Legislative Council Brief : CLP Power Hong Kong Limited's Generating Capacity

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INTRODUCTION

At the meeting of the Executive Council on 7 December 1999, the Council ADVISED and the Acting Chief Executive ORDERED that Government should agree to CLP Power Hong Kong Limited's proposal -
 

  1. to exercise the five-year deferral option to defer installation of Units 7 and 8 at their Black Point Power Station from 2003 and 2004 to 2005 and 2006 respectively; and
     
  2. to sell the 442 MW of diesel-fired turbines at Castle Peak and Tsing Yi.

BACKGROUND AND ARGUMENT

2. In 1994 and 1995, CLP Power Hong Kong Limited (CLP) lowered their forecasts of growth in demand in electricity compared to those included in their 1992 Financing Plan. Government commissioned a study on future demand for electricity in Hong Kong to 2005 and ways of meeting the demand and were advised by our consultants in 1996 that we would be justified in seeking deferral of four 300 MW generating units, commonly known as Units 5 to 8, at the Black Point Power Station. Having consulted the former Executive Council, and after much discussion with CLP in consultation with the Energy Advisory Committee, we reached the following agreement with CLP -
 

  1. Units 5 and 6 (which were already too far advanced at that time to be deferred) should be commissioned in 1998 and 1999 respectively, in accordance with the installation schedule agreed in 1994;
     
  2. Units 7 and 8 should be deferred initially for three years (to 2003 and 2004 respectively), subject to a review in the last quarter of 1999 of a possible further deferral of up to two years; and
     
  3. 442 MW of diesel-fired turbines at Castle Peak and Tsing Yi should be decommissioned and mothballed as an immediate means of reducing CLP's excess capacity. The turbines would be written off the books on decommissioning and so would no longer earn a permitted return, even if they were eventually recommissioned. The 1999 review would also consider whether these turbines should be disposed of, recommissioned or continue to be preserved.

3. Subsequently, CLP reached agreement with the supplier in October 1997 to defer the delivery of Units 7 and 8 by around three years to 2003 and 2004 respectively, with the options to exercise, no later than 7 January 2000, further deferral by either one or two years. Premium payable by CLP for the 3-year deferral option as committed in 1997 amounts to $592 million, with additional premium of about $90 million per machine per annum for each year of further deferral up to a maximum of 5-year deferral in total.

THE 1999 REVIEW

(A) CLP's Proposal

4. According to CLP's current main case forecast, Units 7 and 8 will be required beyond 2005 and 2006 respectively. CLP propose in their proposed Financial Plan 1999-2004 to exercise the 5-year deferral option. CLP also propose that the 442 MW of diesel-fired turbines decommissioned in 1997 should be disposed of through competitive tendering with the proceeds accruing to CLP's customers.

5. Since CLP's main case forecast shows that Units 7 and 8 will be required beyond 2005 and 2006, we have asked CLP to examine whether there is any better option for dealing with Units 7 and 8 apart from the contractual deferral options. During their review with us, CLP considered the possibility of further deferral beyond 2005 and 2006, cancellation and sale of Units 7 and 8 together with subsequent purchase of new plant when their system so requires in future.

(B) Further deferral beyond 2005 and 2006

6. CLP advise that further deferral beyond the maximum contracted five-year period is not an option because they have been so advised by the supplier during the 1997 deferral negotiation and again recently, primarily due to technical and warranty issues. In addition, CLP also advise that further deferral of the units would require extension of the year of maturity of the loan for the purchase of these units beyond 2012, but such an extension was not accepted by the relevant export credit agencies.

(C) Cancellation of Units 7 and 8

7. On cancellation, CLP advise that it is not an option because cancellation costs are likely to be close to the cost of actual delivery of the units.

(D) Sale of Units 7 and 8

8. CLP advise that it would be very difficult to find buyers for these units as there are newer gas combined cycle machines developed with the latest technology. Furthermore, Units 7 and 8 were specifically designed for the Black Point Power Station requirements. Warranty issues would also complicate any sale arrangement. They estimated that the incremental cost of completing the units at Black Point Power Station would be far cheaper than their sale and the subsequent purchase of new plant by CLP to meet further growth in demand.

