Dr.

Albrecht Kaupp

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COSTS OF STEAM
Issue
The client expects a reduction in steam generation costs and does not care about energy consumption.

Learning Objectives

Establishing a list of cost items of steam generation Understanding the different methods of specific steam cost calculation Knowing how to calculate the specific steam costs Rating of the relative importance of cost items Appreciation for specific steam generation costs sensitivity with respect to cost items Recognition of negative influence of cost reduction of one cost item on the others Working experience in the use of software to calculate steam costs

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1. Establish ing a list of cost items

The costs of generation of steam are conveniently split into Fuel costs Electricity for pumps, blowers, other equipment Water Feed water chemicals Repair and maintenance (R+M) ______________ ______________ ___________ Depreciati on of boiler and auxiliary equipment Staff costs
Note 1: The first

NOTES

set of cost items are variable costs. They

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occur only if steam is generate d.

Note 2: The

NOTES

second set of cost items are fixed costs. They occur no matter how many hours the boiler is operated .
Note 3: In

the case of staff costs one could argue, that the staff may be assigned different tasks if the boiler is not operated at all or only intermed iately. Consequ

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ently staff costs are not always entirely fixed. It depends on the case. Howeve r by staff we mean compan y employe es that watch and monitor the boiler operatio n.
Note 4: In

NOTES

the case of R+M costs one could as well argue that part of the repair and mainten ance costs are fixed and part are variable (increme ntal). A

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common method is to either express the fixed R+M part as a percenta ge of the investme nt or as an annual fixed fee and the increme ntal part in Baht/ton of steam. R+M costs usually refer to costs for spare parts and possible external costs to install the parts.

NOTES

2. Unde rstan ding differ

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ent meth ods of speci fic stea m cost calcu latio n

There are methods. two

NOTES

A financial assessment that requires very detailed information of the clients financial dealings with a bank, as well as predictions of future inflation rates of costs. This method would require to account on an annual basis for the depreciation of the boiler at replacement value. In addition a residual value at the end of the observation

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period be set. must

NOTES

An analysis of the average economic costs as well as the life cycle costs of steam in US$/ton of steam. This method is preferred for classroom teaching because it requires less input data and is widely accepted as a tool to compare costs of various systems taking into account the time value (discounting ) of money.
Note 1: Keep in

mind, as a consulta nt whom conducts energy audits one always looks for addition al business opportun

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ities. The usual recomm endations after an energy audit of steam boilers are Do nothi ng, the syste m is O.K. Be tter hous ekee ping meas ures to redu ce fuel costs with no or little inve stme nt Re trofit ting and/ or impr oved

NOTES

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moni torin g and contr ol requi ring inve stme nts Fu el swit chin g Pu rcha se of a new boile r Ste am purc hase contr act (ISP ) One can therefore not afford to be too narrow minded and look only at the reduction of losses ignoring perhaps more beneficial solutions for the clients and the consultant. It is therefore

NOTES

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mandatory that economic costs of steam generation are calculated.

NOTES

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3. Average future economic costs

The basic equation is

NOTES

CSteam =

(1 + d ) (1 + d )
i =0 i =0 T

Ci Si

in US$/ton of steam (1) Where

Ci = Si = annual costs in the year i, US$ annual steam production in the year i, tons discount rate as fraction remaining technical life of the installation

T =

Note 1: The

equation applies to new boilers as well as to already installed ones.

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Note 2: The first

NOTES

cost term, C0, in the sum is either the purchasi ng price for a new boiler, or the resale (residual ) value of an existing one, at the end of the year 0.
Note 3: The

discount rate is the opportun ity cost of money, approxi mated as d = bank interest general inflation .
Note 4: If

it happens that subsidie s are

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given in form of below market interest for loans for efficient boilers, d could become a negative number.
Note 5: The total

NOTES

costs, Ci, are the sum of the individu al cost items as discusse d in 1. You will find that in older literature a great deal of efforts had been spent to simplify this equation into a more compact form to allow calculation by hand. With the proliferation of spread sheets, such calculations are automated and simplifications are unnecessary.

