Importance of feasibility studies in coal-fired power generation

Godknows Nyangwa

COAL-FIRED electricity still occupies a significant portion of the global generation mix as it contributes nearly 40% of the world’s electricity, close to its highest share in decades.

The promise of cheap electricity to fuel economic growth among developing economies has also contributed immensely. In Asia where energy demand continues to spike, coal-fired electricity is still the single largest energy source.

The Sino factor

China plays a leading role in coal-fired electricity production. Over the past few years, Chinese state-owned companies have received initial or full approval to build more than 155 new coal powered plants with a total capacity in excess of 123GW.

In 2016, the Coal Power Economics Study Group of North China Electric Power University published a report on the economics of coal-fired power generation projects in China. The study found that coal-based power generation continues to increase in China mainly due to two factors.

First, the approval of all projects for pulverised-coal power generation plants was delegated to provincial institutions from the National Energy Agency; and
Second, historical guaranteed investment return, driven by the economic advantages of coal power in China, the past and current low coal price and the high on-grid tariff where the electricity is sold, has encouraged the growth in new installed capacity of coal power in excess of actual demand.

Coal-fired power in Southern Africa

There are large coal reserves in South Africa, Botswana, Zimbabwe and Eswatini and, more recently, also in Mozambique in the order of billions. The proven coal reserves are about 32 billion tonnes but could be 10 times more. Current production and consumption is below 1% of those reserves.

Total Sadc coal production levels 10 years ago amounted to 253 million tonnes, compared to consumption of 186 million tonnes and exports of around 67 million tonnes which means that coal will still be available for the next 100 years basing on proven reserves and 1 000 years basing on estimated resources. The challenge is to continue using the coal, for example for electricity generation in the face of global pressure to reduce global warming and climate change.

Coal production in the region has been dominated by South Africa (247 million tonnes/year), Zimbabwe (3,75 million tonnes/year) and Botswana (1,035 million tonnes/year), largely for electricity generation. Most of the projects in this region such as the Hwange 7 and 8 Expansion in Zimbabwe, Medupe and Kusile Power Station projects in South Africa and the Morupule Botswana have come at a huge cost to the respective national purses.

A delicate balance

From a fiscal standpoint, each private and public energy-sector project should be assessed on its ability to provide sufficient energy supply, reasonable energy prices, high energy efficiency, high cost efficiency, low import content, new products for export, employment opportunities, positive effect on public budgets, rural development, technological innovation, and a healthy environment. From a private sector standpoint, there must be a good return on investments, favourable macro-economic and political environment, effective cushion against currency and exchange risks and a permissive regulatory regime, etc. Achieving a proper balance of the twin broad objectives outlined above is always a delicate process.

Both parties, that is the public sector and the private investors, therefore need to carry out detailed and accurate feasibility studies. The feasibility study of a project will answer questions around the economics of the coal plant, whether or not there is a likelihood of redundancy of installed capacity, and determine if there are resource constraint indicators.

At the end of the day, the end consumers of electricity should be able to obtain affordable electricity on the one hand while enjoying favourable economic opportunities in a healthy environment. The investor should be able to profit from the investment without threatening the government or public interests.

The feasibility study

As outlined above, a feasibility study must be carried out regarding any energy project, be it coal-fired thermal or renewable. A feasibility study is basically an examination of a situation to decide if a suggested method, plan, or piece of work is possible or reasonable. Such a study, in the context of energy projects; ought to be bankable financially, technically and legally.

In considering technical bankability of a coal power project, the study should identify technical risks of major concern, either in relation to the general design of the plant (including the boiler design) or to the contractual arrangements to ensure technical integrity of the plant throughout project implementation.

Further, other issues which should be considered are the availability and proximity of the fuels such as diesel and other auxiliary ingredients which include but not limited to limestone (for the purposes of reducing emissions etc).

Financial bankability entails looking at aspects of the tariff, that is the price of the power per kilowatt hour and the extent to which the pricing structure would provide a return on the investment throughout the economic life of the plant. The approach taken in most projects is known as weighted average cost of capital (WACC). The WACC is the average of the debt and equity financing costs. Also called the “hurdle rate”, it is a measure of the anticipated present value of future cash flows and serves as a benchmark for a project’s profitability.

