acid rain - the southern company final

Julian Darden Emily Jannereth Ryan Klein Marshawn Pettes Rotasha Wardlaw December 17, 2013 External Environment, Fall 2013

Problem Statement The Southern Company must determine the least expensive course of action for compliance with the Clean Air Act.

Key Facts and Data -

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The Southern Company is a holding company for electric utilities in Georgia, Alabama, Mississippi and Florida. o Largest subsidies: Georgia Power and Alabama Power. o The Bowen Plant is a coal-fired plant of Georgia Power. Bowen details: o At full capacity, could service one million consumers. o Run off of coal from southeastern Kentucky and kept an inventory on hand weighing over one million tons. In 1990 Bowen: o Generators consumed 8.338 million tons of coal. o Generated 21,551 million kilowatt-hours of electricity.  Average of 5.6 cents/kilowatt hour in revenues. o 30 tons of sulfur dioxide produced each hour. Clean Air Act guidelines: o 1995:  Allowances to emit 2.5 pounds of sulfur dioxide per million British thermal units (MMBtu); 254,580 tons of sulfur dioxide could be emitted per year until 2000 without penalty. o 2000:  Allowances lowered to 1.2 pounds/MMBtu, 122,198 tons/year. o Firms could buy or sell additional allowances for emission of sulfur dioxide based on needs. Bowen will continue to generate electricity at its 1990 levels through 2016. o In 2016 Bowen was likely to be retired with no salvageable value. Price of electricity expected to remain constant. Operating costs exclusive of fuel and pollution-control expenditures expected to remain constant at 0.00281 dollars/kilowatt-hour. Georgia Public Service Commission: o Regulatory pricing authority for the Bowen Plant located in Goergia. o Two options for what the Public Service Commission would do with a request from Georgia Power for a price increase:  Ask the shareholders to absorb some of the costs.  Georgia Power may be able to pass on costs to the customers if they can prove they implemented the least-cost manner of compliance with the Clean Air Act. Cost of purchasing allowances: o 1995: $250/ton of sulfur dioxide. o Price would increase 10%/year through 2010. Georgia Power had a combined federal and state income tax rate of 37.7%. The company used an after-tax discount rate of 10% in evaluating investment opportunities.

Darden, Jannereth, Klein, Pettes, Wardlaw / Acid Rain Case Study

1

Three Options for the Bowen Plant to conform to the Clean Air Act: This Act requires coal-burning plants to minimize the amount of sulfur-dioxide emissions it produces (thus regulating a public good: air) and if it does so, it gives incentive for producers of excess emissions to turn their excess into revenue. The fact that all utilities are required to comply with the Act grants buyers and sellers access to information for planning. It also intends to provide a formal rule for the optimal amount of pollution that can be created by utility plants. The rule helps companies internalize the negative externality i.e. pollution leading to deaths. The resulting cleaner air and decrease in acid rain convert the transaction of utilities into a positive externality.

Option 1: Burn High-Sulfur Coal without Scrubbers and Purchase Allowances -

High-sulfur Kentucky coal burned at $41.46/ton delivered to the plant. In 1996 the price was expected to drop to $29.82/ton. Bowen needed 8.338 million tons of coal/year. With this kind of coal Bowen would be emitting 266,550 tons of sulfur dioxide.

Option 2: Burn High-Sulfur Coal with Scrubbers and Sell Allowances -

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Cost for scrubbers: o $143.85 million in 1992. o $503.61 million in 1993. o $71.97 million in 1994. o Add $0.0013 per kilowatt-hour to the operating costs. o Reduce revenues by 2% due to the electricity they need to operate. 20 year depreciation schedule: o 1995 – 1999 14% of capital costs/year. o 1999 – 2015 2% of capital costs/year.  No salvageable value.

Option 2.2: Postpone installment of scrubbers until 1997, purchase allowances 1995 and 1996 -

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Scrubbers would be ready for Phase Two, but not Phase One. Cost for scrubbers: o $143.85 million in 1997. o $503.61 million in 1998. o $71.97 million in 1999. o Add $0.0013 per kilowatt-hour to the operating costs. o Reduce revenues by 2% due to the electricity they need to operate. 20 year depreciation schedule: o 2000 – 2004, 14% of capital costs/year. o 2005 – 2016, 2% of capital costs/year. o No salvageable value.

