The valuation of an operating electrical plant or specific items of the equipment comprising the plant assumes the transfer of ownership as of a particular date. The transfer price is based on the concept of a willing seller and a willing buyer, neither being forced to participate in the transfer and, also, both being reasonably knowledgeable of the relevant facts associated with the operations and the business.
To determine the transfer price or value of the plant, three primary approaches to value are available to review and consider:
This approach is also known as the "Comparison Sales Approach" (“CSA”) or Fair Market Asset Value (“FMAV) Comparison approach as it is often called is one of three most reliable and recognized approaches utilized in power plant asset appraisal analysis. It involves the aggregation of historical and comparative market data specifically pertaining to the subject assets being appraised.”). As noted earlier, the impetus of this market approach is to determine the desirability of the assets and recent sales or offerings of similar assets, currently on the market or predicted in the future, in order to arrive at an indicative “most probable” selling price for the assets being appraised.
This approach further assumes certain economic adjustments and variables that must be considered in order to bring the values in line as closely possible with the subject assets. In the sales comparison approach, historical transactions in the marketplace are used as the basis to derive a value for the specific item of equipment or for the complete plant based on the actions of buyers and sellers. Actual sales are analyzed and adjusted to the subject item of equipment or the entire plant assets.
Adjustments to consider include (a) size - the generation capability of the generators; (b) production expenses - compare the cost to produce electricity per kW between the plants; (c) time - adjust for the economics between the appraisal date and the date when the sale took place; (d) age - compare the age and level of technology; and (e) location - adjust for different economics between the subject’s location and that of the sale; in other words, is the subject in a better or worse location when considering its ability to receive fuel and transmit power to the grid at a profit. Several other adjustments can be made depending on the circumstances. When taking into account the purpose of the valuation, any fuel inventories, intangible assets, power purchase agreements (“PPAs”), transmission assets, or other assets are removed, as necessary, from the transaction price to result in only the fair market value price of the tangible plant asset (s) under review.
The next indicator of value based on future income realizations is developed using the income approach. This method is used most frequently by buyers and sellers in the marketplace. But, forecasting the future is difficult because power plants are income-producing assets. Buyers and sellers often use a matrix of income approaches to test their forecasts in as many different ways as possible, thus developing a range of values for use in negotiating sessions. Buyers and sellers also are knowledgeable of plant sales (they often participate in the bidding process for plants) and the cost of new construction and the basic concepts of physical deterioration and obsolescence.
Items to be forecast in the income approach include capacity factor (electricity production), prices of electricity and fuel (energy costs), operating expenses, emission credits, future capital expenditures and sustaining capital requirements, additions to the decommissioning trust fund (for a nuclear plant), and the capitalization or discount rate. Forecasts for prices of electricity are frequently available from various published sources or consulting firms specializing in economic forecasts.
Peaking plants tend to operate when the price of electricity is highest. The least efficient plants will operate for a very short period of time, while more efficient plants will operate longer, but still during the peak period price hours of the day. New modern peaking plants, typically combustion turbines, can start up and reach maximum production in about 30 minutes; hence, they can “cherry pick” when they operate. Older, less efficient peaking plants, typically old steam plants, must start up earlier because their ramp-up times are usually several hours. Thus, to take advantage of the peak prices, these plants must operate earlier in the day and also later in the day when the price of electricity will not cover their short-run marginal cost.
Additionally, the valuator must consider they actually are not profitable for much of the time when they are running. Sometimes the ISO will compensate the less efficient plants during these time periods with additional sources of revenue. Also, plants may be are compensated every time they start up. Electricity production and capacity factors can be forecast by reviewing past performance and the future budgets for the plant. Operating expenses can be projected by reviewing operations over the last three to five years. Future capital expenditures are commonly budgeted by plant management for three-, five-, or ten-year periods. Beyond the budget time period, 2% to 3% of the reproduction cost is necessary for sustaining capital, which is needed to keep the plant in safe operating condition.
The result of the income analysis is the value of the entire business enterprise associated with the operating plant. To determine the value of the tangible assets alone, a normal level of net working capital is deducted (based on the guideline company analysis, frequently measured as a percent of revenue); in addition, the intangible assets must be valued, and then deducted. Intangible assets include, but are not limited to, the trained and assembled workforce and management team, operating manuals and procedures, licenses and permits, PPAs, emission credits, and software. The resulting income indicator of value for the tangible assets includes the real estate comprising land, buildings, and land improvements; and the personal property, both electrical generation equipment units and support assets.
The final method to be considered is the cost approach. It typically applies to the complete power plant as a generating asset. This approach requires a certain level of knowledge about the economics of the industry and the technology utilized in the industry. To apply the cost approach, CTG-PSI must calculate the current cost of a plant, the reproduction cost new (an exact replica) and/or a new modern replacement. The difference between the costs is a form of functional obsolescence (loss of value from within the property) due to excess capital costs.
