COGENERATION CHALLENGES & OPPORTUNITIES

MEETING COGENERATION TARGETS IN THE MARKETPLACE Rick W. Meidel

Vice-President, Power Projects ExxonMobil Power & Gas Services Inc.

Because we consume US$7 billion worth of energy each year running our global operations, ExxonMobil takes energy efficiency seriously. Weve developed tools and processes to improve the energy efficiency of our operations and help us understand the efficiency and emissions impacts of new projects. In 2004, we achieved record performance in energy efficiency across our worldwide refining and chemical businesses . Over the past four years, our refineries have improved at a rate greater than the historical industry rate, improving energy efficiency by 5% and by nearly 10% since 1990. Cogeneration - the simultaneous production of electricity and thermal energy - has become a standard feature in many ExxonMobil refining, petrochemical and production facilities around the world. Why? As readers of this publication would recognize, its because cogeneration reduces emissions, is energy efficient and provides a highly reliable power source for our manufacturing and production facilities. Counting our latest investments, the annual energy efficiency savings associated with our cogeneration investments worldwide is estimated at about 13,000 GWh and thats about half of Belgiums annual residential electricity demand. From an environmental perspective, were reducing CO2 emissions by about 9 million tones per year compared to that of making steam using traditional methods and buying electricity from the market. This impact, from a scale perspective, dwarfs the impact of many well-intentioned renewable energy projects. To match the energy savings from ExxonMobils cogeneration facilities with wind generation, it would take roughly 3,000 large (1.5 MW) onshore wind turbines. So with all these benefits, why isnt there exponential growth in cogeneration projects, particularly in Europe but in the rest of the world as well? Why have cogeneration targets been largely unmet? There are a number of factors, but a big reason is that power market rules dont typically recognize the inherent nature of cogeneration facilities and their tight integration within large manufacturing facilities. And thats unfortunate given the cost effectiveness of power from a cogeneration facility. This article will outline some of the key features of power markets that might enable new cogeneration investments. With the expectation that the new EU Cogen Directive will be implemented by Member States in early 2006, its timely to outline potential market structures that, in our view, are required so that both industry and consumers alike can realize the benefits of large-scale industrial cogeneration facilities. Before we discuss enabling power market structures for cogeneration, lets root ourselves in some of the basics of industrial cogeneration facilities.

Cogeneration Challenges and Opportunities RWMeidel Page 2

Chart 1 shows a simplified schematic for a typical configuration. The reason cogeneration can make sense for production operations and many manufacturing facilities is that they can recover the useful energy thats otherwise lost in condensing steam back to water and/or as waste heat being discharged to the atmosphere. Cogeneration configurations are able to take the exhaust heat from, say, a gas-fired turbine and utilize this heat directly in a furnace application. Or, the heat can be converted to steam which is utilized in the manufacturing or production processes. This heat / steam is critical to the manufacturing / production process and without it, capacity of the overall facility would suffer or perhaps shutdown altogether. Chart 2 outlines indicative heat flows of simple cycle, combined cycle and cogeneration configurations for comparison purposes. In a simple cycle peaking configuration, only 34% of the energy results in electricity; the rest is wasted. In a combined cycle configuration the waste heat is captured and converted to steam for additional power output. Once that steam has been through the steam turbine though, it has to be condensed back to water resulting in a loss of efficiency. In this configuration, 50% of the heat flow results in electricity. But with cogeneration, we capture the waste heat and utilize the heat / steam in our manufacturing process resulting in a reduced need for boilers and the fuel that goes with those boilers . When we compare this approach to using a boiler to produce steam and buying electricity from the grid, we can realize efficiencies of almost 80%, or about twice that of traditional methods. If the heat can be used directly in process heat applications (furnaces as example), the efficiencies are even higher. This efficiency benefits all of us industry and consumers alike. If market structures allow, cogeneration facilities can be sized such that costeffective electricity, in excess of the facilitys need, is available as export to the market. As example, our latest cogeneration installation at our Beaumont, Texas plant has over 450 MW of electricity generation and two-thirds of the efficient power generated is exported to the market. Basic thermodynamics and energy balances show that cogeneration is a high efficiency configuration. But industrial cogeneration facilities have some challenges as well. Our cogeneration installations are an integrated part of an overall manufacturing facility where heat / steam are required for continuous manufacturing operations. Thus availability and reliability of the cogeneration facility are critical. These demands require that the site be typically base-load, or must-run which may limit the plants flexibility to capture market opportunities. With steam as the most important output of the facility, there are very limited opportunities for a cogeneration facility to turn down generation in order to take advantage of buying lower priced power in the market or, vice-versa, to ramp up generation in order to capture attractive market prices for the facilitys export power. Cogeneration is also a capital intensive business. To highlight this point , with four new facilities in the USA / Canada comprising over 800 MW of capacity that began operation in 2004/2005 alone, ExxonMobil has invested US$1 billion dollars in our commitment to energy efficiency.

