the set of economic assumptions provided. After performing the DCF analysis, we identify the major sources of uncertainty that might affect investment decisions and perform Monte Carlo simulation for determining the payoff estimates of the CBTL project. Applying the estimates to the real options model, we draw insight into investment decisions regarding CBTL plant construction. We employ the basic continuous-time model of irreversible investment originally developed by ADDIN EN.CITE Mcdonald198640(Robert Mcdonald and Daniel Siegel, 1986)404017Mcdonald, Robert,Siegel, DanielThe value of waiting to investQuarterly Journal Of EconomicsQuarterly Journal Of Economics707-72810141986 HYPERLINK \l "_ENREF_13" \o "Mcdonald, 1986 #40" Mcdonald and Siegel (1986) as extended by ADDIN EN.CITE Dixit199428(Avinash K. Dixit and Robert S. Pindyck, 1994)28286Dixit, Avinash K.,Pindyck, Robert S.Investment under uncertainty4681994New JerseyPrinceton University Press HYPERLINK \l "_ENREF_8" \o "Dixit, 1994 #28" Dixit and Pindyck(1994).
Results
The results of a DCF analysis over a 30 year period by are based on estimated cash flows and associated net present value (NPV) for the projected CBTL plant under a variety of assumptions. The DCF analyses suggest that construction of the new CBTL 50 thousands bpd plant can bes expected to yield a positive NPV of about $767 million at an 8% discount rate under current conditions for an investment in this plant of about $5.6 billion in nominal value. We assess the magnitude of risks for the new CBTL plant investment associated with uncertainties in energy prices and capital costs. We find that uncertainties in the energy market could lower the payoff from the project by 1/3. When we further incorporate the utilized volatility of the net cash flow in the real options valuation, our results indicate that the values of options to wait are relatively high (up to 2/3 of capital costs). Even though the deterministic NPV from DCF analysis creates positive value to invest, the CBTL project should be delayed until the expected payoff would exceed the NPV from DCF analysis over four times. Our analysis shows that lower capital cost and higher energy prices improve the potential for investments into CBTL plants.
Conclusions
Despite the technical feasibility of CBTL processes as an affordable alternative for tranportaion fuel with lower CO2 emissions, there is little evidence of strong commercial viability of CBTL development in the U.S. under present energy prices and projected costs given the current uncertainty in energy markets. Our analysis shows that in the presence of uncertainty over the payoff from investing, the high capital cost of CBTL plant is the main barrier to the construction of a large-scale CBTL plant in the U.S. Uncertaintly plays a significant role in delaying investments into CBTL plants given the option value of waiting. Further, the constraints associated with uncertainty of carbon regulations will most likely postpone investment in the short-run. Overall, our analysis suggests that CBTL technology will need to be substantially more cost effective, either through reductions in capital cost or increased policy incentives. Advancing CBTL technologies to the level when it would be commercially viable could be possible through improved economics by reducing capital costs depending on optimized configuration of the CBTL plant, increase in product demand and government support to attract investment, such as low-carbon subsidies or carbon taxes in order to make CBTL investments attractive and profitable.
References
ADDIN EN.REFLIST Blyth, William. 2010. "The Economics of Transition in the Power Sector " OECD/IEA.
Dixit, Avinash K. and Robert S. Pindyck. 1994. Investment under Uncertainty. New Jersey: Princeton University Press.
Mcdonald, Robert and Daniel Siegel. 1986. "The Value of Waiting to Invest." Quarterly Journal Of Economics, 101(4), 707-28.
NETL. 2009. "Affordable Low-Carbon Diesel Fuel from Domestic Coal and Biomass.," DOE/NTL.
Rothwell, Geoffrey 2006. "A Real Options Approach to Evaluating New Nuclear Power Plants." 27 (1), 37-54.
Yang, Ming; William Blyth; Richard Bradley; Derek Bunn; Charlie Clarke and Tom Wilson. 2008. "Evaluating the Power Investment Options with Uncertainty in Climate Policy." Energy Economics, 30(4), 1933-50.
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