1. Presentation to APPA February 17, 2005 Larisa Dobriansky, Deputy Assistant Secretary, DOE Policy Office David Berg, Chief Advisor, DOE Policy Office Andrew Paterson, Principal, Environmental Business International A Risk Framework Approach Policy Approaches & Incentives in Financing Gasification Plants www.ClimateVISION.gov

2. 2 President’s Climate VISION Initiative On February 14, 2002, President Bush set a goal to reduce U.S. GHG emissions intensity. Based on public – private partnerships, engaging a dozen industry groups. Emphasizing voluntary actions and accelerated commercial use of advanced technologies. And achieving National Energy Policy goals. “My administration is committed to cutting our nation’s green- house gas intensity over the next 10 years.” -- February 14, 2002 www.ClimateVISION.gov

3. 3 Climate VISION Private-Sector Partners Alliance of Automobile Manufacturers Aluminum Association American Chemistry Council American Forest & Paper Association American Iron & Steel Institute American Petroleum Institute Association of American Railroads The Business Roundtable International Magnesium Association National Mining Association Portland Cement Association Power Partners Semiconductor Industry Association

4. 4 Why Is DOE Interested in Gasification? (for Coal and Other Industrial Applications)

5. 5 Aging U.S. Coal Fleet: 70% over 30 in 2010 In two years, over 50% of US total coal-fired generating capacity will be 30 or more years old. Environmental pressures and legislative reforms could push many of these plants into retirement. While excess capacity has caused plant retirements and the postponing or canceling of projects in some regions, other regions remain—and will continue to be—short of power. (Source: Platt’s)

6. 6 Advantages of Gasification Higher potential efficiency >50% v. 40%, if fuel cells added later. Removes S, Hg, and other contaminants before combustion, eliminating scrubbers. Wider range of feedstocks and variability in feedstock quality. Easier to capture by-products for sale Less input water use needed: post- combustion flue gas desulfurization is not needed, as with conventional coal boilers to reduce SOx emissions. Less-cooling water discharge (-30%) than conventional coal. Most gasifiers in operation today are used for processing refinery wastes and making chemicals (ammonia, syngas, methanol). Next speaker, Jim Childress, will cover these points

7. 7 Clean Coal: Leading Questions Market factors and business risks have shifted since 2000 to favor consideration of clean coal (e.g., sharp spikes and volatility in natural gas prices). Yet, few IGCC plants being ordered. Is it primarily a matter of elevated capital costs? Other business risks? Which risks most deter construction of commercial clean coal plants? Which policies could encourage commercial adoption of “clean coal gasification” (e.g., environmental regulations, state & federal financial support)? How can federal credit approaches be coupled with state incentives to improve the prospects for clean coal gasification plants?

8. 8 Market Failures in Power Sector Trigger Evaluation of New Approaches

9. 9 Market Failures in Power Sector 1.Advanced gasification systems for coal face skepticism. 2.Owners of early plants face “first mover” penalties (higher cost and technology risk, more delays, than later movers). 3.Customers of early plants also face “first mover” penalties from higher cost and lower reliability. 4.Classic externalities (e.g., pollution) hinder action by prospective owner / operators and their customers. 5.Regulatory bias in rates (defacto) impacts technology choice—PUCs allow generators to pass through marginal fuel cost price spikes, but restrict cost recovery of capital. 6.Regional differences are vast (fuel use, urban v. rural…) Solving issues requires collaborative approach, nationally.

10. 10 Why Are So Few IGCCs on Order? DOE: CCPI buys down demo plant cost by 40% to 50%, so why are so few utilities considering IGCC ? Utility: Even if DOE puts up $500M on a $1 billion plant, we still have $500M at risk if the gasifier fails to perform. Reliability is king in our business—power. We don’t want to be ‘guinea pigs’. Let someone else try first. Utility: A gasifier looks (and smells) like a chemical plant. We are not in the chemical business. IGCC technology vendor: We make only a component of the total plant and don’t want to be liable for delivering power. Our units make fuels and by-products. PUC commissioner: What does gasification cost per KW? Who stands behind the performance guarantee to protect my rate payers? Lab: Our research shows that IGCC may not be the best choice for low- rank coals (sub-bituminous, lignite – with higher moisture). ? Excerpts from interviews

11. 11 Risk Profile of Clean Coal Technology Faces Market Failures, Suggesting the Importance of Risk- Targeted Assistance

12. 12 Risk Framework Built to Project Timeline Market failures require an assessment of risks. “Risk framework” approach is… Not a technical framework, e.g., RD&D roadmap. Not a regulatory framework, e.g., IPCC. Not biased toward any specific fuel source. Not based solely on economic analysis. Not another “barriers” study. Based on the analysis of “business risks” from the perspective of project development and plant owner.