Option 3: Burn Low-Sulfur Coal -

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Begin using new coal in 1996. o Heat content of 24.110 MMBtu/ton. o 1996 – 1999, $30.37/ton. o 2000 price increase to $34.92/ton. o 8.391 million tons needed/year.  Generating 167,650 tons of sulfur dioxide/year. Phase One (1995), Bowen could sell allowances. Phase Two (2000), Bowen would have to buy allowances. Purchase of $22.1 million in electrostatic precipitators would be needed for lower-sulfur coal


2

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20-year depreciation schedule: o 1995 – 1999, 14% of capital costs/year. o 1999 – 2015, 2% of capital costs/year.  No salvageable value.

Analysis of Alternative Courses of Action The Southern Company has four cost options to consider in complying with the Clean Air Act. The options are examined with information for the Bowen Plant within Georgia Power. In examining each of the options that the Southern Company is faced with, some things are constant: -

What are the rules: Coal fired plants must comply with the Clean Air Act in 1995. The Bowen Plan will be limited to 254,580 tons per year (or 2.5 pounds of sulfur dioxide MMBtu) from 1995-2000. Starting in 2000 the Act lowers the amount of Sulfur Dioxide emissions for Bowen to 122,198 (or 1.2 pounds of sulfur dioxide MMBtu). If the plant needs to produce more than the allotted amount of sulfur dioxide they could purchase additional allowances (or sell if they produced under the limited amount).

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Why does the rule exist: In 1990 Congress and President Bush signed into legislation the Clean Air Act to limit the amount of sulfur dioxide being emitted into the atmosphere as it was found to be a precursor of acid rain. The purpose of this act is to help protect the environment by decreasing the amount of acid rain production.

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Who made the rule: The United States Congress and the President of the United States.

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Who benefits: The Clean Air Act benefits the environment by helping to reduce the fall of acid rain and improving the quality of air. This will benefit future generations with cleaner air and reduction of acid rain production. Reduction in acid rain may reduce the amount of deaths and other pollution-related health problems that can impact humans, thus reducing medical costs and allowing people to spend money elsewhere. Something that is bit more difficult to see and should be considered once the effects of the Act are measured is whether or not there are any adverse effects to reducing emissions of sulfur dioxide. o For example on Monday, December 9, 2013 Stephen Colbert had a guest on his show, Harvard environmental scientist David Keith who authored a new book, “A Case for Climate Engineering.” In this book Keith suggests that adding sulfuric acid to the atmosphere will stop global warming! Colbert stated, “So in the end, pollution saved them all.”


3

Option One: Burn High-Sulfur Coal without Scrubbers; Purchase Allowances Net Present Value: $3,016,327,488.43 Figure 1:

Bowen Plant Discounted Cash Flow Option 1: Burn High-Sulfur Coal without Scrubbers; Purchase Allowances (In millions)

Revenue COGS Operating Expense

1992

1993

1994

1995

1996

1206.86

1206.86

1206.86

1206.86

1206.86

345.69

345.69

345.69

345.69

248.64

.06

.06

.06

.06

.06

2.99

3.29

Expense for Allowance Depreciation Expense Earnings Before Income Taxes

861.10

861.10

861.10

858.11

954.86

Income Tax Expense (37.7%)

536.47

536.47

536.47

534.60

594.88

Net Income

324.64

324.64

324.64

323.51

359.98

.00

.00

.00

.00

.00

324.64

324.64

324.64

323.51

359.98

Add Depreciation Free Cash Flow


4

Figure 1, Cont’d: 1997

1998

1999

2000

2001

1206.86

1206.86

1206.86

1206.86

1206.86

248.64

248.64

248.64

248.64

248.64

.06

.06

.06

.06

.06

3.62

3.98

4.38

58.12

63.93

Earnings Before Income Taxes

954.54

954.17

953.77

900.04

894.22


594.68

594.45

594.20

560.72

557.10

Net Income

359.86

359.72

359.57

339.31

337.12

.00

.00

.00

.00

.00

359.86

359.72

359.57

339.31

337.12

2002

2003

2004

2005

2006

1206.86

1206.86

1206.86

1206.86

1206.86

248.64

248.64

248.64

248.64

248.64

.06

.06

.06

.06

.06

70.33

77.36

85.09

93.60

102.96


887.83

880.80

873.06

864.55

855.19


553.12

548.74

543.92

538.62

532.79

Net Income

334.71

332.06

329.14

325.94

322.41

.00

.00

.00

.00

.00

334.71

332.06

329.14

325.94

322.41

Revenue COGS Operating Expense Expense for Allowance Depreciation Expense

Add Depreciation Free Cash Flow Figure 1, Cont’d:




