Chapter three

Economics of Power Generation

3.1 Economics of Power Generation
The art of determining the per unit (i.e., one kWh) cost of production of electrical energy is
knownas economics of power generation. The economics of power generation has assumed a
great importance in this fast developing power plant engineering. A consumer will use electric
power only if it is supplied at reasonable rate. Therefore, power engineers have to find
convenient methods to produce electric power as cheap aspossible so that consumers are tempted
to use electrical methods. Before passing on to the subjectfurther, it is desirable that the readers
get themselves acquainted with the following terms much usedin the economics of power
generation :
(i) Interest. The cost of use of money is known as interest.
A power station is constructed by investing a huge capital. This money is generally
borrowedfrom banks or other financial institutions and the supply company has to pay the annual
interest onthis amount. Even if company has spent out of its reserve funds, the interest must be
still allowed for, since this amount could have earned interest if deposited in a bank. Therefore,
while calculating thecost of production of electrical energy, the interest payable on the capital
investment must be included. The rate of interest depends upon market position and other
factors, and may vary from 4%to 8% per annum.
(ii) Depreciation. The decrease in the value of the power plant equipment and building due
toconstant use is known as depreciation.
If the power station equipment were to last for ever, then interest on the capital investment
wouldhave been the only charge to be made. However, in actual practice, every power station
has a usefullife ranging from fifty to sixty years. From the time the power station is installed, its
equipment steadily deteriorates due to wear and tear so that there is a gradual reduction in the
value of the plant. This reduction in the value of plant every year is known as annual
depreciation. Due to depreciation, the plant has to be replaced by the new one after its useful life.

3.2 Cost of Electrical Energy

The total cost of electrical energy generated can be divided into three parts, namely ;
(i) Fixed cost ; (ii) Semi-fixed cost ; (iii) Running or operating cost.
(i) Fixed cost. It is the cost which is independent of maximum demand and units generated.
The fixed cost is due to the annual cost of central organization, interest on capital cost of
landand salaries of high officials. The annual expenditure on the central organization and salaries
of highofficials is fixed since it has to be met whether the plant has high or low maximum
demand or itgenerates less or more units. Further, the capital investment on the land is fixed and
hence the amount of interest is also fixed.
(ii) Semi-fixed cost. It is the cost which depends upon maximum demand but is independent of
units generated. The semi-fixed cost is directly proportional to the maximum demand on power
station and is onaccount of annual interest and depreciation on capital investment of building
and equipment, taxes, salaries of management and clerical staff. The maximum demand on the
power station determinesits size and cost of installation. The greater the maximum demand on a
power station, the greater isits size and cost of installation. Further, the taxes and clerical staff
depend upon the size of the plant and hence upon maximum demand.
(iii) Running cost. It is the cost which depends only upon the number of units generated. The
running cost is on account of annual cost of fuel, lubricating oil, maintenance, repairs and
salaries of operating staff. Since these charges depend upon the energy output, the running cost
isdirectly proportional to the number of units generated by the station. In other words, if the
powerstation generates more units, it will have higher running cost and vice-versa.
3.3 Expressions for Cost of Electrical Energy
The overall annual cost of electrical energy generated by a power station can be expressed in two
forms viz three-part form and two-part form.
(i) Three part form. In this method, the overall annual cost of electrical energy
generated isdivided into three parts viz fixed cost, semi-fixed cost and running cost.
Total annual cost of energy = Fixed cost + Semi-fixed cost + Running cost= Constant
+ Proportional to max.demand + Proportional tokWh generated.= Rs (a + b kW + c
kWh)
Where a= annual fixed cost independent of maximum demand and energy output.
b = constant which when multiplied by maximum kW demand onthe station gives the
annual semi-fixed cost.
c = a constant which when multiplied by kWh output per annumgives the annual running
cost.
(ii) Two-part form. It is sometimes convenient to give the annual cost of energy in two-
part form. In this case, the annual cost of energy is divided into two parts viz., a fixed
sum per kW of maximum demand plus a running charge per unit of energy. The
expression for the annual cost of energy then becomes: Total annual cost of energy =
Rs. (A kW + B kWh)
Where A= a constant which when multiplied by maximum kW demandon the station
gives the annual cost of the first part.
B = a constant which when multiplied by the annual kWh generated gives the annual
running cost. It is interesting to see here that two-part form is a simplification of three-part form.
A littlereflection shows that constant “a” of the three-part form has been merged in fixed sum per
Kwmaximum demand (i.e. constant A) in the two-part form.
3.4 Methods of Determining Depreciation
There is reduction in the value of the equipment and other property of the plant every
year due to depreciation. Therefore, a suitable amount (known as depreciation charge) must be
set aside annually so that by the time the life span of the plant is over, the collected amount
equals the cost of replacement of the plant. The following are the commonly used methods for
determining the annual depreciation charge:
(i) Straight line method;
(ii) Diminishing value method;
(iii) Sinking fund method.
(i) Straight line method. In this method, a constant depreciation charge is made every year
on
the basis of total depreciation and the useful life of the property. Obviously, annual
depreciation charge will be equal to the total depreciation divided by the useful life of the
property. Thus, if the initial cost of equipment is Rs 100,000 and its scrap value is Rs
10,000 after a useful life of 20 years, then,
 .

