Dayton defends coal optimization program at PUCO

Dayton Power and Light told the Public Utilities Commission of Ohio that its coal “optimization” program is a valid, useful process, despite criticism of that program in a fuel audit done for the PUCO by an outside consultant.

On Oct. 4, DP&L, a unit of AES Corp. (NYSE: AES), filed testimony with the commission, some of it redacted, about issues raised in that audit. Energy Ventures Analysis and Larkin & Associates PLLC wrote the audit, with EVA providing the part about coal procurement. Among those testifying was David Crusey, DP&L’s Vice President, Commercial Operations.

Crusey noted that the fuel audit report proposed disallowances in three areas:

  • The first involves the company’s share of optimization gains that were the result of an optimization transaction where low-sulfur coals previously bought under contracts for the Killen plant (where DP&L has a 67% ownership share) and were sold to the Stuart plant (35% DP&L ownership share) and replaced at Killen with a lower-priced, high-sulfur coal. The amount reflected in the fuel rider and proposed for disallowance is $2,164,024.
  • The second is with respect to the company’s share of optimization gains that were a result of the company’s ownership interest in a redacted plant. The amount reflected in the fuel rider and proposed for disallowance is $1,163,773.
  • The third involves trucking costs that were incurred by DP&L due to a November 2011 unloader outage at Stuart that temporarily made it impossible to unload coal from barges.

Crusey noted that optimization is a process by which the company reviews and compares its existing portfolio of coal supply contracts, including both price and quality characteristics, against the current prices available in the market were it to sell coal in its portfolio and buy replacement coal for its plants. When opportunities arise to sell an existing coal contract at one price and purchase replacement coal at a lower price, that sale and purchase would financially improve DP&L’s coal position, thus is considered an “optimization.”

The fuel audit reports for both this year and last year mischaracterize what optimization is and how it benefits customers, Crusey said. In several places the latest report alleges that the company has not demonstrated the “net benefits” of optimizations. “However, each time that allegation is made it is in the context of an erroneous belief that the net benefit calculation should start with the initial purchase price of the initial contract,” he added.

Prior to 2010, DP&L did not have a PUCO-administered fuel rider, and rates (including fuel) were fixed. Any financial benefits that DP&L could achieve from optimization was retained 100% by the company. The PUCO said, though, that with the fuel rider DP&L has to pass through to customers a portion of the benefits of the gains from the sale of coal. This change retained a significant part of the incentive DP&L had in lowering fuel costs through optimization, Crusey noted.

Optimization benefits for jurisdictional customers for 2010 totaled $10,728,465 and were shared 75%/25%, which DP&L getting the 75%, Crusey wrote. There were no disallowances proposed within the 2010 fuel audit report with respect to any optimization involving 2010 deliveries and costs. The jurisdictional optimization benefits for 2011 totaled $5,490,079 and also should be shared 75%/25% with no disallowances.

Crusey was asked if DP&L bought NYMEX quality coal as a premium product with the expectation of reselling it and replacing it with higher sulfur coals to generate optimization gains? “Absolutely not,” he wrote. “DP&L, based on its knowledge and expectations at the time, projected substantial future needs for low sulfur coal. Over time the Company gained experience in operating the scrubbers and other environmental systems, and our operators learned how best to operate the system to bum a higher percentage of higher sulfur coals while still meeting environmental requirements. Where we once projected an ongoing need for 75% low sulfur at Stuart and 50% low sulfur coal at Killen, we modified our projections over time as we increased our experience burning high sulfur coals. In turn, what that meant was that NYMEX quality or near-NYMEX quality coals that had already been purchased and were in the portfolio for future deliveries could be resold and replaced with higher sulfur coals. This was the result of exceptional work by the power plant operators to perform beyond expectations. The Company did not deliberately buy higher-priced coal that was unneeded.”

Dayton says Optimization A worked out well

The latest fuel audit report recommends that 75%/25% sharing of optimization gains not be applied to something called Optimization A. The result would be a disallowance of $2,164,022 to DP&L.