442MW of Diesel-fired Turbines at Castle Peak and Tsing Yi

9. The 442MW of diesel-fired turbines at Castle Peak and Tsing Yi were designed mainly to cover peak demand. CLP project that they will not require new peaking capacity to meet current or projected demand before 2010. They therefore propose to sell these turbines rather than continuing to mothball them for no practical purposes. It costs some $0.4 million a year to mothball these turbines and an additional sum to recommission them in future if required. If these turbines are kept further until 2010, they would either be over or approaching 30 years old. CLP have advised that these turbines would then become obsolete as it would be difficult to obtain spare parts. By then their sales value would also be depleted.

Assessment by our Consultants

10. Government's independent consultants, Burns and Roe Company of the United States (B&R), have evaluated CLP's proposal in the context of the overall review of the CLP's proposed Financial Plan 1999-2004. Their conclusions are-

  1. based on their independent demand forecast, (which turns out to be close to the forecast produced separately by the Economic Analysis Division (EAD)) and existing generation planning criteria, Units 7 and 8 will be required in 2008 and 2010 respectively;
     
  2. the sale of Units 7 and 8 is not recommended because of the uncertainty regarding the disposal value of the units, and hence the amount of loss that would be passed through to consumers. Also, they will not recommend pursuing the ideas of further deferral with vendor's agreement or cancellation of Units 7 and 8 because based on the information provided by the utility, the contractual terms give little leverage to CLP;
     
  3. having examined the cost to consumers of each of the three contractual deferral options (in terms of net present value at 1999 price over the time span for the economic analysis of the project i.e. up to 2035), they recommend the contractual 5-year deferral of Units 7 and 8. Their examination was based on a discount rate of 8% under their own forecast and CLP's main case forecast, using capital expenditure profiling they consider appropriate1. It also covers similar computation using a discount rate of 12%, considered by CLP as appropriate2, for sensitivity analysis purpose.
     
  4. 442 MW of diesel-fired turbines at Castle Peak and Tsing Yi should be retired and they do not see any advantage in keeping these turbines in the system. There is more effective peaking unit support available to CLP and the prospects for future use of these units in the system are becoming remote. B&R also share CLP's view about difficulty in obtaining spare parts. They consider that when the units are sold, CLP should arrange for competitive tenders and necessary publicity to ensure that competitive prices are obtained for them.

11. At 8% discount rate, the cost of the 5-year deferral option over a 35 year period is only marginally higher (up to $151 million or about 0.1% of total cost) than the other two contractual deferral options. However, there would be higher cumulative savings for consumers in the near term up to $730 million under different scenarios (See the Annex). The consultants feel that greater weight should be given to cumulative savings in the near term due to their relative certainty over those in the longer term. In addition, at 12% discount rate both B&R's and CLP's assessments indicate that the 5-year deferral option would result in the least cost to consumers in both short and long terms.

The Administration's Views

12. In principle, we feel that Units 7 and 8 should be installed on a demand basis. However, a 5-year deferral in total is the longest period provided in options available under the contract between CLP and the supplier. In the light of the above analysis and the consultants' recommendation, and in line with the advice of the Energy Advisory Committee, the proposal to extend to 5 years the period of deferral for installation of Units 7 and 8 is considered acceptable. The 5-year deferral option would result in lower reserve margins for CLP compared to the 3-year and 4-year deferral options.

13. On a similar basis, CLP's proposal to sell the 442 MW of diesel-fired turbines decommissioned in 1997 is also considered acceptable. Electrical & Mechanical Services Department (EMSD) have also advised that the economic life of these turbines is up to 2006. Although they may still be operable by 2010 with proper preservation and maintenance, it would unlikely be economical to maintain and run them at that time. However it should be possible to sell them in the market now as these turbines are relatively small in size and their usage is wider than large-size turbines.