5


2008

2009

2010

2011

1206.86

1206.86

1206.86

1206.86

1206.86

248.64

248.64

248.64

248.64

248.64

.06

.06

.06

.06

.06

113.26

124.59

137.04

150.75

150.75


844.90

833.57

821.11

807.41

807.41


526.37

519.31

511.55

503.02

503.02

Net Income

318.53

314.26

309.56

304.39

304.39

.00

.00

.00

.00

.00

318.53

314.26

309.56

304.39

304.39

2012

2013

2014

2015

2016

1206.86

1206.86

1206.86

1206.86

1206.86

248.64

248.64

248.64

248.64

248.64

.06

.06

.06

.06

.06

150.75

150.75

150.75

150.75

150.75


807.41

807.41

807.41

807.41

807.41


503.02

503.02

503.02

503.02

503.02

Net Income

304.39

304.39

304.39

304.39

304.39

.00

.00

.00

.00

.00

304.39

304.39

304.39

304.39

304.39


Add Depreciation Free Cash Flow Figure 1, Cont’d:


Add Depreciation Free Cash Flow Discount Rate Net Present Value

10% $3,016,327,488.43


6

Considerations for Option 1 -

Who pays: Under this option, Bowen would be responsible for covering the costs of the changes necessary for complying with the Clean Air Act. However, under this option Bowen expects the cost of coal/ton to decrease by $11.64 in 1996. This would partially offset the increase in cost of what Bowen would need to spend purchasing allowances from other companies due to their annual production of coal being above the limit set by the Clean Air Act.

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Who benefits: High-sulfur coal providers would continue to benefit by providing Bowen with the coal to operate. Other power companies, who were able to sell allowances, may benefit as Bowen has to purchase 11,970 tons of sulfur dioxide allowances.

-

Who has the power and why: In this situation both the government and the companies who can sell allowances hold the power. The government is instituting the change, therefore they hold the power. The companies who are able to produce sulfur dioxide under their allowed will have allowances to sell thereby generating a new revenue stream.


7

Option Two: Burn High-Sulfur Coal with Scrubbers; Sell Allowances Net Present Value: $3,075,011,197.00 Figure 2:

Bowen Plant Discounted Cash Flow Option 2: Burn High-Sulfur Coal with Scrubbers; Sell Allowances (In millions)

Revenue

1992

1993

1994

1995

1996

1206.86

1206.86

1206.86

1182.72

1182.72

56.98

62.68

Sell Excess Allowances COGS Operating Expense Capital Outlays

345.69

345.69

345.69

345.69

248.64

0.06

0.06

0.06

0.09

0.09

143.85

503.61

71.97 20.14

20.14

Depreciation Expense Earnings Before Income Taxes

717.25

357.49

789.13

871.00

973.75


446.85

222.72

491.63

542.63

606.65

Net Income

270.40

134.77

297.50

328.37

367.10

0.00

0.00

0.00

20.14

20.14

270.40

134.77

297.50

349.56

388.29

1997

1998

1999

2000

2001

1182.72

1182.72

1182.72

1182.72

1182.72

68.95

75.84

83.43

38.47

42.32

248.64

248.64

248.64

248.64

248.64

0.09

0.09

0.09

0.09

0.09

20.14

20.14

20.14

0.96

0.96

980.02

986.92

994.50

968.73

972.57


Figure 2, Cont’d:

Revenue Sell Excess Allowances COGS Operating Expense Capital Outlays Depreciation Expense Earnings Before Income Taxes