Cogeneration Challenges and Opportunities RWMeidel Page 3

Chart 3 compares the relative capital cost and efficiency of various gas-fired generation facilities. Capital cost is shown as a bar using the left scale (Euros per kW) and efficiency is shown as a line using the right scale (percent). This chart shows cogenerations total capital costs including both electricity and steam production divided by the kWs of electricity capacity. This approach puts cogeneration on the same basis as other gas-fired generation types but does not take into account the steam that is produced and utilized within the manufacturing facility that would otherwise have to be produced in boilers . In reality, only a portion of the capital costs and fuel costs are electricity related and thus, on an incremental energy efficiency basis, electricity produced via cogeneration has a low marginal cost of production. Cogeneration may represent a significant investment but, if the integration is right, the efficiency related benefits as shown in the chart are significant. Before considering cogeneration, one must first examine steps to optimize existing operations with minimal investment. In other words, one should find and implement the low cost or no-cost investment steps to improve site efficiency. An example might include burner management. Thus when cogeneration is considered, our facilities are starting from a relatively efficient base case. From an investor perspective, higher efficiency by itself may not be enough to justify a cogeneration investment. In many cases, other credits or synergies may be required in order for the cogeneration investment to make economic sense. These credits might include the transmission and distribution savings from self-generating power. They might also include credits for postponing / eliminating boiler maintenance, boiler life extension projects, avoiding new boilers needed for growth, or even outright replacement of older boilers within the facility. The use of alternative, low value fuels can also be an attractive concept and, in addition to being economical, may solve operational challenges as well. An example might be low value manufacturing by-products that would otherwise incur transportation and disposal costs or require sale at a distressed price. Other alternative fuels might include those that are not otherwise commercial. Leveraging its technical expertise, ExxonMobil has developed a patented process for burning high inert / low BTU gas in a gas turbine. The technology highlights ExxonMobils extensive experience with steam methane reforming, syngas production and low BTU gas combustion. Commercially proven, the technology transforms low methane gas into a flame stable gas turbine fuel. In the right application, the result is a reasonably priced fuel source for power generation facilities. In addition to alternative fuels, economies of scale are important and theres an advantage to using the largest, most efficient gas turbines available. In the past, ExxonMobil has developed smaller cogeneration projects that simply meet the power demand of the particular site. This typically results in supplemental steam requirements that must be sourced from a boiler. On the other hand, weve also developed large projects, such as our new Beaumont project, to match the steam requirements of the site. This typically results in excess power above the sites needs that must be exported to the grid. Whether the inherent miss-match between power and steam demand at a particular site is a constraint or an opportunity depends on the market structure for accepting export power from cogeneration facilities.