Optimization A involves the sale of NYMEX coal positions that were originally entered into under contracts executed between May and September 2009 with scheduled deliveries in 2011. The NYMEX contracts were designated, when acquired, for Killen. For this optimization transaction, it is important to understand that Killen is operated by DP&L but owned by both DP&L and Duke Energy (NYSE: DUK), with 67% and 33% ownership shares, respectively, Crusey noted. Stuart is operated by DP&L but owned by DP&L, Duke and American Electric Power (NYSE: AEP) at ownership shares of 35%, 39%, and 26%, respectively. Because the ownership interests are different between Killen and Stuart, DP&L’s partners are not indifferent to shifting coal that was committed to one plant but instead having it delivered to the other plant, he added.

At the time the initial purchases were made, DP&L’s expectations were that Killen would need to burn about 25% low sulfur coal (NYMEX quality) in 2011. Because of exceptional work by the Killen operators and a management focus on trying to operate as efficiently as possible, DPL&L learned how to operate the environmental control systems and boiler to maximize use of high sulfur coal while still complying with environmental requirements, Crusey wrote. As a result, by July 2010, the utility was confident that Killen no longer needed as much low-sulfur coal in its 2011 portfolio. The opportunity arose to sell the NYMEX coal and replace it with a lower-cost, high-sulfur coal. At the same time, Stuart was projected to need about 40% of its coal in the form of a low-sulfur coal (NYMEX quality), which was more low-sulfur coal than was in its portfolio at the time.

Cooper says Dayton erred on side of caution with unloader

Supplying Oct. 4 testimony about the Stuart barge unloader problem was G. Aaron Cooper, DP&L’s Director, Fuel Procurement. On Nov. 22, 2011, there was an equipment failure that temporarily made it impossible to unload barges on the Ohio River. At the time the unloader went down, and based on projected burn rates, Stuart had about 26 days of coal inventory already on its pile. DP&L also had another 17 days of supply on barges bound for or already at Stuart.

Within 24 hours, DP&L had made some preliminary assessments of the scope of the equipment failure and projected that it would take about 14 days to return the unloader to service. But, during the repairs additional problems could be discovered that extended the repair period or unexpected weather conditions might cause electric demand to rise substantially above projections.

“As a precautionary measure, therefore, DP&L determined that a limited amount of coal bound for Stuart Station would be delivered to Killen Station to be unloaded and, from there, trucked to the Stuart Station,” Cooper wrote. “Trucking began on November 23, 2011 and continued for a period of 10 days. A total of 104,998.26 tons were trucked at a total cost of $684,183.43. Of note, only $70,492 of these costs actually was charged to the Fuel Rider. This is because DP&L’s share of Stuart Station is 35% and during this period of time, much of Stuart Station’s output (and associated costs) were being allocated to DP&L’s non-jurisdictional sales. Only about 10% of Stuart Station’s costs, including these trucking costs, were assigned to DP&L’s SSO customers and charged through the Fuel Rider.”

For one thing, Cooper noted that DP&L saved more money in avoided demurrage charges, which are racked up when a barge sits around for a time with a full load and isn’t available for further use, than it incurred in trucking costs by making the decision to unload coal bound for Stuart at Killen. The fuel audit report recognizes those savings and calls that decision a prudent one, he added.

The audit report writer appears to believe once the barge was unloaded at Killen, the coal should have just remained at Killen and either settled between Stuart and Killen financially or through an offsetting delivery of some future barge with coal bound for Killen to be delivered instead to Stuart. “That approach would not have resulted in coal supplies being available for use at Stuart Station to guard against the risk of running short of coal in the event that the unloader repairs took longer than expected or weather conditions caused Stuart Station’s burn rate to be higher than expected,” Cooper argued.

There are several reasons the Stuart coal pile was at a 26-day inventory, which is short of the normal target, when the unloader went down, Cooper noted.

  • The most significant is the capability of the unloader itself and Stuart’s burn rates. The unloader was designed to match closely with Stuart’s maximum burn rate. Thus, during the summer months in particular, when Stuart’s burn is high, the unloader is unloading enough coal each day to meet the daily burn with little or no “extra” to place on the pile.
  • A second major factor affecting the inventory size was that there were abnormally high water levels during much of the spring of 2011 that significantly reduced the number of barges that could deliver coal to Stuart prior to the summer period.
  • A third significant contributor was the fact that the unloader had a planned maintenance outage that was scheduled for seven days beginning Oct. 9, 2011. That outage was taken and, in fact, lasted two days longer than expected.