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4. Rating of the relative importa nce of costs items

The client expects reduction of steam costs and this can be done in many ways, by reducing individual or a combination of cost items listed in paragraph 1. As a consultant you dont want to be in a situation where you waste time and efforts to reduce cost items that are marginal, while missing the big cost reduction opportunities.

NOTES

5. Sensitivity analysis
Predicting future steam generation costs for boilers that have a technical life of 20 to 30 years is always a gamble. To safe guard

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against errors, it is common to vary all cost items by -10% to +10%. By this way one finds out which cost item will reduce or increase specific costs of steam generation significantly.

NOTES

6. Interferi ng recomme ndations

It will be shown that some recommendations to reduce fuel consumption will increase costs for other consumable. In the extreme, fuel consumption is reduced but steam costs go up. A typical example are recommendations to reduce blow down. It may lower fuel consumption, but will for sure increase consumption of chemicals for feedwater treatment and may as well

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increase stack gas temperature.

NOTES

7. Deprecia tion of investme nt

One of the more challenging task is to decide which method is used to account for the depreciation of the investment. By investment we understand equipment costs for the steam generation part including possibly the boiler house. Case 1: New installation, economic analysis The most simple case is to calculate the future economic costs for a new boiler installation. The value C0 in equation 1 is the total investment costs at the end of the year 0 (beginning of the year 1). The observation

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period T is 20 years or less and represents either the book life, tax life or useful technical life of the boiler. We prefer to set T=20 and view it as the useful technical boiler life. The residual value of the boiler after 20 years is a matter of opinion. One may be optimistic and assume a residual value of 10-20% of the initial investment (case A) or pessimistic and set the value equal to 0 (Case B). The residual value enters the time series of investments as a negative number because it is a revenue at the end of the useful life of the boiler. However one could be even more conservative and argue that the boiler has no resale value and it will even cost to decommission and scrap the old boiler (Case C). In this case the residual value is

NOTES

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positive. Furthermore we may discount investment flows to account for the time value of money. Table 1: Investment cash flow at d=0%
End of year Cash flow Cash flow Cash flow

NOTES

0 1 19 20 Case

10,000,000 0 0 0 0 0 A

10,000,000 0 0 0 0 -1,000,000 B

10,000,000 0 0 0 0 +500,000 C

Assuming a discount rate of d=5 % it follows

Table 2: Investment cash flow at d=5 %

End of year Cash flow Cash flow Cash flow

0 1 19 20 Total Case
Note 1: The

10,000,000 0 0 0 0 0 10,000,000 A

10,000,000 0 0 0 0 -376,889 9,623,111 B

10,000,000 0 0 0 0 +188,445 10,188,445 C

discount for the residual value is 1.0520 = 2.6533

Note2: The

disc oun

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t fact or is rou ghl y the diff eren ce bet wee n the opp ortu nity cost s of mo ney and the infl atio n rate of boil er cost s. In an financial analysis we need to make provisions that at the end of the useful life of the boiler there is money available to buy a new boiler at inflated replacement costs. Quite a

NOTES

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number of methods exist to account for it. Case 2: New installation, financial analysis A financing proposal requires to state the funding source, the duration of the pay back period and the effective interest paid before tax. It is customary to pay the loan back in equal annual installments called annuities. Table 3: Investment, financial analysis
EOY 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 5 years A2 0 2,637,975 2,637,975 2,637,975 2,637,975 2,637,975 0 0 0 0 0 0 0 0 0 0 0 0 0 20 years A2 0 1,174,596 1,174,5960 1,174,596 1,174,596 1,174,596 1,174,596 1,174,596 1,174,596 1,174,596 1,174,596 1,174,596 1,174,596 1,174,596 1,174,596 1,174,596 1,174,596 1,174,596 1,174,596 Sinking F1 0 721,287 721,287 721,287 721,287 721,287 721,287 721,287 721,287 721,287 721,287 721,287 721,287 721,287 721,287 721,287 721,287 721,287 721,287 Dep at Repl3 0 525,000 551,250 578,812 607,753 638,140 670,048 703,550 738,728 775,664 814,447 855,170 897,928 942,824 989,966 1,039,464 1,091,437 1,146,009 1,203,310

NOTES

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EOY 19 20 5 years A2 0 0 13,189,874 20 years A2 1,174,596 1,174,596 23,491,925 Sinking F1 721,287 721,287 14,425,7455 Dep at Repl3 1,263,475 10,500,004 26,532,977

NOTES

Note 1:

Bank interest for sinking fund savings is 6%. Inflatio n on boiler equipm ent is 5%. New boiler will cost 26,532, 977 Baht in 20 years. If the sinking fund does not earn interest than annuall y 1,326,6 49 Baht are paid into the fund for twenty years to accumu

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late 26,532, 977 Baht.