Cogeneration Challenges and Opportunities RWMeidel Page 4

For a cogeneration project (or any generator for that matter), the electricity price is the most important variable in determining a projects success more so than capital costs, operating & maintenance costs and even fuel costs. In working through the process of determining whether or not its advantageous to export power from a large-scale cogeneration facility into the market, its critical to understand the market fundamentals. A solid understanding of generation by fuel type and the relative order of dispatch is required for each individual market. At ExxonMobil, we spend considerable time developing such an understanding. Along these lines, Chart 4 shows a simplified merit order stack and load duration curve for a hypothetical power market where one might consider development of a large cogeneration facility. The X-axis represents a one-year period in percentage terms. The capacity of the different generation types (the colored bars) and the demand curve (the dark line) are shown along the Y axis in MWs. The generation types are stacked in order of lowest to highest marginal costs and it is at this cost that they are assumed to be dispatched. Assuming a power pool concept, the last unit dispatched to meet demand sets the price for all other plants dispatched before it. At a high level, one could look at this chart and say that for 45% of the year (going left to right) power demand is at least 45,000 MW. In addition, at this demand level, the market would need all the nuclear, renewables, low cost coal, cogeneration and high cost coal plants in the system to meet that demand. On the other hand, we could also say that for 30% of the year (looking right to left) not all of the cogeneration facilities are needed to meet the demand in this particular market. But within a manufacturing facility particularly a refinery or petrochemical complex steam reliability is of paramount importance. The facility must run continuously and steam production cant be compromised simply because the market doesnt have a need for the electricity. The amount of electricity produced from an integrated ExxonMobil cogeneration facility is a secondary consideration and determined based on the need to produce specific quantities of reliable of heat / steam to the manufacturing process. In a competitive market, cogeneration facilities might have the option of bidding their power below their marginal costs to ensure they are dispatched thus taking whatever the marginal price happens to be for each hour. The price paid for power during these times when cogeneration might not otherwise be dispatched isnt too attractive for the investor, but across the year on average, cogeneration is very attractive in terms of supplying lower cost, efficient power to the market. Creating a win-win environment for industry and the consumer thus requires enabling mechanisms for these cogeneration facilities. Certain countries have realized that, across the dispatch profile, cogeneration is an attractive power generation source for the market and consequently, are providing market structures that support additional investments. Some even, in an effort to promote new high-efficiency, environmentally friendly industrial cogeneration investments, are offering incentives such as investment credits. But to be successful, the base efficiencies, to which cogeneration will be compared must be established at realistic levels. Too often, they can be set too high making it impossible for even the most efficient industrial cogeneration facility to meet the required improvement above an artificial base that a combined cycle facility cant meet. Beyond investment credits, what are the enabling market mechanisms or structures that might be considered to help encourage cogeneration investments?

Cogeneration Challenges and Opportunities RWMeidel Page 5

The first important mechanism is a rational dispatch scenario. With a cogeneration facility, power and steam cannot be made separately and both are integral to site operations. The manufacturing sites heat / steam demand dictates a must-run operation for the cogeneration plant in order to achieve high availability / reliability standards of the overall facility. Translated, a cogeneration facility cannot have external control of its start-up nor its shutdowns and there can no external control of cogeneration scheduling as one might have in a typical electricity only facility. Countries like Italy have recognized this important point and have developed priority dispatch mechanisms within their new market structure. Secondly, manufacturing facilities with cogeneration must be allowed to purchase their net requirements or sell potential excess without discrimination. Variability has to be accommodated without penalty. In regulated markets, such as some within the United States, there exists a put option within the Public Utility Regulatory Policies Act (PURPA). This allows cogeneration facilities to place, or put their power into the market and be paid at the utility companys avoided cost of generation. Regardless of whether the avoided cost is high or low at any particular time, this mechanism generally represents the market clearing price. This structure recognizes that electricity output from a cogeneration plant is difficult to schedule and thus accepts the facilitys efficient power without discrimination. Its a simple fact there is variability in the electricity output of a cogeneration facility because theres variability in the steam demand at these manufacturing facilities. As an example, at our newest Baytown, Texas installation, the facility was designed to meet the peak summer electricity demand. Yet daily electricity demand at this particular site can fluctuate by as much as 50 MW due to operations variability. The swing from summer to winter can be as much as 100 MW. So what happens to the surplus electricity that might otherwise be available when our own demand swings to the low side? Do we simply turn down the machines or do we export the efficient power to the market? Fortunately, the Texas system operator provides for a non-discriminatory balancing market where cogenerators can sell (or buy) power and thus receive the market price for that hour. In contrast, the U.K. has a balancing mechanism that is punitive in nature and, consequently, cogeneration investment has effectively (with one notable exception) been stalled in that country. Punitive balancing mechanisms reflect the system operators desire that sellers accurately plan their output and buyers accurately plan their demand. While a reasonable request for some, power output from a cogeneration facility is difficult to schedule reflecting a facility that produces both electricity and steam where both are used, and must be m anaged, within the manufacturing / production process. If cogeneration is a desired generation source and one can argue that it should be based on its efficiency and environmental benefits - then a mechanism must be in place such that we have options to sell the cogeneration facilitys power, or purchase our net requirements, at the equivalent of the market clearing price.

