A large-scale CHP project cannot be evaluated financially as an isolated project because its capital cost is likely to be sufficiently large to affect the company’s overall financial profile. The effects of the project on the company’s finances, and its impact on the profit/loss account and balance sheet, should therefore be considered in some detail. CHP projects will also be competing with other projects for (usually) limited capital resources.
Financial appraisal is a rational method of comparing the costs and benefits of a proposed project so as to choose the best investment for the future of the company. Furthermore, where capital funding is limited, it is a means of ranking competing calls on that funding. The aims of financial appraisal can be summarised as follows:
- To determine which investments make best use of the company’s money.
- To guide the optimisation of benefits from each investment opportunity.
- To guide the company’s risk management strategies.
- To provide a basis for the subsequent analysis of investment performance.
CHP Choice & CostsThe capital cost of any CHP plant depends on its size and type. However, there are a number of issues that should be taken into account in relation to costs:
- A CHP plant is more efficient than a simple power plant when the heat output is used effectively. Where CHP power generation produces heat that subsequently remains unused, the plant is effectively operating in the open cycle mode and therefore, probably, at a lower efficiency than the competing external power station.
- The plant will operate at its greatest energy efficiency, thereby maximising savings, when it is maintained as close as possible to its maximum load – as long as all the output is used.
- Economies of scale do exist. As the size of a CHP plant increases, capital and installation costs, expressed as £/kW, both fall. Operating and maintenance costs are also significant factors, especially for reciprocating-engine-based systems.
- Although a plant sized to meet maximum electrical demand will produce the greatest savings in purchased electricity, it may end up operating at part load – and thus less efficiently and economically – for a greater part of the time.
- Although electricity can be exported to the national grid during periods of surplus, these surpluses are most likely to arise at night when selling prices are at their lowest.
The first step in most financial appraisals is to assemble information on the capital costs and the annual cost benefits of the project and then to calculate the cash flow.
Calculating the capital cost is unlikely to be as straightforward for a CHP plant as for lesser capital expenditure projects such as replacing an item of machinery. A replacement machine is likely to be bought through the capital budgeting process: the project engineer will have little interest in the financing method and may regard it as a problem solely for the finance department. A CHP plant, on the other hand, will need special consideration because the scale of its cost and the long-term nature of the commitment required may mean that its inclusion in the normal capital budget is inappropriate. A CHP project is not directly process related, so confidence in the capital cost estimate is more difficult to achieve than with more familiar, core-business investments.
The first step in determining the annual cost benefits of a project is to evaluate its profit/loss and cash flow benefits. These are rarely the same.
For CHP, the annual cash benefits consist of the difference between the annual costs of the two options:
- Possessing a CHP plant.
- Not possessing a CHP plant.
It is important to use common assumptions regarding, for example, potential fuel price increases, when evaluating the costs of each option.
Overall Cost Savings
The first step is to determine the site’s base-load energy demands and non-CHP energy costs over several time bands. This also indicates the heat to power ratio of the site during each time band. The second step is to calculate the costs of meeting the same energy demands using the CHP plant selected. The energy cost savings associated with the CHP plant can then be determined.
The third component incorporates a cost estimate for maintaining the CHP plant. This is deducted from the energy cost savings to give the net annual cost saving potentially achievable by the plant. This potential saving is then assessed against the installed cost of the plant.