Cyprus Mail
Opinion

‘Interim gas’ tender that was doomed to fail

By Elias Hazou

WHY DID talks between the Natural Gas Public Company (DEFA) and Itera crash and burn? If the Electricity Authority of Cyprus (EAC) is to be believed, not only did the Russians’ quoted price fail to lower the cost of electricity, it would actually have ended up increasing electricity bills to end-consumers. Itera, in turn, insists the opposite holds true, and accuses the Cypriots of constantly moving the goalposts.

Forget Itera for a second. We’re being told that natural gas won’t lower the utility’s power generation costs and thus the bills to us paying customers. Sounds counter-intuitive, doesn’t it?

During a big powwow at the Palace on September 2, experts advised the President that Itera’s offer was ultimately not cost-effective. At one point a piqued Anastasiades reportedly blurted out: “You mean to tell me it’s not beneficial even if they gave us the gas for free?”

Good question. Incidentally, at that meeting, an official apparently told the President that for natural gas to be cost-effective it had to be sold to Cyprus for around $11.5 per mmtbu.

Which is weird, to say the least, because $11.5 is even lower than what LNG currently goes for on the spot market (between $12 and $13).

The Mail has looked at a barrage of data – fuel prices, electricity generation numbers, calorific values of the different fuels, thermal efficiency of the turbines – the whole shebang. Without laying claim to expertise, the Mail ran a battery of ‘simulations’. In every single case calculations showed that total fuel costs would drop with natural gas.

Under even the ‘harshest’ scenarios for natural gas, Itera’s final, all-in price – understood to be $15.5 per mmbtu – yielded cash savings of between 6 to 8 per cent.

A crucial clarification should be made: the cash spent on fuel, and the relative cost of generating electricity from that fuel, are not one and the same. It’s possible for example to spend less on fuel in absolute terms, but that doesn’t necessarily mean your cost for electricity generated (per kilowatt-hours or per mmbtu) is also lower. And as far as the EAC is concerned, the cost of generation is the bottom line.

Under the tender, DEFA is not obliged to sign a contract unless the price of electricity to end-consumers drops, to quote, “substantially.”

DEFA/EAC won’t spell out what “substantially” is. At the end of the day, they say, it’s the government that calls the shots. Fair enough. The energy minister has been quoted as saying that a reduction of at least 10 per cent in electricity bills would be sufficient.

There do appear to be grounds for insisting on the 10 per cent. Whether they’re justified is another matter. Apparently DEFA/EAC want a ‘buffer’ of between 10 to 15 per cent, in case ‘unknown parameters’ in utilising natural gas technology drive up the actual generation costs and eliminate any benefits compared to liquid fuels.

For the foreseeable future the power utility plans to burn only heavy fuel oil, or mazut.

But is LNG cheaper than mazut? Using figures from an analysis done by the EAC itself (a confidential report dated August 2, more on that later), mazut with a 1 per cent sulphur content goes for $561 per metric tonne; mazut with a 0.23 per cent sulphur content is $761; and diesel (or gas oil) costs $870. And LNG is said to cost $620 per tonne, although strangely a footnote states that this includes a DEFA “administration fee” of $0.5 per mmbtu.

But the devil is indeed in the details. One tonne of LNG or natural gas yields anywhere between 48 and 52 mmbtu. By contrast, one tonne of oil equivalent produces 40 to 42 mmbtu. Putting it simply, per unit, LNG generates more energy than does fuel oil or diesel, thus requiring a lesser amount of it to produce a certain amount of energy.

This has to do with the higher calorific value – or energy content – of natural gas. To illustrate the point, and according to the EAC’s so-called “working paper” of August 2, for 2015 (the first year of the contract) the utility would buy 745,000 tonnes of mazut to generate the required electricity by the grid. With natural gas, it would need 484,000 tonnes of the fuel, plus some small amounts of fuel oil.

So LNG may be more ‘expensive’ on paper, but that by no means is the bottom line. What matters is how much of that fuel you actually need – plus a host of other factors.

There are several elements which, combined, determine the cost of electricity generation – and hence the price of electricity. But the main ones are three: a fuel’s calorific value; the efficiency of the machines when burning a fuel; and last but certainly not least the price of the fuel, either per quantity or per energy units (measured in British Thermal Units).

Using the same EAC internal document – leaked to the media within hours of the September 2 meeting at the Palace – we can calculate the respective costs for liquid fuels and for natural gas.