In Zimbabwe, there are four main thermal power stations, namely Hwange, Bulawayo, Munyati and Harare and these are run by the Zimbabwe Power Company (ZPC), having been taken over from the respective local municipalities.

Most of these have outlived the 25 to 30-year life expectancy of a typical thermal power station and are therefore not only antiquated but also very expensive to run. The Hwange plant, currently under expansion;

is the youngest and cheapest to run as it also uses a cheaper type of coal. Hwange Power Station’s expansion on its two units, that is 7 and 8, is expected to cost in the region of US$1,5 billion. The two additional units are supposed to each generate 300 megawatts (MW).

If, for example, Stations 2 and 3 of the Harare Power Station in Workington were to be run alone, the tariff cost per kW/h would be 19 or 20 US cents. This is because they use coal peas which are very expensive. The plant also requires almost daily maintenance due to obsolescence and therefore is very expensive.

Further, Stations 2 and 3 have a total installed capacity of more than 120MW but their dependable capacity is less than 50MW capacity. According to a friend from the ZPC, to just “hot start” the plant, about two million litres of diesel are required. This is why the Harare plant is serving merely as a back-up.
Under legal bankability, regulatory aspects around compliance, licensing and permitting are supposed to be fully taken into account and addressed to avoid bottlenecks along the way of the project.

Shortcomings of feasibility studies

The challenge with most projects is that the feasibility studies only focus on aspects such as the proximity of coal, limestone and the adequacy of the reserves of coal without looking at aspects such as life of the plant, or adequately addressing the issue of to what extent the project can that provide a return on the investment throughout the economic life of the plant.

Further, most feasibility studies underestimate the costs which the project will consume and this will usually have the effect of straining balance sheets due to cost overruns. The study should also reveal if there are any encumbrances — especially where debt finance is used. This will reveal the securities given to the lenders of the project and also interrogate the extent would that new plant can be used free of encumbrances. These will provide decision-making reference for planning and construction of not only coal power projects but other energy projects in general.

In other instances, carrying out a feasibility study would reveal the extent of demand for power, thereby reducing the prospect of redundancy of installed coal-fired capacity. Further, some political whims and caprices jeopardise the viability of energy projects, especially involving state utility generators, as will be shown in the example of the Medupe Power Plant in South Africa.

Lack of due diligence on selected EPC contractors has come at a high cost. We look at the Morupule Power Station example below:

Morupule B Power Station extension

The 600-megawatt coal-fired Morupule B plant in Botswana, which was commissioned in 2012 and built by China National Electric Equipment Corporation (CNEEC) at a cost of US$970 million, has often broken down, leading to a reliance on diesel generators and imports from South Africa. The power plant is run by Botswana Power Corporation, the state-owned utility.

Because demand was overestimated, the expected rate of economic return was lower than initially projected. The design for Morupule B included some features, such as the fluidised bed heat exchangers (FBHE) with reheat and superheating coils external to the main furnace. This design required a very close coordination between the basic and the engineering designs and appropriate quality control of manufacturing, construction, and commissioning of the boilers. Although the EPC contractor stated at the time of contract award that such arrangements (namely, to manufacture, deliver, and install on site the FBHEs) were in place, it appeared that they broke down during implementation and the risk of disconnects between the various project phases materialised.

Had the risk been fully appreciated by Botswana Power Corporation (BPC) or the World Bank (the funder) at the time, a better assessment of the viability of the technical proposal could have been made at the time of contract award, which could have resulted either in rejection of the proposal or strengthening it with stronger safeguards of the technical and project implementation risks.

According to a report by the World Bank, there were significant shortcomings in the due diligence undertaken by BPC during the process of selecting EPC contractor, especially in relation to examining the qualifications of the bidders with respect to circulating fluidised bed (CFB) technology. CFB is a developing technology for coal combustion to achieve lower emission of pollutants.