In general, the annual depreciation charge on the straight line method may be expressed as :

where P = Initial cost of equipment

n = Useful life of equipment in years
S = Scrap or salvage value after the useful life of the plant.
.
(ii) Diminishing value method. In this method, depreciation charge is made every year at a
fixed rate on the diminished value of the equipment. In other words, depreciation charge is
first applied to theinitial cost of equipment and then to its diminished value.
As an example, suppose the initial cost of equipment is Rs 10,000 and its scrap value after
the useful life is zero. If the annual rate of depreciations 10%, then depreciation charge for
the first year will be 0·1 ×10,000 = Rs 1,000. The value of theequipment is diminished by Rs
1,000 and becomes Rs 9,000. For the second year, the depreciationcharge will be made on
the diminished value (i.e. Rs 9,000) and becomes 0·1 ×9,000 = Rs 900. Thevalue of the
equipment now becomes 9000 - 900 = Rs 8100. For the third year, the depreciationcharge
will be 0·1 ×8100 = Rs 810 and so on.
Mathematical treatment
Let P = Capital cost of equipment
n = Useful life of equipment in years
S = Scrap value after useful life
Suppose the annual unit* depreciation is x. It is desired to find the value of x in terms of P, n
andS.
Value of equipment after one year
= P - Px = P (1 - x)
Value of equipment after 2 years
= Diminished value - Annual depreciation
= [P - Px] - [(P - Px)x] = P - Px - Px + P𝑥 2
= P(𝑥 2 - 2x + 1) = P (1 − 𝑥)2
Value of equipment after n years
= P (1 − 𝑥)𝑛
* If annual depreciation is 10%, then we can say that annual unit depreciation is 0·1.
But the value of equipment after n years (i.e., useful life) is equal to the scrap value S.

From exp. (i), the annual depreciation can be easily found. Thus depreciation to be made for the
first year is given by :
Depreciation for the first year = xP
(iii) Sinking fund method. In this method, a fixed depreciation charge is made every year and
interest compounded on it annually. The constant depreciation charge is such that total of annual
installments plus the interest accumulations equal to the cost of replacement of equipment after
its useful life.
LetP = Initial value of equipment
n = Useful life of equipment in years
S = Scrap value after useful life
r = Annual rate of interest expressed as a decimal
Cost of replacement = P -S
Let us suppose that an amount of q is set aside as depreciation charge every year and interest
compounded on it so that an amount of P -S is available after n years. An amount q at annual
interest rate of r will become *q(1 + 𝑟)𝑛 at the end of n years.
Now, the amount q deposited at the end of first year will earn compound interest for n -1 years
and shall become q(1 + 𝑟)𝑛−1i.e., Amount q deposited at the end of first year becomes
= q(1 + 𝑟)𝑛−1

Amount q deposited at the end of 2nd year becomes

= q(1 + 𝑟)𝑛−2
Amount q deposited at the end of 3rd year becomes
= q(1 + 𝑟)𝑛−3
Similarly amount q deposited at the end of n -1 year becomes
= q(1 + 𝑟)𝑛−(𝑛−1)
= q (1 + r)
Total fund after n years = q(1 + 𝑟)𝑛−1 + q(1 + 𝑟)𝑛−2+..... + q(1 + r)
= q [(1 + 𝑟)𝑛−1 + (1 + 𝑟)𝑛−2+ .... + (1 + r)]
This is a G.P. series and its sum is given by

This total fund must be equal to the cost of replacement of equipment i.e., P S.