13. 13 Overview of Risk Framework Approach Power Plant Project Development Timeline Risk Analysis of Coal Project Development Stages Risk Analysis by Stage of Project Development “Showstoppers”: Air regulatory issues? Tech performance and availability? PUC rate approval? Major Risk Category Technology / Design Development / Siting Regulatory Construction Operating performance Fuel price, supply Demand Dispatch Waste, byproducts Transmission Rating and Ranking of Risks by Stages Evaluation, Application of Risk Mitigation Mechanisms Interview and Rating Approach. Design of survey instrument Work with industry groups for interview candidates Selection of interview candidates Contact of candidates Interviews, risk ratings Evaluation of risks Workshops with industry on results Evaluation of Mitigation Mechanisms Financial model and sensitivity analysis (conducted by utilities) Delineation of mechanisms Matching of possible mechanisms to risks Evaluation of risk coverage for each stage Determination of measures, legislation needed to implement Negotiations Timeline Evaluation. Delineation of key development stages for power plant Matching of development stages with financing events The risk framework approach builds on work done for the “Business Case for Nuclear Power” (www.nuclear.gov) This diagram depicts the study’s logic flow and approach to the analysis.

14. 14 Risk Questionnaire: 33 Respondents Utilities, IPPs AEP Cinergy EPRI Excelsior Energy Tennessee Valley Authority Tri-State Generation Engineering Firms & Energy Cos. Alstom Bechtel Burns & McDonnell Conoco Energy CONSOL Eastman Chemical Technology Firms, Labs, DOE Air Products & Chemicals ChevronTexaco Gasification Gas Technology Institute Gasification Technology Council Powerspan Siemens TMS DOE & NETL Financial Community CS First Boston JP Morgan Chase EBI Rosenberg & Associates Fluor Engineering Foster Wheeler USA Kennecott Energy Global Energy Southern Co. Tampa Electric WE Energy

15. 15 Risk Rating Recap: Highest Risks Technical Regulatory Market Clean coal systems offer public benefits, but are not fully proven. High capital costs magnify risks. State and national policies not yet clear. Financing large plants poses challenges… Risk-informed credit-based assistance may help address them effectively and efficiently.

16. 16 Risk Profile: Too High Early in Plant Life Risk Profile  Plant Project Timeline  Development & Engineering Construction Operations & Maintenance  High capital costs Excessive downtime Regulatory uncertainty Electricity competition 1. Not enough coverage of operating risks and technical performance at startup. 2. Too much risk coverage after successful operations: Buydown of costs reduces generation cost over life of the plant. Cost to government unnecessarily high. Selection for support $ Startup Tax credits don’t provide enough lift early on, and offer too much over life of plant.

17. 17 IGCC Risk Traits – 1,2,3: Observations Industry rates technology risks of IGCC, other advanced technologies as too high without government support. Top concerns:  Technical: High capital cost and excessive downtime, which make financing difficult. Warranties appear to be inadequate.  Regulatory: Potential for big advantage in CO 2, but owners remain skeptical of full valuation, near term, of CO 2 advantage. IGCCs have apparent edge on capture of mercury, plus on water and solid wastes.  Market: Note that risk of decline in gas prices rates as a low probability, high severity event. Gas price rises make clean coal plants more competitive.

18. 18 IGCC Risk Traits – 1,2,3: Observations Other observations: State policy can help, but probably will be insufficient in most states. PUC dispatch preference, rate approval, or ROI assurance would usefully mitigate risk. Electricity competition is a concern due, in part, to uncertainties about regional impacts of market reforms. If government accepts significant technology risk, then adequate EPC warranties probably could be negotiated. Also, government reliability backing should reduce contingency in price of plants by >$100 / kWe. Workforce risks (for construction and operation) rate low. (continued)

19. 19 Designing Risk-Targeted Assistance for the Power Generation Sector

20. 20 New Financing Approaches Needed? Tax credits and co-funding are inefficient and expensive for the federal budget. They are not targeted to specific risks. –Compounded by tying tax credits to “heat rate” for electricity or by allowing conventional plants to qualify for tax benefits Government (federal and state) risk-sharing with advanced clean coal plant owner / operators could offer more flexibility on financing and ownership structures. –Could better allocate risks (e.g., higher capital cost on first units, technical performance uncertainties) Federal credit process could force healthy negotiation and independent credit analysis—and it would complement state actions. Credit process would add rigor and improve project quality, and it may dampen earmarking.