The cost of replacement (“COR”) represents the cost of the same equipment or a new modern plant with the same capacity and utility of the subject plant. Such a plant represents current technology from a cost and performance perspective. A deduction from the COR for physical deterioration, based on wear and tear experienced by the property, must be made. This can be calculated based on an age-life relationship of the entire plant, of major component parts of the plant weighted based on the current cost investment in each component, observation, or a combination of the analyses.
Economic obsolescence (a loss of value from an external economic force) also must be investigated. This investigation may include a study of spark spreads or gross margins, inutility, supply/demand relationships, competition, and return on capital; economic obsolescence also can be derived from actual market transactions if appropriate data are available.
The next deduction is another form of functional or operating obsolescence caused by changes in technology. New or different technology frequently results in better control systems, which increase yield and reduces labor and energy requirements; as a result, the new modern plant becomes more valuable. The most frequent difference between an older plant and a new modern plant is reduced operating expenses and a lower heat rate (the ability to convert fuel into electricity). To reflect functional obsolescence due to excess operating expenses or operating obsolescence, an adjustment based on the present value of the after-tax operating expense penalty is made in the cost approach.
The last deduction is a form of both functional and economic obsolescence and sometimes is termed a necessary capital expenditure. Such a capital expense is required by a government agency primarily for environmental reasons. In the case of a coal-fired plant, it is the additional environmental equipment the plant must install to remove various types of emissions, or other types of government-required changes to the plant that do not make the plant larger or more efficient. In fact, most government-required changes tend to make the plant more expensive to operate. For nuclear plants, it is primarily the additional contributions to the decommissioning trust fund. Additional costs could be related to cooling-water environmental concerns related to fish and other water life, or sometimes-just temperature changes in the discharge water. Again, based on the capital budget, the present value of these capital costs is deducted.
After all these deductions are made, the value of the land is added after deducting any known and budgeted clean-up costs from the land value as if clean. This typically is not a major deduction, but should be investigated. The result is the cost indicator of value.
At this point, three indicators of value have been developed for the subject plant. The value indicated by the sales comparison approach can be a very strong indicator of value because it directly reflects the actions of buyers and sellers in the market. Using even one, two, or three sales gives the client a range of value into which the subject property’s value should fall. Even in a market where few sales are available, the appraiser cannot ignore the market. Of course, the sales must be investigated to ensure the sales data used reflect an electrical generating plant similar to the subject. The sold equipment or plants do not have to be exactly the same as the subject, as adjustments will be made to the sale prices; however, they should be as similar as possible. Any other assets, such as PPAs and other non-operating assets, must be deducted from the sales comparison indicator of value. Because sales of operating plants, actually an operating business, can reflect the investment value of the plant to a particular owner, not a true market value, recognition must be given to the fact that sales prices also can include hidden assets, contracts or agreements, and financing arrangements that may not be public information. In addition, plants that have sold for unusually low or high prices may not reflect a true open market transaction; buyers of operating plants sometimes just want to buy into a market, not only to buy the plant operations.
The income approach, as noted above, is the method buyers and sellers rely upon to make a decision. Buyers and sellers make the market; appraisers only reflect that market. In preparation for negotiating a price, participants in the market typically develop several income approaches to develop a range of reasonableness because they cannot forecast the future with any degree of certainty. No one can! Now, appraisers such as CTG-PSI use the results of buyers and sellers in the sales comparison approach and try to imitate their actions by developing an income indicator of value based on projections and an industry-based discount rate. Application of the income approach can be very volatile based on minor changes in the forecast. Although the income approach is a useful valuation tool, it should be supported by either the cost or sales comparison approach to value to increase this approach’s reliability.
The cost approach is especially useful for unique property where sales do not exist and an income approach is not possible. In this approach, the current cost of the property being valued, less all forms of depreciation and obsolescence, plus land value, is developed. One problem, however, is that the appraiser must be knowledgeable of the industry’s economics and technology. Preparing a complete and detailed cost indicator of value is very time consuming and can be costly to the client, but the cost approach can produce the most subject-specific detail of any of the three indicators of value. Unless they are inserted in the cost indicator of value, working capital and intangible asset values are not included.
When fully developed, the three value approaches reflect all attributes of the market. The most supportable and complete valuation, utilizes all three indicators of value. In a perfect world, they all support the same value conclusion, or at least a narrow range. All three indicators reflect the market. The market is defined by the actions of buyers and sellers, projections of electricity, fuel prices, operating expenses, future capital investments, the required returns of equity investors, the cost of debt, an industry capital structure, the cost of new modern construction, all forms of depreciation and obsolescence, and industry economics.
When deriving a conclusion from the investigation and analysis of the market to arrive at the most accurate opinion possible, CTG-PSI must use its best judgment, experience and common sense to correlate the final conclusion of value. The conclusion must consider market indicators. Valuators don’t make the market, valuators reflect the market, but when the market speaks, we listen.
FEES: CTG-PSI’s fee structure is open, very competitive and totally dependent upon the size, scope and complexity of each assignment. Before initiating any assignment a complete disclosure of the total fee plus any relevant travel expenses will be made and agreed upon by both parties. A desktop valuation does not require an onsite inspection. A full proposal outlining the services to be performed and the appropriate time-frame for rendering the final report will be made known to the client.