We’re not taking into account things like fuel storage fees, excise duties, carbon emissions penalties and operation and maintenance costs under the two scenarios (liquid fuels and natural gas). But even factoring these in would cancel each other out.

Before we go further, some basics: a watt-hour is a unit of energy equal to the power of one watt operating for one hour. One gigawatt-hour (GWh) is equal to one billion (1,000,000,000) watt-hours. One GWh is roughly equal to 3,412 mmbtu no matter which fuel is concerned. And one mmbtu equals 293kWh.

The EAC document says that the total power to be generated by the grid in 2015 will be 3,665 gigawatt-hours. Deducting the power to be generated from wind energy (317 GWh), we are left with 3,348GWh.

Still there? Good. So, 3,348GWh multiplied by 3,412 gives us a total of 11.4 million mmbtu (or 11.4 trillion btus) of energy generated by the grid. The cost was 484,000 tonnes of natural gas (or 24 million mmbtu) at $15.45 per mmbtu, totalling $370m. In addition, small amounts of fuel oil are to be purchased in 2015 for an extra $24m. Grand total: $394m. So the overall generation cost was 394/11.4, or $34.56 per mmbtu.

In the liquid fuels-only scenario, 3,346 Gwh were similarly generated (again excluding 319GWh of wind energy). That’s equal to 11.4 million mmbtu. The total fuel costs (mostly mazut, with very small quantities of diesel) come to 745,000 tonnes of mazut at $561 per tonne, giving $418m. Add another 2,823 tonnes for diesel at $870 per tonne gives $2.4m. Grand total: $420.4m. The generation cost is 420.4/11.4, or $36.87 per mmtbu.

From the calculations, natural gas wins out when it comes to either the cash price in absolute terms or to the overall generation cost – but not by much. The cash savings are just 6 per cent, and the difference in generation cost cannot be described as staggering. Perhaps the DEFA/EAC people have a point after all.

But wait. First, the fuel prices used by the EAC are a bit iffy. Mazut (1 per cent sulphur) actually goes for around $610 per tonne, not $561. And mazut (0.23 per cent sulphur) is closer to $800 per tonne, not $761 as cited in the EAC document. With these prices, the total cost of liquid fuels climbs would climb further.

A word here about the thermal efficiencies of machines. In a hypothetical example, 100MWh are generated with a machine rated at 50 per cent efficiency. The original energy in the fuels purchased was: 100MWh multiplied by 100/50, giving 200MWh.

The EAC’s table indicates that natural gas would be fired by the two Combined Cycle Gas Turbines (CCGT) at Vasilikos, whose thermal efficiency according to the EAC is 45.15 per cent, and by the steam turbines at Vasilikos (converted to also burn natural gas) with an efficiency of 38.63 per cent. The CCGTs would generate 2551GWh, the steam turbines 638GWh.

Another 132 GWh would be produced by the two Internal Combustion Engines (ICE) at Dhekelia power plant. Their rated efficiency is 42.16 per cent. And another 25GWh by a steam turbine at Dhekelia at 30.7 per cent thermal efficiency.

Under the EAC’s model (August 2 report), the CCGT turbines – by far the most efficient engines – would be used to produce only about 80 per cent of power generated from natural gas, the remaining 20 per cent coming from the extremely inefficient steam turbines at Vasilikos, which are to be converted to burn natural gas as well.

The upshot is that in the natural gas scenario, the most efficient generators do not appear to be used in the optimal configuration. The reverse holds true in the liquid fuels-only situation.

Ah, the plot thickens. The EAC cites a raft of technical reasons why this must be so. These include, but are not limited to, maintenance schedules or running the CCGTs at lower loads because, to put it in layman’s terms, these engines are ‘unpredictable’. In brief, they don’t want to drive the machines too hard, for safety reasons – basically because CCGTs form part of what is known as the grid’s base-load capacity (the minimum required capacity).

As you’d expect, the August 2 report is replete with technical jargon: de-rating, forced outage rates, spinning reserve, and so on. To quote from one passage: “Due to RES [Renewable Energy Sources] intermittent generation that affects the NG consumption (something which cannot be modelled with our existing simulation tool), the CCGTs’ maximum generation capability is restricted to 180 MW. This restriction is also necessary for the provision of spinning reserve [reserve capacity for safety reasons] and takes into consideration the Forced Outage and the derating of the units to high summer temperatures.”