Note 2:

NOTES

Bank interest for loan is 10%. Invest ment is 10,000, 000 Baht. Data series for depreci ation at replace ment costs is explain ed in task 12. The sum of last depreci ation of 1,326,6 49 Baht and residual value of 9,173,3 51 Baht. The sum of 14,425, 745 has been paid in a

Note 3:

Note 4:

Note 5:

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sinking fund that earns 6% interest. Funds of 26,532, 745 Baht are availabl e at the end of the 20th year to purchas e a new boiler The annuities A, are easily calculated by the equation A = I0 RF(i,T), (2) where
RF (i , T ) = q n (q 1) q n 1

NOTES

, recovery factor
i = effective interest rate as fraction T= pay back period q = 1+i

Another way to account for annual costs to replace equipment is the sinking fund method. It assumes that the firm pays

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annually a constant amount in an interest earning account in such a way that after 20 years the fund has grown to 26,532,977 Baht, the amount needed to buy a new boiler. A method preferred by banks is depreciation at replacement costs with residual value, R, after T years. This method is very flexible since it allows to vary the useful life of the investment. The method is described in task 14. By far the most plausible and easy to apply depreciation strategy that results in realistic annual equipment depreciation costs and constant annuities is the sinking fund methodology with or without interest paid. It is the only methodology that results in a

NOTES

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constant steam generation cost fraction due to depreciation of equipment.

NOTES

8. Summar y
The outcome of an economic analysis of the steam costs of a new or old boiler installation is presented in a summary table and graphics. It highlights all the parameters discussed in the previous paragraphs and is part of a base line assessment of any boiler energy audit. The exercise part of this lecture consisting of 14 standard tasks applies the theory for most common situations in the field.

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NOTES

EXERCISES
Exercises using a simulation software gives a good overview of what cost factors and other parameters such as discount rate and technical life are important. The approach follows closely the methodology shown in the KFW discussion paper # 7, Economic Appraisal Criteria for Electric Power Projects. However in the exercises we have made some simplifications to speed up classroom calculations such as: The calculation for the residual value of the boiler at the end of the observation period is not discussed in detail. We simply assume it is the book value or some resale value and do not include inflation and base the residual value on the current replacement value. Only the long range marginal cost (type 2) are calculated. An existing boiler is not depreciated on an annual basis with its annual depreciation value, but rather viewed as a boiler with a lower investment value(=book value) at the end of the year 0. The EXCEL spreadsheet can as well handle the more complicated method. Standard references used are: Economic Appraisal Criteria for Electric Power Projects, KFW, discussion paper # 7, April 1994. Economy calculation systems for capital goods and plants, VDI 6025, 1996. The economic analysis of industrial projects, Lynn E.Bussey, Ted G. Eschenbach, Prentice-Hall Inc., ISBN 0-13-223801-2 A guide to the financial evaluation of investment projects in energy supply. Horst Finck, Gerhard Oelert, TZVerlagsgesellschaft , Germany, ISBN 3-88085-250-2

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Exercises reflect the 14 most common issues an energy auditor may discuss with clients. The scenario spinner loads typical cases of a large fire tube boiler with the following properties and assumptions.
Investment costs: Actual capacity: Electricity cost: Water costs: Chemicals: Fuel costs: Discount rate: Inflation: Technical life: Staff costs: Steam generation: R+M costs: 10,000,000 Baht 10 tons/h @ 10 bar, saturated steam 1.8 Baht/kWh 15 Baht/m3 @ 25,000 m3/year 7 Baht/ton of steam @ 50,000 tons/year 5000 Baht/ton of fuel @ 1 ton of fuel per 13.6 tons of steam variable variable 20 years (observation period) 1,500,000 Baht/year 50,000 tons/year 450,000 Baht/year

NOTES

Chemicals

300,000 Baht/year

The following common questions and issues are to be solved:

Task 1
Calculate the average future economic steam costs (AFC), assuming the client needs a new boiler with 13.6 tons of steam per ton of fuel. Steam costs are ___________ Baht/ton Also show the fractional cost of various cash flows. The fuel costs are _____ % of the total steam cost.