21. 21 Risk-Targeted Assistance for IGCC Risk Area High capital cost Excessive downtime (poor availability) Lagging national policy Lagging state policy Lack of standardization Possible Assistance Targets Enhance financial returns Improve warrantees Backstop cash to avoid default Helpful national policies PUC, environmental roles Financial support for standardized designs

22. 22 Next Steps through Climate VISION For discussion… Collaborate with states, NARUC, EPA, EPRI, CURC, GTC, APPA and NCC on further risk analysis work. Evaluate how to target potential assistance on critical business risks that hinder orders of early commercial plants. Conduct sensitivity analysis of federal assistance options, including credit. Review results across DOE and with OMB, Treasury. Consider complementing state incentives with potential federal credit (or other) assistance. www.ClimateVISION.gov

23. 23 www.ClimateVISION.gov Contact us: Larisa Dobriansky 202-586-1524 Deputery Asst. Secretary, DOE Policy Office David Berg 202-586-1117 david.berg@hq.doe.gov Chief Advisor, DOE, National Energy Policy Office Andrew Paterson 619-807-3267 adpaterson@aol.com Principal, Environmental Business International FINISH

24. 24 Backup Slides

25. 25 Beyond IGCC ? Many advanced energy technologies are reaching commercialization, but most face market entry difficulties. These technologies improve energy efficiency, electricity transmission, nuclear power, and renewable energy. NEP advocates rapid commercial use of a portfolio of such advanced technologies—if, long term, they can compete. Market use of advanced energy technologies developed with DOE support rewards taxpayer support for applied RD&D programs—and advances U.S. energy security. Traditional government deployment assistance tools are not targeted on key market risks—and they are expensive. Negotiated federal credit tools, teamed with state incentives, could address specific risks to accelerate market adoption effectively—at a lower cost.

26. 26 The Climate VISION Challenge Climate VISION – Challenges industries to make voluntary commitments to adopt cost-effective systems, technologies, and best practices to reduce GHG emissions. Commitments from 12 industries and Business Roundtable; thousands of companies; nearly 45% of U.S. GHG volume. Climate VISION partnership: –Industries commit to make meaningful commitments toward the 18% intensity reduction goal and to report emissions in 1605(b) –Partners identify, implement cost-effective solutions for reducing GHGs –Partners develop and use the tools to calculate, inventory, and report GHG emissions reduction, avoidance, and sequestration –Government recognizes voluntary mitigation actions –Partners develop enabling strategies across the economy to further reduce GHG emissions

27. 27 Climate VISION Enabling Initiatives Goal: Garnering private actions to extend voluntary commitments across entire economy. Current focus: Major energy end-use sectors, such as transportation, buildings, and electricity system. DOE, industry exploring enabling initiatives in key sectors: –Efficiency in buildings, starting with new homes –Advanced Clean Coal power generation –Acceleration of renewables and bioenergy –Others based on analysis Potential goal for new homes: 50%+ market penetration of energy efficient new homes by 2012. Potential goal for clean coal power generation: Build first of several new plants in a series starting in 2006 – 2007.

28. 28 Climate Vision Promotes Energy Security Energy Security goals adapted from “Energy Challenges” in NEP (May 2001) Climate VISION approaches contribute to overall energy security goals.

29. 29 Oil & Gas Price Volatility Continued in 2004 Crude Oil Ascent of crude oil prices in 2004 has hindered full economic recovery, and provides a painful reminder of U.S. commercial vulnerability due to import of more than 60% of our crude oil, the primary fuel for all transport modes. Natural Gas Natural gas volatility, varying more than 80% within a 12 month period, has aggravated industries dependent on gas as a primary feedstock or heating fuel, such as chemicals, fertilizers, metalworking and cement. LNG terminals are facing stakeholder resistance. Market volatility not being addressed.