Cogeneration Challenges and Opportunities RWMeidel Page 6

Thirdly, the market structure must provide for transmission costs and ancillary services based on the actual costs the cogeneration facility imposes on the grid in other words, a facilitys net load versus its total site requirements . For example, if a manufacturing facility has on-site power demand of 100 MW on average and has a cogeneration facility that is capable of producing 80 MW on average, then grid-related costs and fees should be based on the 20 MW that is typically imported from the grid, not the 100 MW of potential import in the event of an operational upset of the cogeneration facility. In some circles, this is described as net versus gross. W hen market structures charge fees based on the sites total requirements (gross), it is a major obstacle for new cogeneration investments. Were happy to pay our fair share of the distribution and ancillary services required to support the grid. But charging fees based on total requirements tends to be discriminatory. Fourth, there must be flexibility around market participation and compliance costs. For services like reserve capacity or back-up power these should be market based costs reflective of services actually required. Fifth, recognizing that cogeneration can be twice as efficient as the average generator in a market, there should be no discrimination of cogeneration facilities relative to other state / country promotions such as renewable support schemes. High efficiency industrial cogeneration has a significant, positive impact on the environment and it saves energy. And, due to its scale, it takes a lot of wind turbines to have the same impact. Lastly, but importantly, cogeneration represents a substantial investment and investors need assurance that market rules, mechanisms, and/or administrative procedures supporting cogeneration will not materially change preferably for the life of the investment. Power and particularly cogeneration is not something new at ExxonMobil. We have interest in nearly 15,000 MW of power generation around the world including approximately 7,600 MW in our Hong Kong regulated joint venture with China Light and Power. Weve been in the cogeneration business for over 50 years and, as shown in Chart 5, we now have over 3,700 MW of installed cogeneration capacity including our most recent investments which began operation in 2005. Putting these numbers into context, ExxonMobils 3,700 MW of cogeneration capacity, along with other self-generated power, supplies about 50% of our world-wide electricity demand! In total, we now have 85 cogeneration installations in more than 30 locations around the world. And were not stopping there. Were always looking for new cogeneration opportunities and were currently considering projects in North America, Asia and Europe. Specific to Europe, we are currently evaluating investment opportunities in our Production and Refining companies that could increase our European cogeneration capacity by as much as 50%. This reflects our strong commitment to energy efficiency.

Cogeneration Challenges and Opportunities RWMeidel Page 7

It takes a lot of energy to make energy. And as the world's demand for energy continues to rise - experts predict demand in 2030 will be 50% higher than today - it will inevitably take a lot more. That's why at ExxonMobil, we continue to take significant steps to conserve it. Over the past four years alone, our worldwide energy efficiency efforts have saved enough energy to supply the annual electrical needs of 1.5 million European households. With a steady rise in energy demand worldwide, every effort to improve efficiency counts. The challenge lies in meeting the world's growing energy needs more efficiently with lower emissions. Energy conservation is how ExxonMobil is doing both. Energy saving initiatives including cogeneration - have had a dramatic effect on emissions, the equivalent of taking well over a million cars off the road, every year. In a world where easy-sounding answers simply won't solve the problem, we're making a real contribution to a very real challenge. Markets that encourage the development of high efficiency generation investments like cogeneration not just in words but with enabling mechanisms - can make a real contribution as well, for industry and consumers alike. ExxonMobil. Taking on the worlds toughest energy challenges.

NOTES:
If edits are required as the article is put together, ExxonMobil reserves the right to review the final copy before publication. Reference charts have been sent as a separate PowerPoint file. Rick Meidels photograph, in the event one is needed, will be sent under separate cover. Photographs of ExxonMobil cogeneration facilities and related captions will be sent under separate cover. Should you need to discuss the article or have any other questions, please contact me at 713-656-3201. My e-mail address is rick.w.meidel@exxonmobil.com