Task 2
The client is worried about the technical life of the boiler. Show the influence of the technical life of the boiler on steam costs. Technical life 20 years ____________ Baht/ton 10 years 1 year ____________ Baht/ton ____________ Baht/ton

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Hint: Load scenario 1. Use the T-life spinner and cycle through the technical life. The new costs are shown under Steam costs, Baht/ton.

NOTES

Task 3
Assume the boiler is already 12 years old and it will last perhaps 10 more years. Calculate the steam costs for the remaining 10 years. Steam costs are _______________ Baht/ton

Hint: Load scenario 1. Lower the investment to about 30 % of the initial investment and set technical life to 10 years.

Task 4
The client wants to buy a new boiler but does not want to invest in a high efficiency boiler. The cheaper the better is most clients wrong philosophy. Assume the premium paid for an energy efficient fire tube boiler (10t/h) is 20 % of the 10 Million Baht paid for an inefficient one. The more expensive boiler will save at least 2 % fuel. Calculate the loss the company will have over 20 years, if management decides to buy the cheaper boiler. Loss over 20 years: ________________ Baht

Repeat this exercise with a fuel inflation rate of 2% per year. Loss over 20 years: ________________ Baht

Hint: Load scenario 1. Press the lock button. Increase investment costs and R+M costs by 20%. Lower fuel consumption by 2% and look at the Cost/benefit, Baht.

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An interesting issue is to what extend an investment increase of 20% would imply an R+M increase of 20%. Excluding the 20 % increase in R+M would significantly increase the benefit over 20 years. One could argue that better equipment is also more reliable. On the other hand if the investment increase is due to more monitoring and control instrumentation there is a danger of increased R+M costs.

NOTES

Task 5
Your client is a firm that believes in paying as little as possible for boiler operators. Management also does not care about proper instrumentation and frequent cleaning of boilers. Boiler operators do not receive any training and operate by gut feeling. Assume that better trained and paid operators would save at least 2 % of the fuel. Calculate the net benefit to the firm. Net benefit is ______________ Baht
Hint: Load scenario 1. Press the lock button. Increase Staff costs to 20% to account for higher salaries and training. Increase Investment at the end of year 0 by 300,000 Baht to account for investments in better monitoring equipment and verification of savings. Lower Fuel costs by 2 %.

Task 6
So far inflation of fuels and other cost items had not been considered. Assume that fuel costs go up by 2 % per year. Calculate the net benefit to the client for Task 5. Initial net benefit (0 % inflation) New net benefit (2 % inflation) Additional savings ______________ Baht ______________ Baht ______________ Baht

Hint: Load scenario 1. Increase Inflation to 2 %. Press Lock. Increase Staff costs by 20 % and Investment by 300,000. Lower Fuel consumption by 2 %.

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Task 7
Financial managers of large firms require precise steam cost calculations, with a so called hurdle rate, that reflects the companys policy how much an investment should earn. In this case the investment is the boiler and the product is steam. The firm requires a hurdle rate of 35 % for this investment and likes to know, how much they should charge for steam in their internal accounting. Calculate the costs of steam for a discount rate of 0 % and 35 %. Steam costs (d = 0 %) Steam costs (d = 35 %) Difference Difference in % ______________ Baht/ton ______________ Baht/ton ______________ Baht/ton ______ %

NOTES

Hint: Load scenario 1. Cycle through the Discount spinner.

Task 8
Consider a situation where you operate a boiler for others and sell steam. Your investment is the boiler, and you provide the staff and take care of all the boiler repair and maintenance. Calculate the price difference in steam, based on a discount rate of 0 % (break even) or d = 50 %. Steam costs (d = 0 %) Steam costs (d = 50 %) ___________ Baht/ton ___________ Baht/ton

Hint: Load scenario 1. Cycle trough the Discount spinner.