8


610.55

614.85

619.57

603.52

605.91

Net Income

369.47

372.07

374.93

365.21

366.66

20.14

20.14

20.14

0.96

0.96

390.66

393.26

396.12

367.21

368.67

2002

2003

2004

2005

2006

1182.72

1182.72

1182.72

1182.72

1182.72

46.55

51.20

56.32

61.95

68.15

248.64

248.64

248.64

248.64

248.64

0.09

0.09

0.09

0.09

0.09

0.96

0.96

0.96

0.96

0.96


976.80

981.46

986.58

992.21

998.41


608.55

611.45

614.64

618.15

622.01

Net Income

368.26

370.01

371.94

374.06

376.40

0.96

0.96

0.96

0.96

0.96

370.26

372.02

373.95

376.07

378.40


Figure 2, Cont’d:

Revenue Sell Excess Allowances COGS Operating Expense Capital Outlays Depreciation Expense



9


2008

2009

2010

2011

1182.72

1182.72

1182.72

1182.72

1182.72

74.96

82.46

90.71

99.78

99.78

248.64

248.64

248.64

248.64

248.64

0.09

0.09

0.09

0.09

0.09

0.96

0.96

0.96

0.96

0.96

1005.22

1012.72

1020.96

1030.03

1030.03


626.25

630.92

636.06

641.71

641.71

Net Income

378.97

381.79

384.90

388.32

388.32

0.96

0.96

0.96

0.96

0.96

380.97

383.80

386.91

390.33

390.33

2012

2013

2014

2015

2016

1182.72

1182.72

1182.72

1182.72

1182.72

99.78

99.78

99.78

99.78

99.78

248.64

248.64

248.64

248.64

248.64

0.09

0.09

0.09

0.09

0.09

0.96

0.96

0.96

1030.03

1030.03

1030.03

1030.99

1030.99


641.71

641.71

641.71

642.31

642.31

Net Income

388.32

388.32

388.32

388.68

388.68

0.96

0.96

0.96

0.00

0.00

390.33

390.33

390.33

389.73

389.73



Figure 2, Cont’d:


FIGURE 2 CONTINUED: Add Depreciation Free Cash Flow


10

Discount Rate Net Present Value

10% $3,081,902,242.70


Who pays: Under this option, Bowen would be responsible for the cost of purchasing and installing the scrubbers, a three-year capital outlay. Also, in this option, with the installation of scrubbers, Bowen would have allowances for sulfur dioxide production to sell off to other companies. This would allow them to create a new revenue stream.

-

Who benefits: The environment: air quality improvement combined with the decrease of acid rain. A long-range decrease in medical concerns for people living in areas where acid rain is directly effecting their environment. The makers and sellers of the scrubbers for Bowen would gain a large sale. Also, the high-sulfur coal providers would continue to benefit by providing Bowen with their coal. Other utility companies who need allowances to remain compliant would benefit from Bowen’s ability to sell their extra allowances, as Bowen would benefit from selling to them.

-

Who has the power and why: In this situation both the government and the companies who can sell allowances hold the power. The government is instituting the change that Bowen has to abide by and Bowen, who is producing sulfur dioxide under their limit, can sell allowances to other utility companies. If other companies need to purchase allowances, to them, Bowen would hold some power.


11

Option 2.2: Burn High-Sulfur Coal with Scrubbers (starting in year 2000); Sell Allowances Net Present Value: $3,099,268,050.02 Figure 3:

Bowen Plant Discounted Cash Flow Option 2.2: Burn High-Sulfur Coal with Scrubbers (yr. 2000); Sell Allowances (In millions)

Revenue

1992

1993

1994

1995

1996

1206.86

1206.86

1206.86

1206.86

1206.86

345.69

345.69

345.69

345.69

248.64

0.06

0.06

0.06

0.06

0.06

2.99

3.29

Sell Excess Allowances COGS Operating Expense Capital Outlays Expense for Allowance Depreciation Expense Earnings Before Income Taxes

861.10

861.10

861.10

858.30

955.35


536.47

536.47

536.47

534.72

595.19

Net Income

324.64

324.64

324.64

323.58

360.17

0.00

0.00

0.00

0.00

0.00

324.64

324.64

324.64

324.64

361.22



12

Figure 3, Cont’d:

Revenue

1997

1998

1999

2000

2001

1206.86

1206.86

1206.86

1182.72

1182.72

38.47

42.32

Sell Excess Allowances COGS Operating Expense Capital Outlays Expense for Allowance

248.64

248.64

248.64

248.64

248.64

0.06

0.06

0.06

0.09

0.09

143.85

503.61

71.97

3.62

3.98

4.38 20.14

20.14

Depreciation Expense Earnings Before Income Taxes

811.50

451.74

883.38

949.54

953.39


505.57

281.44

550.35

591.56

593.96

Net Income

305.94

170.31

333.04

357.98

359.43

0.00

0.00

0.00

20.14

20.14

306.99

171.36

334.09

379.17

380.62

2002

2003

2004

2005

2006

1182.72

1182.72

1182.72

1182.72

1182.72

46.55

51.20

56.32

61.95

68.15

248.64

248.64

248.64

248.64

248.64

0.09

0.09

0.09

0.09

0.09

20.14

20.14

20.14

1.20

1.20


957.62

962.27

967.39

991.97

998.17


596.60

599.50

602.69

618.00

621.86

Net Income

361.02

362.78

364.71

373.97

376.31


Figure 3, Cont’d:

Revenue Sell Excess Allowances COGS Operating Expense Capital Outlays Expense for Allowance Depreciation Expense


13


20.14

20.14

20.14

1.20

1.20

382.21

383.97

385.90

376.22

378.55


2008

2009

2010

2011

1182.72

1182.72

1182.72

1182.72

1182.72

74.96

82.46

90.71

99.78

99.78

248.64

248.64

248.64

248.64

248.64

0.09

0.09

0.09

0.09

0.09

1.20

1.20

1.20

1.20

1.20

1004.98

1012.48

1020.72

1029.80

1029.80


626.10

630.77

635.91

641.56

641.56

Net Income

378.88

381.70

384.81

388.23

388.23

1.20

1.20

1.20

1.20

1.20

381.12

383.95

387.06

390.48

390.48

Revenue Sell Excess Allowances COGS Operating Expense Capital Outlays Expense for Allowance Depreciation Expense Earnings Before Income Taxes



14


2013

2014

2015

2016

1182.72

1182.72

1182.72

1182.72

1182.72

99.78

99.78

99.78

99.78

99.78

248.64

248.64

248.64

248.64

248.64

0.09

0.09

0.09

0.09

0.09

1.20

1.20

1.20

1.20

1.20

1029.80

1029.80

1029.80

1029.80

1029.80


641.56

641.56

641.56

641.56

641.56

Net Income

388.23

388.23

388.23

388.23

388.23

1.20

1.20

1.20

1.20

1.20

390.48

390.48

390.48

390.48

390.48

Revenue Sell Excess Allowances COGS Operating Expense Capital Outlays Expense for Allowance Depreciation Expense Earnings Before Income Taxes

Add Depreciation Free Cash Flow Discount Rate Net Present Value

10% $3,106,189,177.49

Considerations for Option 2.2 -

Who pays: Under this option, Bowen would be responsible for the cost of purchasing and installing the scrubbers, a three-year capital outlay (one that is delayed until 1997). Also, in this option, with the installation of scrubbers, Bowen would have allowances for sulfur dioxide production to sell off to other companies (again, after 1997). This would allow them to create a new revenue stream. **As this option is the most cost effective for Bowen, they could also seek a rate-increase from the Public Service Commission, under the Public Service Commission’s request to prove the least expensive option was undertaken to comply with the Clean Air Act. Increasing consumers’ rates for electricity from the plant would also allow them to recoup costs. This is dependent on the Public Service Commission’s approval.

-

Who benefits: The environment: air quality improvement combined with the decrease of acid rain. Again improving human health. The makers and sellers of the scrubbers for Bowen would gain a large sale. Also, the high-sulfur coal providers would continue to benefit by providing Bowen with their coal. Other utility companies who need allowances to remain compliant with the Clean Air Act would benefit from Bowen’s ability to sell their extra allowances, when they are able.

-

Who has the power and why: In this situation both the government and the companies who can sell allowances hold the power. The government is instituting the change that Bowen has to abide by and Bowen who is producing sulfur dioxide under their limit can sell allowances to other utility companies. The Public Service Commission also holds the power to approve or deny the potential rate increase.