From the above, it can be learnt that a system of well-defined and relevant qualification requirements, in conjunction with a thorough due diligence process of examining the qualifications and experience of bidders, are fundamental to selecting a well-qualified EPC contractor. Furthermore, the proposed design must be well proven through the EPC contractor’s reference plants, in order to be accepted for the project.

Medupe coal power plant

Medupi is a dry-cooled coal-fired power station in Lephalale, South Africa, having started off as Project Alpha and Charlie when the plant’s construction began in August 2007 which is owned by Eskom, South Africa’s state-owned power corporation, at an estimated cost of R122,5 billion. The power plant has six units that are supposed to have the combined installed capacity of 4 800MW.

The project came under criticism by the locals due to political issues. Further, the cost of the project has continued to balloon beyond measure as contractors have varied the price upwards. The coal mills are of wrong design, causing excessive wear and tear, with increased maintenance and downtime. The design height of the boilers is inadequate (i.e. too low), thus causing excessive temperatures within the boiler and flue gas.

Excessive flue gas temperature is causing premature failure of the pulse-jet fabric filters, which are essential for fly ash collection and pollution control. The ash handling system is unable to cope with the volume of bottom ash and fly ash from the boilers. The reason is that — when the tender for the expansion of Medupe was floated, it had not been fully evaluated and considered by Eskom itself as there was no detailed feasibility study carried out. Had such been carried out, there would have been no attempt to vary the price upwards.

Kusile coal-powered project

The Kusile coal-fired power plant project is located in the province of Mpumalanga, South Africa, initiated again by Eskom, the state electricity company. It is supposed to be one of the largest power plants of its kind in the world when the entire project is completed in 2021 and one of the largest industrial point sources of greenhouse gas emissions. This project continues to promote outdated, heavily polluting and harmful fossil fuel technology. A proper feasibility would have entailed thorough attention to environmental and social safeguard concerns.

The costs of both the Medupi and Kusile plants have already escalated more than double to over R290 billion and they have taken at least an additional five years extra to build. Both the power plants were supposed to add almost 9 600 megawatts to the grid, but they are at their tail end of the build.

Instead of resolving the energy shortfall in Africa’s most industrialised nation, the plants have been textbook studies on how not to execute large infrastructure projects. There were issues around the technical specification of the plant and this has led to an inferior tariff being used and the project has failed to fully provide a return on investment (the project was funded through debt from International Monetary Fund and local lenders in South Africa).

Lessons and way forward

The energy industry is a highly technical and intricate industry and there is need for technical experts to be roped in where in-house expertise is unavailable especially where there are complex contractual arrangements. It is always cost-effective to employ independent consultants for technical assessments and project monitoring.

Care should be taken to ensure that modifications to loan agreements or contracts do not vitiate performance conditions. The project timetable should allow for delays or lags of preferably 4-6 months between placing plant and civil contracts, allowing the building design to reflect the actual choice of plant.

Forecasts of demand for power should be rigorously analysed at the feasibility study stage and the implications thereof should be clearly stated taking into account a number of factors such as economic performance indicators and population growth. In addition to the least cost option, factors such as simplicity of design should be taken into account when selecting generating plant.

The risk of redundancy of installed coal-fired capacity should also be considered as it provides an estimation of the likelihood of overcapacity of coal-fired power generation and power supply. The National Energy Agency in China has warned the local Chinese coal electricity generators on the dangers of overcapacity forecasting the period of 2023.

The planning and building; the resource constraint indicator is a binding indicator, reflecting the local feasibility of planning and building coal-fired power projects. Most importantly, the economics of building coal-fired power projects for local power consumption should reflect the various considerations by the various players in the power generation sector. This will avoid the present situation where most state-run utilities in Southern Africa are technically insolvent. Zesco, the Zambian utility, as well as Eskom of South Africa and Zesco in Zimbabwe are all reeling from technical insolvency.

Nyangwa is an energy and commercial litigation lawyer at MawereSibanda Commercial Lawyers where he is a partner. This article is part of a series focussing on the legal, economic and other areas around the energy sector in Zimbabwe.

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