Task 9
The software can be as well used to perform a financial analysis. Assume the new boiler is financed by a bank that charges 15 % interest over 5 years. Repayment is in equal installments. Calculate the steam costs. Steam costs are ____________ Baht/ton

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Additional costs ____________ Baht

NOTES

Hint: Load scenario 1. Make sure the discount rate is 0%. First calculate the annual payment to the bank by the formula

A= I0 RF(i,T) where I0 = initial investment of 10,000,000 Baht

q n ( q 1) RF (i , T ) = = the recovery factor q n 1

where n = loan pay back period, 5 years i = bank interest rate, 15%
Set the investment at the end of the year 0 to zero. Insert A for the next 5 years in the investment row.

Task 10
As you may have noticed, inflation of fuels has a very pronounced effect on costs. Test this sensitivity. Steam costs (inflation 0 %) Steam costs (inflation 1 %) Steam costs (inflation 5 %) ______________ Baht/ton ______________ Baht/ton ______________ Baht/ton

Additional cost over 20 years Inflation, 0 % _______________________ Baht Inflation, 1 % _______________________ Baht Inflation, 5 % _______________________ Baht This exercise has a very real practical application. Any independent steam producer would never agree on an escalation rate for the price per ton of fuel taking into consideration future inflation rates of fuels. Instead he would set a hurdle rate for a decent return on the investment, and agree with the client on a specific energy consumption in tons of steam/tons of fuel. That gives the steam retailer the option to have significant additional

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revenues or losses depending on how efficiently he can operate the boiler.

NOTES

Task 11
Charging a client a fee for energy audit services is one way to make a living. On the other hand consider the tremendous fuel cost saving potential of the boiler. An agreement to share the fuel cost reductions, is much more difficult to negotiate but could be more profitable. Assume that such an agreement exists, and all investments as well as verification and documentation of the savings are your expenses while the client pays you 50 % of the verified annual savings for the first 5 years. Use the software to assess the level of your costs (including your own and staff income). You may target 3 % fuel savings. Take into account risks such as a steam production reduction by 50 %. Be aware that the question is not to what extend you manage a fuel cost reduction of 3 % with the given investment. That task can always be achieved. A more complicated issue is how to measure and verify the savings.
Hint: Load scenario 1. Reduce technical life to 5 years.

Write down the life cycle costs:

____________ Baht

Reduce fuel consumption by 3%. The new life cycle costs are ____________ Baht Your income from this deal is 25 % of the difference, assuming the worst case scenario that steam production is only 50 % on the average. In the worst case your income of __________ Baht has to cover all your efforts, time and investments.

Task 12
In particular with older boilers, one faces the task to either recommend the usual energy cost reduction options as discussed or look into the installation of a new boiler.

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Assume the boiler is 12 years old and would be 13 more years in operation. A new energy efficient boiler would cost 12,000,000 Baht (20 % premium for efficiency). The new boiler based on its design efficiency will save 5 % of the fuel. Two cases should be considered: 0 % inflation and 2 % inflation on fuels. Look into the benefit/cost of a new boiler.
Hint: Load scenario 1. Reduce technical life to 13 years. Assume a resale value of the boiler of 10,000,000 (13/13+12) = 5,200,000 Baht

NOTES

Write down the life cycle costs for inflation rates of 0 %: 2 %: _____________ Baht and _____________ Baht.

Change the investment to 12,000,000 Baht for the new boiler. Include the boilers residual value of 7/20 of 12,000,000 as a negative number in the 13th year. Write down the life cycle costs for inflation rates of 0 %: 2 %: _____________ Baht and _____________ Baht.

Compare numbers. Which option is the better one? The calculation was done in a very conservative way. It is acceptable to argue that there will be a resale value for the old decommissioned boiler that lowers the investment of the new boiler. The new boiler costs are therefore not 12,000,000 Baht but perhaps only 8,000,000 Baht depending on the market for used boilers.

