Polar Works-Inlet Cooling Technology Overview-Economics and Financing-Short Term Capital vs. Long Term Capital

Economics and Financing

Short-term Capital vs. Long-term Capital

In order to put up the money for such a capital improvement project, the plant would need to take the money out of the current year operating budget, or would have to borrow additional capital. Remember that the provision for receiving additional capital is usually closed by restrictive covenants. ("You can't go back to the well.") Therefore, the money would have to be taken out of the current year budget; it would also need to be paid back during the current year budget, so that at the end of the financial reporting period, no money has been lost on the project. This is one origin of the 9 to 12 month payback so often needed by most capital improvement projects.

In fact, some corporate decision makers are loathe to undertake a project-funded capital improvement, even at a 9 month payback, for fear that any risks or resultant upsets to that quick payback could result in missing the debt coverage ratio during a reporting period. Too often, it just isn't worth the risk.

Alternatively, that additional capital could be provided at the corporate level of the developer. However, the developer/manager usually only holds a management contract on the plant. The plant itself, in so many financing structures, is known as a "single (or special) purpose entity" or SPE. The finance method is called non-recourse financing, in which the debt holders have no additional recourse in a default against the equity holders, other than taking over the project. The whole structure is complicated, and there are generally few ways to get the equity holders to pump in capital for improvements. Of course, utility plants and certain developers who can develop from their own balance sheet can move money as they see fit; though they usually don't.

Therefore, while power plants can be built on long-horizon finance structures, capital improvements are undertaken with very short horizons.

It is our contention that large inlet cooling projects, in particular projects that involve deep refrigeration like the Polar Works inlet air cooling system, provide so much additional summer power that they should be treated, at least financially, as capacity additions instead of as capital improvements. (The alternative is usually to build another plant.) This means that low temperature inlet cooling systems should be screened with a longer horizon, instead of a one-year payback. On the other hand, fogging systems, while having comparatively limited power augmentation capabilities, have rather short payback periods. Fogging systems make good capital improvement projects.

Here is where we get into the distinction between Net Present Value and Payback. Serious power augmentation projects, like the Polar Works inlet air cooling system, will always have a significantly higher NPV than a fogging project, even if the foggers have a shorter payback. The reason for this is that the annual revenue from a Polar Works addition will always be vastly larger than the revenue from a fogging project. We have recently performed economic analyses for the addition of a Polar Works system, a standard refrigeration system, and a fogging system at a large merchant combined cycle facility. At a 17% discount rate, the Polar Works system had a NPV nearly 14 times higher than the fogging project, and over 21 times the NPV of a standard refrigeration project.

Not surprisingly, if we used a 30% discount rate for the fogging project, to represent a self-funded program as a traditional "capital improvement" at the internal cost of capital, the Polar Works system has an advantage of nearly 21 times over the fogging system in the NPV calculation.

The reason for these staggering differences in NPV numbers is not just the deeper refrigeration offered by the Polar Works system. It is also the increased operating period of the system during the year, which results in a much higher capacity factor for the investment. It is what we call "area under the curve." It is this kind of performance which yields superior NPV calculations.

That is the power of the NPV calculation; and it clearly demonstrates the economic superiority of the type of low-temperature inlet air cooling that Polar Works will be offering.

Given our position, that an inlet air cooling system should be financed in the same manner as capacity additions, here's our model for making that possible.