NTPC SCHOOL OF BUSINESS

PROGRAMME NAME: PGDM (Executive)

COURSE TITLE: ENERGY ECONOMICS
Faculty Name: Dr. Abhinav Jindal, PhD (Economics) IIM Indore
Email: fi17abhinavj@iimidr.ac.in

Lecture Notes
Sessions 3: Economic analysis of Energy investments

• To learn how to conduct a Cost Benefit Analysis (CBA),

• What is the time value of money,
• What is the utility of NPV analysis and Discounting factor

3.1 Cost Benefit Analysis

• An economic analysis is aimed at identifying the welfare impacts of a project.

• This typically involves three stages:

(i) Identification and estimation of costs related to an investment,
(ii) Identification and estimation of benefits related to an investment,
(iii) Comparing the costs and benefits. C>B unviable otherwise viable.

• Types of costs:
(i) Opportunity costs,
(ii) Marginal costs,
(iii) Sunk costs
(iv) Working capital
(v) Indirect costs
(vi) Contingencies

• Types of Benefits:
(i) Direct benefit (Utility),
(ii) Indirect (Society)
(iii) Indirect (System)
(iv) Marginal Benefits
• Example: Costs of coal plant decommissioning/repurposing: Components.

Employee costs, station overheads as well as O &

M expenses post retirement

Environmental regulation, such as asbestos &

hazardous material abatement

Demolition of the plant and scrap removal from

Direct costs: the coal plant equipment and machinery

Plant specific costs

Coal combustion residuals (i.e., ash/residue
ponds) cleanup

Coal storage areas clean up

Contingency costs, such as unanticipated

Costs of
environmental costs
decommissioning/
repurposing Indirect costs
Lost local (city, state) tax revenue

System balancing costs (e.g., reactive power)

originally provided by the coal plant

Remaining capital expenditure (CAPEX) on the

coal plant
Additional
Repurposing costs Remaining operational expenditure (OPEX)
margins on the coal plant
 • Example: Benefits of decommissioning/repurposing: Components

Salvage value/scrap value of coal plant

machinery

Land reutilization

Direct benefits: Equipment (i.e., switchyard, substation)

reutilization
Plant specific benefits

Remediation benefits i.e., reduced

remediation costs

Transmission and interconnection

evacuation reutilization

Benefits of repurposing Peaking power benefits with BESS by

(and decommissioning) Indirect benefits: retaining ancillary services

System benefits Reactive power benefits with SynCON by

retaining system balancing services

Carbon benefits

Health benefits
Indirect benefits:
Societal benefits
Water benefits

Re-employment benefits

3.2 Time value of money

• Methods without time value-Undiscounted costs and benefits

• Methods employing time value-Discounting
 • Choosing a higher discount rate (i.e. >5%) could potentially deemphasize (and
devalue) the economic impact of various environmental benefits (indirect) such as
carbon and water benefits. Importantly, a single discount rate needs to be applied
to all future costs and benefits.
3.3 NPV based indicators

• Project with Positive NPV needs to be chosen. Higher NPV projects must be given
preference.
• Equation (1) provides an estimation of the present value of future costs (i.e., discounted).

[(A.1+A.2+A.3+A.4+A.5)+ (B.1+B.2+B.3)+ (C.1+C.2+C.3)]

Costs (PV) = ∑𝑛0[ ]
(1+d)𝑛

(1)

where A.1-C.3 are individual cost components, d is discount rate and n is the lifetime.

• Equation (2) provides an estimation of the present value (PV) of future benefits (i.e.,

discounted):

[(A.1+A.2+A.3+A.4+A.5)+ (B.1+B.2+B.3+B.4)]
• Benefits (PV) = ∑𝑛0[ ]
(1+d)𝑛

(2)

where A.1-B.4 are individual benefit components, d is discount rate and n is the lifetime.

• Costs (PV)>Benefits (PV), project is unviable.

3.4 Role of discount rates

• Any investor would expect a return higher than the rate of investment elsewhere.
• Social rates of discount could be quite different from the private rates of discounting
as the society may value differently.
• For example in climate related projects, a high rate of discounting implies putting a
very low value to the distant cash flows, there by negating their influence on
decision making.
• If the Discount rate is Zero, the NPV is the undiscounted cash flow.
• For infinite Discount rate, the NPV is the initial investment.
• A high Discount rate is for the preference to use the resource now and low Discount
rate implies relative indifference between present and the future.
• Discount rates affects NPV.
Takeaways:

• Economic vs financial analysis

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Objective: Is the economic analysis similar to the financial analysis? What are the important
aspects related to an economic analysis of energy investment?

Learning Outcomes?