Task 13
The previous 12 tasks were in preparation for one of the most challenging issues of how to convince a client to replace an existing energy inefficient boiler by a new more efficient one. There is a so called boiler design efficiency that is verified during commissioning and after some time of operation the boiler will run on its operational efficiency that is usually

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lower. Your task is to find out whether the client has made an investment error that cannot be reversed, or to what extend the boiler could be decommissioned and replaced by a new one. Assessing the options and estimating the risk is not difficult , but requires the right methodologies. There are two obvious theoretical extremes: Replacing a boiler that is only one year old. Replacing a boiler that will be in operation for only one more year, because its useful life comes to an end. We apply the following methodology State the remaining technical life of the existing boiler. Estimate its todays resale value (a positive number), or set the resale value to zero if the boiler is scrapped. State the investment costs of the new boiler and estimate by how many percent it would reduce specific fuel costs per ton of fuel. Assume a residual value for the new boiler at the end of the observation period which is the end of the remaining technical life of the existing boiler. Calculate life cycle costs based on fuel inflation rates of 0 % and some other value (Low and high fuel inflation scenario) Consider the two options to include/exclude the residual value of the existing boiler in the calculation. Consider the two options to include/exclude the residual value of the new boiler at the end of the observation period. You will notice that the options to include/exclude residual values may influence the life cycle cost significantly. Assume the remaining technical life of an existing boiler is 1,5,10,15, or 19 years. The design efficiency of the proposed new boiler will at least on paper reduce specific fuel consumption by 5 %. Load scenario 1 as the base case and assume the new boiler will cost 12 million Baht. Report the results (Life Cycle Costs) in the table.

NOTES

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Years 0 % fuel inflation 3 % fuel inflation

NOTES

Resale + Residual + 1 5 10 15 19

Resale Residual +

Resale + Residual-

Resale Residual-

Resale + : Include a negative resale value calculated as residual fractional book value by which the investment costs for the new boiler are lowered. Resale -: Assume full cost for new boiler. Residual +: Assume negative fractional book values of the new boiler at the end of the 20 th year. Residual -: Assume the new boiler is nothing worth at the end of the 20 th year. Lowering the investment for the new boiler by an assumed resale value of the old boiler is only justified if the old boiler is sold. Including the residual value of the new boiler at the end of the 20 th year is always required. The case Residual - is only included to demonstrate the error on life cycle costs if the residual value of the boiler is not included in the calculation.

Task 14
In any economic/financial assessment the question is how to account for the investment costs. Economic analysis is not a science but rather an art dealing with how to estimate the risks. Expert opinion how to calculate these risks differ and the literature describes as well contradicting methodologies. One interesting point is todays worth of a past investment and how to depreciate it over the reminder of its technical life. International financing institutions recommend to depreciate the capital investment at the replacement value for this year.

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Boiler depreciation at replacement value is much higher than depreciation at book value. Using the book value one would account for annual equipment depreciation costs of 500,000 Baht for twenty years. However using the method to depreciate based on the replacement value one would have a string of annual deprecations calculated as follows: 10,000,000 1.03/20 = 515,000 10,000,000 1.032/20 = 530,450 10,000,000 1.0320/20 = 903,056 The boiler was depreciated at a total of 13. 838 Million Baht over 20 years. With straight line book depreciation only 10 Million Baht would be charged as costs for the boiler replacement over 20 years and the residual book value is 0. In the case of depreciation at replacement value the residual value of the boiler after 20 years equals the replacement value at the end of the 20th year minus the cumulated depreciation at replacement costs at the end of the 20th year. Note that a new boiler at an inflation rate of 3 % per year would costs 10,000,000 1.0320 = 18,061,112 Baht. However only 13,838,243 Baht were depreciated. Consequently the positive residual value of the boiler at the end of the 20th year equals 4,222,869 Baht. Don't view this residual value as income or scrap value of the boiler. These are additional costs. One may view the annual depreciation at replacement costs as costs that have been paid into a bank account at 0% interest and the residual value of 4,222,869 Baht as the amount that must be provided in addition at the beginning of the 21st year to buy a new boiler at cost of 18,061,112 Baht. Consequently the annual capital costs due to depreciation of the equipment are considerable higher then book values. They are also not constant..

NOTES