14. EMSD have also advised that extending to 5 years the period of deferral and the disposal of the 442 MW of diesel-fired turbines will not have any material effect on the transmission and distribution development plan of CLP currently being examined by the Administration and B&R.

15. At this stage, we do not see a need to link the capacity installation schedule of CLP to the issue of increased interconnection until the detailed engineering feasibility studies on increased interconnection have been conducted. In fact, we note that an agreement for CLP to exercise the 5-year deferral option would unlikely impact adversely on any decision on increased interconnection as according to the current demand forecast, CLP will continue to have high reserve margins even before installation of Units 7 and 8 in the years 2005 and 2006 respectively.

FINANCIAL AND STAFFING IMPLICATIONS

16. There are no financial and staffing implications for Government.

ECONOMIC IMPLICATIONS

17. Of the three contractual deferral options, the recommended 5-year deferral option should result in the lowest cumulative net cost to CLP's customers over the next 10 years. It may however result in a marginally higher cumulative net cost than the other two options over a 35-year period, depending on the discount rate used in the economic assessment. The sale of the 442 MW diesel-fired turbines will also bring some benefits to CLP's customers, though this would be relatively small.

ENVIRONMENTAL IMPLICATIONS

18. Units 7 and 8 are more environmentally friendly than the existing units at Castle Peak Power Station. Further deferral of Units 7 and 8 would therefore defer the environmental benefits that could be made available with the commissioning of these units. The exact environmental implications would however depend on CLP's operational procedures in the despatch of different units in their system to cater for electricity demand.

PUBLIC CONSULTATION

19. We consulted the Energy Advisory Committee on 19 November 1999. The Committee was of the view that it would be ideal to defer Units 7 and 8 to the maximum extent possible having regard to the latest demand forecast. However, recognising the contractual obligations of CLP and other practical constraints, the Committee advised that Government should agree to CLP's proposal as set out in para. 4 above.

PUBLICITY

20. A press release will be issued and a spokesman will be available for answering media enquiries.

ENQUIRIES

21. Enquiries on this Brief may be directed to Mr Howard Lee, Principal Assistant Secretary for Economic Services on telephone number 2810 2128.

Economic Services Bureau
File Reference : ESB CR 1/2061/99
17 December 1999

1B&R consider an 8% discount rate appropriate taking into account their assumption of an inflation rate of around 4% for Hong Kong (which the Government Economist feels broadly agreeable for the period up to 2003, but has no view beyond that) and a 4% real discount rate (as advised by the Government Economist as being adopted for economic evaluation of major capital works projects).

2CLP consider a 12% discount rate appropriate based on a real discount rate of 8% (which they consider their consumers would expect from alternative use of money spent on electricity tariff), plus long term inflation rate of 3.5% for Hong Kong.
 

Annex
 

The cumulative benefits/cost to consumers of the 5-year deferral option over the other two deferral options calculated by B&R on the basis of their own forecast and by CLP on the basis of their main case forecast


  Cumulative benefits(+) / Cost (-)($M)
  5-year vs 3-year 5-year vs 4-year
  Near Term
1999-2008		 Long Term
1999-2035		 Near Term
1999-2008		 Long Term
1999-2035
At 8% Discount Rate        
Done by B&R +730 -54 +284 -151
Done by CLP +716 -181 +332 -150
         
At 12% Discount Rate        
Done by B&R +659 +243 +251 +23
Done by CLP +644 +148 +292 +30


Note :

B&R's assessment based on CLP High Case Forecast indicates that the 5-year deferral option would result in the least cost to consumer at both 8% and 12% discount rates. No calculation of cost to consumers has been done for CLP Low Case Forecast because under this forecast, capacity addition would be required way beyond 2005 and 2006, the latest contractual installation schedule of Units 7 and 8. The cumulative benefits/cost to consumers of the 5-year deferral option over the other two deferral options would therefore be in a similar direction as for CLP Main Case Forecast.