To decipher all that gobbledygook and cut to the chase, the newer CCGT units – which incidentally cost a combined €500m – are to be under-operated, something which the EAC freely admits to.

Now, were you to generate almost all power from natural gas the benefits would be significant. The catch is, the EAC says natural gas will replace fuel oils only to a degree. The net result is that the benefits of natural gas – high calorific value, efficiency of the CCGT turbines – are ‘thinned out’.

The August 2 document posited doing without the two so-called must-run steam units at Dhekelia in order to “maximise quantities and receive the best possible price from the supplier(s).”

The gist of it was that the supply period was to be extended from 3.5 years (ending September 2018) to six years (from mid-2015 ending mid-2021).

But in the meantime, according to EAC general manager Stelios Stylianou – who also sits on DEFA’s board – DEFA was advised by its lawyers that these new conditions would be regarded as a breach of the terms of the tender.

Thus the EAC scrapped this report, delivering a fresh one just days later. Under this new report, dated August 6, the Dhekelia must-run units would be used after all, thereby reducing the quantities of natural gas needed.

Asked to comment, Stylianou described the initial report of August 2 as merely a “working paper”.

The language of the actual report suggests otherwise. It states that the calculations (for a six-year supply) stem from a “decision” taken at a meeting at the Presidential Palace on July 26 to extend the contract period.

At any rate, the new report of August 6 was the game-changer, though it didn’t scupper the ongoing negotiations between DEFA and Itera.

Given the new (lower) quantities of gas, Itera presumably needed to take a look at its margins and revise its price.

Invoking plummeting demand for electricity due to the financial crisis, in this new state of play DEFA now asked for just 0.5 billion cubic meters per annum (bcma) of natural gas, down from 0.65 bcma as per the August 2 report.

By reducing the gas quantities, the capital costs (liquefaction and re-gasification) become a bigger proportion of the gas price for the supplier.

Despite this, the Russians kept trying. The Mail learns, for instance, that Itera offered a few perks to sweeten the deal, such as building for free a pipeline connecting the gas-receiving buoy in the sea to the Vasilikos power station.

To cut a long story short, it seems that given the short duration of the contract, the limited supplies as well as considerable capital costs, Itera had little leeway to drop its price to the EAC’s satisfaction.

It is for these very reasons that some experts think the ‘interim gas’ tender was always doomed to fail. The timeframe is simply too small for any company – not just Itera – to turn a profit with LNG. Unless of course Cyprus takes a leap of faith and goes for compressed natural gas.

The talks with Itera officially broke down on September 12 and the rest, as they say, is history.

Itera, now wholly-owned by Russian oil giant Rosneft, feels it was taken for a ride. This was made abundantly clear from sources, who spoke to the Mail on condition of anonymity.

To Itera, it seemed like the Cypriots were changing the rules of the game on the fly.

“We never sat down to agree a common set of values…which left a great deal of guesswork,” a source close to the company said.

DEFA and the EAC may or may not be correct about their overall cost analysis. The verdict, one hopes, will come shortly from the auditor-general. Should her findings be made public, at the very least they will shed some light on the EAC’s ‘clandestine’ cost formula.

While we wait for the auditor-general, all sorts of theories – you might even call them conspiracy theories – are doing the rounds. One holds that vested interests (read: fuel importers) are leaning on the EAC not to switch to gas. A variation on this theory goes a step further, but shall not be repeated here as it may be deemed slanderous.

Others believe that secretly the EAC ‘hates’ gas because it fears that private entrepreneurs with power production licences – that’s all they are for now – stand poised to undercut the utility by generating power with gas more efficiently. Yet more suspicion is fueled by the fact that DEFA – regarded by some as the EAC’s twin sister – is by law the sole importer and distributor of natural gas.

Still, even quarters outside Itera describe the whole tender process as clumsy at best.

One industry source summed it up: “The tender was launched in September 2012. The objective was to close a deal quickly before the presidential elections and in this way earn some brownie points for the then government. This left little time to think things through…it was a rush job. When you negotiate with big corporations and keep changing your mind about what you want, you lose credibility.”

The Cypriots may well be right in asserting that Itera’s offer would not reduce generation costs. That remains to be seen. But what can be safely said is that this has less to do with the suppliers than with how well the EAC utilises its own infrastructure.

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