Ohio Consumer’s Counsel wants coal optimization halted

Gregory Slone, employed by the Office of the Ohio Consumers’ Counsel (OCC) as a Senior Energy Analyst, said in Oct. 4 testimony that DP&L’s current fuel optimization program practices, including those of utilizing the replacement of NYMEX coal with lower quality and higher sulfur coal, should be discontinued.

He recommended that a refund of $7.3m be credited back to the Fuel and Purchased Power Rider (FUEL Rider) for improper fuel optimization program activities. The $7.3m represents the total optimization proceeds identified by the company in response to OCC discovery associated with twelve optimizations for 2011 that were reviewed in the audit in this case and charged to the FUEL Rider. “In addition I recommend that 25% of the jurisdictional coal sales gains for 2011 be netted against the fuel and purchased power costs for 2011, which is consistent with the [Electric Security Plan] Stipulation, and will benefit customers,” Slone added.

“Without a clear demonstration that the optimization transaction results in a net decrease of cost to the retail customer, DP&L should not be allowed to continue to collect seventy-five percent of the imputed optimization ‘benefits (or gains)’ by imposing a higher (i.e. more than what DP&L actually spent in coal procurement fuel cost rider on jurisdictional customers,” Slone added.

Slone proposed alternatives, including: “If the Company has the ability to burn high sulfur coal, but purchases NYMEX coal for resale, the optimization benefit as currently calculated should be altered so that it is based on the price of Illinois Basin coal at the time of the original NYMEX coal purchase and the price of the replacement Illinois Basin coal. The fact that the Company purchases the NYMEX coal and eventually sells it for a profit and then buys and burns the high sulfur Illinois Basin coal at a lower cost than the sales price of the NYMEX coal does not guarantee that the optimization charge applied to the FUEL Rider was prudent or a least cost option for customers.”

Noteworthy is that prior to joining the OCC in May 2010, Slone was vice president of generation services for Ohio-based American Municipal Power Inc., where he was responsible for the daily operations of the company’s generating plants, which included negotiating all the commodity contracts for purchasing and selling coal, natural gas and emission allowances. So he has direct experience in this area.

Audit provided details of Dayton’s recent coal buying

In 2011, DP&L purchased 7.5 million tons of coal at an average delivered price of $60.51/ton or $2.61/MMBtu, the EVA audit said. Its coal plants are Stuart, Killen and O H Hutchings. All of the coal purchased for Hutchings, a little-used plant, was classified as spot. The remaining spot coal was mostly non-Central Appalachia NYMEX coal purchased for Stuart.

One EVA recommendation from the prior audit was that DP&L should develop a hedging strategy considering the type of coal it expects to burn and the quantity of that coal, and should not enter into NYMEX hedges that exceed its expected low-sulfur coal requirements. The commission then ordered that if DP&L chooses to incorporate financial hedging, DP&L must demonstrate in its procurement strategy why the use of financial hedging is in the best interest of jurisdictional customers compared to the other alternatives DP&L has available, including staggered contract dates, larger open positions, and resale options under high-sulfur coal contracts.

In a heavily-redacted status update on that commission finding, DP&L indicated it had not purchased any NYMEX coal for Stuart or Killen since a redacted time. “Hence, DP&L did not develop a financial hedging strategy,” the audit added.

Said the audit about the barge unloader problem: “EVA believes the decision to truck this coal to Stuart only occurred because DP&L had allowed the Stuart inventory to fall to very low levels. While in no way suggesting this was the motive, the reality is that DP&L realized significant working capital savings as a result of its low inventory at Stuart. Jurisdictional customers should not bear the burden of the incremental costs incurred for the transfer of the fuel because DP&L allowed the inventory to fall to such low levels.”

About Barry Cassell 20414 Articles
Barry Cassell is Chief Analyst for GenerationHub covering coal and emission controls issues, projects and policy. He has covered the coal and power generation industry for more than 24 years, beginning in November 2011 at GenerationHub and prior to that as editor of SNL Energy’s Coal Report. He was formerly with Coal Outlook for 15 years as the publication’s editor and contributing writer, and prior to that he was editor of Coal & Synfuels Technology and associate editor of The Energy Report. He has a bachelor’s degree from Central Michigan University.