30. 30 Competitiveness in U.S. Chemical Sector Letter to the President (Nov. 19, 2004) “Mr. President, we believe that the high and volatile price of natural gas is the number one threat to our ability to compete in global markets. All consumers are paying a terrible price. Solving this problem will require committed leadership on the part of the next Energy Secretary. I urge you to select an Energy Secretary who will champion the cause of the consumer and tackle the problem of high and volatile natural gas prices head on.” Thomas E. Reilly, Jr. President and CEO American Chemistry Council National Petroleum Council The NPC calls for increased energy efficiency, greater flexibility in industrial and residential fuel choices, immediate development of new sources of supply, and enhanced infra- structure investment. (gas report, 2003)

31. 31 Coal’s Leading Role in Power Sector By 2020, EIA forecasts that U.S. will still use coal for 45% – 50% of U.S. electricity… Climate VISION: How do we best use coal to economically sustain industrial competitive- ness and energy security with minimal environmental impact? EIA forecast for U.S. Electricity Generation, 2002 – 2020 (AEO 2004)

32. 32 IGCC Risk Study – 1: Questions TECHNOLOGY & OPERATIONS RISKS (system performance) Risk: Electric price is materially higher for IGCC due to high capital costs. Lack of competitiveness of electricity due to higher labor or operating costs. Excessive IGCC breakdown, downtime, non-routine engineering & repair costs. Poor technical performance of IGCC relative to specs (e.g., higher heat rate). Lack of standardized IGCC systems (higher costs or reduced performance). Lack of skilled workforce to build IGCC plants to specifications. Lack of skilled operators to properly run IGCC plants to specifications. Lack of materials and engineering progress keep system costs high (>$1,500/KWe). Acute accidents generate penalties or severely damage the plant. EPC or vendor fails to provide adequate support of IGCC to maintain performance after startup. Waste disposal risk (e.g., price of disposal rises sharply or location is closed). Risks are evaluated based on “probability of occurrence” and “severity of impact”, if risk is realized.

33. 33 IGCC Risk Ratings – 1: Technical 33 ratings

34. 34 IGCC Risk Study – 2: Questions REGULATORY & POLICY RISKS (differentiation for IGCC) Risk: State-level air permitting delays fail to deter conventional coal plant orders. Federal mercury regulations favor conventional coal (e.g., PC) plants. Federal SOx and NOx regulatory delays favor conventional coal plants. Economic value of carbon capture fails to materialize, reducing advantage of IGCC. Risk that IGCC is regulated (by states or EPA) based on NGCC performance. Cost of carbon sequestration for PC plants approximates that for IGCC. Regional and state policies fail to provide any or sufficient incentives for IGCC National policies provide insufficient rewards, incentives for IGCC (e.g., tax, NSR, etc.).

35. 35 IGCC Risk Ratings – 2: Regulatory 33 ratings

36. 36 IGCC Risk Study – 3: Questions MARKET & FINANCE RISKS (dynamics of demand and supply) Long-term electricity demand (for utilities, IPPs) fails to grow as fast as forecast. Erosion of coal transportation infrastructure raises delivered cost of coal over time. Competing “old coal” generation reduces dispatch of IGCC, thereby curbing revenues. Low natural gas prices make NGCC more competitive (reducing dispatch). Coal prices rise markedly, inflating IGCC electricity generation costs. Interest rates rise in the medium term, penalizing new capital-intensive projects. State PUC does not approve long-term contract or rate review to cover IGCC costs. Financing of IGCC is difficult, or requires lots of equity, even at low interest rates. Revenues of IGCC by-products (e.g., sulfur, slag) fail to materialize as forecast. Customer of IGCC suffers significant losses and cancels IGCC project midway.

37. 37 IGCC Risk Ratings – 3: Market 33 ratings

38. 38 Example Terms: Three Risk Mitigants

39. 39 Power Project Timeline Different risks arise at each phase of power projects; value in matching appropriate tools to particular risks. Long Lead-Time Procurement Start-Up $ Close Financing Regulatory Approval Engineering Construction Operation (or delay) $ Development Operations and generation Scheduled Startup $ Repayment of debt and equity from future revenues Industry Investment $ Power Project Timeline  “Go / “No Go” decision

40. 40 Long Lead-Time Procurement Start-Up $ Close Financing “Shakedown” Regulatory Approval Engineering Construction Operation (or delay) 1 Standby Credit Facility for Regulatory & Commissioning Risk: Debt + Equity 1a) Coverage of interest payments in downtime 1b) Loan guarantees for debt coverage (established before close of financing) 2) Direct Loan for Engineering & Construction $ Development Timing of Mitigants: Combined Possible early downtime Scheduled rampup $ 1b) Loan guarantees 1a) Interest Coverage Repayment of government credit from future revenues Industry Investment Government Credit $ $ Power Project Timeline  3 Direct Loan 2 3) Power production incentive for X years 1