15

Option Three: Burn Low-Sulfur Coal; Sell Allowances Net Present Value: $3,060,818,339.70 Figure 4:

Bowen Plant Discounted Cash Flow Option 3: Burn Low-Sulfur Coal (In millions)

Revenue

1992

1993

1994

1995

1996

1206.86

1206.86

1206.86

1206.86

1206.86

Sell Excess Allowances COGS Operating Expense

23.91 345.69

345.69

345.69

345.69

254.83

.06

.06

.06

2.86

2.86

Expense for Allowance

2.99

Investment Expense

22.10

Depreciation Expense

.62


861.10

861.10

861.10

855.31

950.35


536.47

536.47

536.47

532.86

592.07

Net Income

324.64

324.64

324.64

322.45

358.28

.00

.00

.00

.00

.62

324.64

324.64

324.64

322.45

358.90



16

Figure 4, Cont’d:

Revenue Sell Excess Allowances COGS Operating Expense

1997

1998

1999

2000

2001

1206.86

1206.86

1206.86

1206.86

1206.86

26.30

28.93

31.82

254.83

254.83

254.83

293.01

293.01

2.86

2.86

2.86

2.86

2.86

18.30

20.13

Expense for Allowance Investment Expense Depreciation Expense

.62

.62

.62

.62

.03


974.84

977.47

980.36

892.06

890.82


607.32

608.96

610.76

555.75

554.98

Net Income

367.51

368.50

369.60

336.31

335.84

.62

.62

.62

.62

.03

368.13

369.12

370.21

336.93

335.87

2002

2003

2004

2005

2006

1206.86

1206.86

1206.86

1206.86

1206.86

293.01

293.01

293.01

293.01

293.01

2.86

2.86

2.86

2.86

2.86

22.14

24.36

26.79

29.47

32.42

.03

.03

.03

.03

.03


888.81

886.59

884.16

881.48

878.53


553.73

552.35

550.83

549.16

547.32

Net Income

335.08

334.25

333.33

332.32

331.21

.03

.03

.03

.03

.03

335.11

334.28

333.36

332.35

331.24


Figure 4, Cont’d:

Revenue Sell Excess Allowances COGS Operating Expense Expense for Allowance Investment Expense Depreciation Expense



17


2008

2009

2010

2011

1206.86

1206.86

1206.86

1206.86

1206.86

293.01

293.01

293.01

293.01

293.01

2.86

2.86

2.86

2.86

2.86

35.66

39.23

43.15

47.47

47.47

.03

.03

.03

.03

.03


875.29

871.72

867.80

863.48

863.48


545.30

543.08

540.64

537.95

537.95

Net Income

329.98

328.64

327.16

325.53

325.53

.03

.03

.03

.03

.03

330.01

328.67

327.19

325.56

325.56

Revenue Sell Excess Allowances COGS FIGURE 4 CONTINUED: Operating Expense Expense for Allowance Investment Expense Depreciation Expense



18


2013

2014

2015

2016

1206.86

1206.86

1206.86

1206.86

1206.86

293.01

293.01

293.01

293.01

293.01

2.86

2.86

2.86

2.86

2.86

47.47

47.47

47.47

47.47

47.47

.03

.03

.03

.03


863.48

863.48

863.48

863.48

863.51


537.95

537.95

537.95

537.95

537.97

Net Income

325.53

325.53

325.53

325.53

325.54

.03

.03

.03

.03

.00

325.56

325.56

325.56

325.56

325.54

Revenue Sell Excess Allowances COGS Operating Expense Expense for Allowance Investment Expense Depreciation Expense


Discount Rate Net Present Value

10% $3,060,818,339.70


Who pays: Under this option, Bowen would be responsible for purchasing low-sulfur coal as well as the other equipment required to burn this grade of coal. This option will also result in excess emissions for Bowen and allow the company to sell the remaining amount to other companies creating a new revenue stream.

-

Who benefits: The environment: air quality improvement and decrease in acid rain production. The producers and sellers of the low-sulfur coal would also benefit in this scenario by being able to sell large amounts of coal to Bowen. Due to the reduction of sulfur dioxide emissions Bowen would have excess allowances to sell off to other companies (including other Southern Company plants) increasing revenue. Other utility companies, who need allowances to remain compliant with the Clean Air Act, would benefit from Bowen’s ability to sell their extra allowances.