The value of q gives the uniform annual depreciation charge. The parenthetical term in eq. (i)
is frequently referred to as the “sinking fund factor”.

Though this method does not find very frequent application in practical depreciation
accounting,it is the fundamental method in making economy studies.
Example 1.A transformer costing Rs 90,000 has a useful life of 20 years. Determine the
annual depreciation charge using straight line method. Assume the salvage value of the
equipment
to be Rs 10,000.
Solution :
Initial cost of transformer, P = Rs 90,000
Useful life, n = 20 years
Salvage value, S = Rs 10,000
Using straight line method,

Example 2.A distribution transformer costs Rs 2,00,000 and has a useful life of 20 years. If
the salvage value is Rs 10,000 and rate of annual compound interest is 8%, calculate the amount
to
be saved annually for replacement of the transformer after the end of 20 years by sinking fund
method.
Solution :
Initial cost of transformer, P = Rs 2,00,000
Salvage value of transformer, S = Rs 10,000
Useful life, n = 20 years
Annual interest rate, r = 8% = 0·08
Annual payment for sinking fund,

Example 3.The equipment in a power station costs Rs 15,60,000 and has a salvage value of
Rs 60,000 at the end of 25 years. Determine the depreciated value of the equipment at the end of
20 years on the following methods :
(i) Straight line method ;
(ii) Diminishing value method ;
(iii) Sinking fund method at 5% compound interest annually.

3.5 Importance of High Load Factor

The load factor plays a vital role in determining the cost of energy. Some important advantages
of high load factor are listed below :
(i) Reduces cost per unit generated :A high load factor reduces the overall cost per unit
generated. The higher the load factor, the lower is the generation cost. It is because
higher load factor means that for a given maximum demand, the number of units
generated is more. This reduces the cost of generation.
(ii) Reduces variable load problems :A high load factor reduces the variable load
problems on the power station. A higher load factor means comparatively less
variations in the load demands at various times. This avoids the frequent use of
regulating devices installed to meet the variable load on the station.
Example 4. A generating station has a maximum demand of 50,000 kW. Calculate the cost
per unit generated from the following data : Capital cost = Rs 95 ×10^6 ; Annual load factor =
40% Annual cost of fuel and oil = Rs 9 ×10^6 ; Taxes, wages and salaries etc. = Rs 7·5 ×10^6
Interest and depreciation = 12%
Example 5.A generating station has an installed capacity of 50,000 kW and delivers 220
106 units per annum. If the annual fixed charges are Rs 160 per kW installed capacity and
running charges are 4 paise per kWh, determine the cost per unit generated.

Example 6.A generating plant has a maximum capacity of 100 kW and costs Rs 1,60,000.
The annual fixed charges are 12% consisting of 5% intererst, 5% depreciation and 2% taxes.
Find the fixed charges per kWh if the load factor is (i) 100% and (ii) 50%.
Solution :
Maximum demand = 100 kW Annual fixed charges = Rs 0·12 ×1,60,000 = Rs 19,200

It is interesting to note that by decreasing the load factor from 100% to 50%, the fixed charges/
kWh have increased two-fold. Incidentally, this illustrates the utility of high load factor.
Example 7.Estimate the generating cost per kWh delivered from a generating station from
the following data : Plant capacity = 50 MW ;Annual load factor = 40% Capital cost = 1·2
crores ; annual cost of wages, taxation etc. = Rs 4 lakhs ; cost of fuel, lubrication, maintenance
etc. = 1·0 paise/kWh generated. Interest 5% per annum, depreciation 6% per annum of initial
value.
Solution :The maximum demand on the station may be assumed equal to the plant capacity i.e.,
50 MW.
Annual fixed charges

Example 8.A generating station has the following data : Installed capacity = 300 MW ;
Capacity factor = 50% ; Annual load factor = 60% Annual cost of fuel, oil etc. = Rs 9 ×10^7 ;
capital cost = Rs 10^9 ; annual interest and depreciation = 10%. Calculate (i) the minimum
reserve capacity of the station and (ii) the cost per kWh generated.