-

Who has the power and why: In this situation both the government and the companies who can sell allowances hold the power. The government is instituting the change that Bowen has to abide by and Bowen, who is producing sulfur dioxide under their limit, can sell allowances to other utility companies.


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Figure 5:

BOWEN’S POSSIBLE NET PRESENT VALUES UNDER EACH AFOREMENTIONED OPTION TO ADHERE TO THE CLEAN AIR ACT

Net Present Value $3,120,000 $3,100,000 $3,080,000 $3,060,000 $3,040,000 $3,020,000 $3,000,000 $2,980,000 $2,960,000 Option 1

Option 2

Option 2.2

Option 3

Extended Analysis for Southern Company The above highlights Bowen’s net present value to identify the cost minimizing choice given the new emission regulations. Southern Company will use Bowen as a test-case to determine the best courses of action for the rest of its operating units. Due to limited data from the other plants, it is important to understand Bowen’s place within Southern Company’s portfolio. Bowen is noted as being “unusually large” and “fairly clean.” The size is significant as only 100 companies in the United States fell under Phase One regulation due to their size. Other plants in Southern Company’s network will only be subject to Phase Two regulations, based on being smaller plants. As the case states: “Starting in 1995, each of about 100 large coal-fired utility plants across the country, including Bowen, would receive allowances to emit 2.5 pounds of sulfur dioxide per million British thermal units (MMBtu) of coal consumed. In the year 2000, all coal-fired utility plants, including those regulated in Phase One, would get allowances worth 1.2 per MMBtu of coal.” Each plant’s cleanliness dictates their flexibility with allowances and could create large swings in allowance expense. For the below analysis, Bowen, with coal output of 21,551 million kilowatt-hours will be considered Large. A small plant will be considered output at 75% of Bowen, or 16,163. Factors including tons of coal needed, allowances, operating costs, additional costs, and emissions will be reduced at the same rate.


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The Small classification will also disregard the Phase One requirements. Bowen will be the standard of clean as well, with emissions of 266,550 tons using high sulfur coal and 167,650 tons when using low sulfur coal. The case mentions that other plants were emitting up to twice the amount of Bowen, representing a pollution ceiling. The analysis will consider a plant as Dirty when polluting 75% more sulfur dioxide than Bowen. Certain factors will have to be held static including: plant efficiency, the plant’s remaining life, and state revenue allowance. The results are below, showing the adjusted figures by plant type, which were then entered into the above spreadsheets, examining each option the Sothern Company faced, to determine the net present value.


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Figure 6

COMPARABLE PLANT ANALYSIS

Output Revenue (per kwh) Input (million tons) High Sulfur Low Sulfur Cost of Coal High Sulfur Options 1992-1995 1996-2016 Low Sulfur Options 1992-1995 1996-1999 2000-2016 Operating Costs Add. Operating Costs Energy Cons. (% of Rev) Pollution High Sulfur High Sulfur w/ Scrub. Low Sulfur Allowances 1995-1999 2000-2016 Net Present Value Option 1 Option 2 Option 2.2 Option 3

Large, Clean (Bowen) 21,551.00 0.056

Large, Dirty 21,551.00 0.056

Small, Clean 16,163.25 0.056

Small, Dirty 16,163.25 0.056

8.338 8.391

8.338 8.391

6.254 6.293

6.254 6.293

41.46 29.82

41.46 29.82

41.46 29.82

41.46 29.82

41.46 30.37 34.92 0.00281 0.00130 2.00

41.46 30.37 34.92 0.00281 0.00130 2.00

41.46 30.37 34.92 0.00281 0.00098 1.50

41.46 30.37 34.92 0.00281 0.00098 1.50

266,550 26,655 167,650

466,463 46,646 293,388

199,913 19,991 125,738

349,847 34,985 220,041

254,580 122198

254,580 122198

-

91649

91649

$3,016,327,488.23 $2,754,371,504.46 $2,265,077,229.66 $2,116,870,494.64 $3,081,902,242.70 $3,055,707,037.41 $2,267,092,365.01 $2,252,271,098.42 $3,106,189,177.49 $3,086,398,395.41 $2,331,575,763.30 $2,316,694,496.72 $3,060,818,339.70 $2,897,293,630.13 $2,284,587,630.69 $2,191,371,017.17


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Figure 7:

VISUAL REPRESENTATION OF FIGURE 6’s RESULTS 3500000 3000000 2500000 Large Clean

2000000

Large Dirty Small Clean

1500000

Small Dirty 1000000 500000 0 Option 1

Option 2

Option 2.2

Option 3

For all four classification combinations above, Option 2.2 offers the highest potential net present value. Southern Company will still have to treat the plants on a case-by-case basis, mainly due to differences in efficiencies, plant life span, and the individual state regulatory agencies. The net present value analysis shows that Option 2.2 works across multiple variations. It also buys the company time while it sifts through the regulatory nuisances and awaits a decision from the regulatory commission regarding how the costs can be recouped. Additionally, in the event the commission allows the company to recover costs, it provides proof that the company has chosen the overall cost minimizing solutions.

Implementation and Control Given the data analyzed previously, Southern Company should begin construction of the scrubbers at the Bowen Plant in 1997. It appears that other plants within Southern Company’s umbrella will undergo similar practices. Prior to construction a detailed timeline, budget, and key contractors for the construction should be identified. For the changes to be implemented at Bowen, Southern Company should start with a request for proposal from the largest commercial contractors. -

The company should select the three best proposals. A request for final proposal should be requested from the three finalists.


23

-

The company should evaluate the proposals based on experience, cost, reputation and estimated time of completion. A fixed price contract would be in its best interest. Once a general contract is selected regular meetings should be held to ensure timely completion. If there is not enough construction expertise within the organization, it would be wise for Southern to hire an owner’s representative. This person will manage the project with their expertise while ensuring that the best interest of the company is being met.

Once the construction of the scrubbers is complete Southern Company should create a score card and benchmarks to evaluate the effectiveness and efficiency of the new scrubbers. There are several items that they should track. 1. The amount of pollutions that is being created. 2. Revenues and expenses associated with the allowance a. Total Revenue b. Lost Revenue c. Expense associated with selling 3. Operating Margins 4. Expenses associated with running scrubbers a. Energy b. Labor c. Unexpected cost These items should be tracked monthly, quarterly and annually and test for any major variances against expectations set by the Clean Air Act. Also they should be measured against the forecasted revenue streams, sulfur dioxide emissions and net present value calculations. This will allow Southern Company to build a case for potential rate increases with the Public Service Commission as well as monitor efficiencies of the new scrubbers. It is also necessary for the government to measure the effects of the Act’s application in order to conclude whether or not the Act is actually helping reduce negative effects of sulfur-dioxide production. The air and rain (water) can be tested to provide this information however, what is unknown to utility companies is whether this analysis of the effects of the Act will be a cost that the government will pass down to utility companies.


24

Decision and Closing Remarks All data indicates that the Southern Company, with plants throughout Georgia, Alabama, Mississippi and Florida as a very successful operation. However, with the passage of the Clean Air Act, they are faced with some tough decisions on whether to adapt and reduce emission or pay for allowances for their current production. Looking through the data provided from their Bowen factory, which was serving as a test case, the value-optimizing decision is to install the scrubbers for use beginning with Phase Two of the Act. This accounts for differing levels of cleanliness and plant size, while holding the other aspects of Bowen constant, the best choice is Option 2.2. Southern Company needs to look at some remaining variables including plant efficiency, state regulations and the plant’s remaining life to make final decisions and begin its course of action. Other items that Southern Company needs to take into consideration are what the market will be for emission allowances; will enough be available for their plants to purchase, or will there be demand in the market if their plants have extra to sell? Also, will the actions of other utility companies (outside of Southern) as well as coal providers who are preparing for the Clean Air Act changes affect whether or not the high-sulfur coal will be available in the amount their plants need? After taking these further questions into consideration Option 2.2 proves to be the best course of action through all plant types analyzed. Again, with the understanding that Southern Company will take the additional variables and state regulatory practices that are not able to be accounted for here under consideration through a plant-by-plant analysis.


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acid rain - the southern company final

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