Example 9.The capital cost of a hydro-power station of 50 MW capacity is Rs 1,000 per kW.
The annual depreciation charges are 10% of the capital cost. A royalty of Re 1 per kW per year
and Re 0·01 per kWh generated is to be paid for using the river water for generation of power.
The maximum demand on the power station is 40 MW and annual load factor is 60%. Annual
cost of salaries, maintenance charges etc. is Rs 7,00,000. If 20% of this expense is also
chargeable as fixed charges, calculate the generation cost in two part form.
Example 10.The annual working cost of a power station is represented by the formula Rs(a
+ b kW + c kWh) where the various terms have their usual meaning. Determine the values of a, b
and c for a 60 MW station operating at annual load factor of 50% from the following data :
(i) capital cost of building and equipment is Rs 5 × 106
(ii) the annual cost of fuel, oil, taxation and wages of operating staff is Rs 9,00,000
(iii) the interest and depreciation on building and equipment are 10% per annum
(iv) annual cost of organization and interest on cost of site etc. is Rs 5,00,000.
Example 11.A hydro-electric plant costs Rs 3000 per kW of installed capacity. The total
annual charges consist of 5% as interest ; depreciation at 2%, operation and maintenance at 2%
and insurance, rent etc. 1·5%. Determine a suitable two-part tariff if the losses in transmission
and distribution are 12·5% and diversity of load is 1·25. Assume that maximum demand on the
station is 80% of the capacity and annual load factor is 40%. What is the overall cost of
generation per kWh?
Solution : Let the installed capacity of the station be 100 kW.
Maximum demand = 100 - 0·8 = 80 kW Average demand = 80 - 0·4 = 32 kW
Example 12.Compare the annual cost of supplying a factory load having a maximum demand of
1 MW and a load factor of 50% by energy obtained from (i) a private oil engine generating
plant and (ii) public supply.
(i) Private oil engine generating unit :
(ii) Capital cost = Rs 12 ×10^5 ; Cost of repair and maintenance = Rs 0·005 per kWh
generated Cost of fuel = Rs 1600 per 1000 kg ; Interest and depreciation = 10% per
annum Fuel consumption = 0·3 kg/kWh generated ; Wages = Rs 50,000 per annum
(ii) Public supply company : Rs 150 per kW of maximum demand plus 15 paise per
kWh
Solution :
Units generated/annum = (1000) × (0·5) ×8760 = 438 ×10^4 kWh
(i) Private oil engine generating plant
Annual fuel consumption = 0·3 ×438 ×104 = 13·14 ×10^5 kg
Annual cost of fuel = Rs 13·14 ×10^5 ×16001000 = Rs 21,02,400
Annual cost of repair and maintenance = Rs 0·005 ×438 ×104 = Rs 21,900
Annual wages = Rs 50,000
Annual interest and depreciation = Rs 0·1 ×12 ×10^5 = Rs 1,20,000
∴ Total annual charges = Rs (21,02,400 + 21,900 + 50,000 + 1,20,000)
= Rs 22,94,300
(ii) Public supply
Annual fixed charges = Rs 150 ×1000 = Rs 1,50,000
Annual running charges = Rs 0·15 ×438 ×10^4 = Rs 6,57,000
Total annual charges = Rs (1,50,000 + 6,57,000) = Rs 8,07,000
Example 13. A power station having a maximum demand of 100 MW has a load factor of
30% and is to be supplied by one of the following schemes:
(i) a steam station in conjunction with a hydro-electric station, the latter supplying 100 × 106
kWh per annum with a maximum output of 40 MW.
(ii) a steam station capable of supplying the whole load.
(iii) a hydro-station capable of supplying the whole load.
Compare the overall cost per kWh generated, assuming the following data :
Steam Hydro
(a) Capital costkW installed Rs 1250 Rs 2500
(b) Interest and depreciation on capital investment 12% 10%
(c) Operating costkWh 5 paise 1·5 paise
(d) Transmission costkWh negligible 0·2 paise
Solution :
Units generated/annum = Max. demand×L.F. ×Hours in a year
= (100 ×10^3) × (0·3) × (8760) = 262·8 ×10^6 kWh