Curbing Construction Costs

RESPONDING TO TOUGH TIMES

Published In: EnergyBiz Magazine November/December 2009

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RECESSION IS OVER AND RECOVERY IS HERE. And although there's an economic lag, it isn't expected to weigh down the utility industry.

In recent years, power companies have paid increasingly higher building costs that have been largely predicated on volatile fuel prices as well as escalating raw material and skilled labor costs. Bleaker economic times, however, have blunted the trauma and led to a relative decline in construction-related expenses.

Is this downward drift tied directly to the recession, or is it a longer-lasting phenomenon, given that the costs of raw materials hit a peak in 2008? If reduced prices are linked to tough times, then it would stand to reason that they would rise once the demand for goods and services picks up. After all, the long-term projections are that the nation is short of power and that a critical swath of qualified workers will soon retire.

Despite an inevitable movement toward economic growth, the costs of steel, concrete and copper won't automatically bounce back to their all-time highs. Such materials, which are used to build everything from nuclear plants to natural gas combined-cycle facilities to wind turbines, have begun piling up as projects have been delayed. Manufacturers would, therefore, have to sell them before those prices would spike again.

Economic productivity is unlikely to head straight up. Rather, its rise is expected to be gradual. Some utility projects have, therefore, become uneconomical, at least for now. Consider Sempra Energy's plan to build a 600-megawatt natural gas facility in Maryland. It was approved in 2005 and scheduled to go into operation in 2011. But the utility was unable to secure the long-term power contracts that would have paid for the plant.

Hard times, however, are making certain prices more attractive. According to Cambridge Energy Research Associates, the cost of constructing new plants has fallen by at least 3 percent in 2009 in a trend that began last year. Still, a power plant that cost $1 billion in 2000, would run, on average, $2.17 billion today.

All types of power generation are affected by the cost of raw materials. Beginning in the first quarter of 2008, nuclear plants saw some price relief. In the intervening months, falling prices touched all utility investments. Now – and for the first time in a decade – the cost of building coal, natural gas and wind plants has also dropped.

“The current 3 percent drop may appear modest compared to the sizable global decline in new construction orders, but in this case it represents a true turning of the tide,” said Candida Scott, director of Cambridge's cost and technology. “We can expect the downward pressure to continue to build as falling costs work their way through the supply chain.”

The Cambridge firm went on to say that wind energy has benefited most from the fall in prices – 11 percent, because of a drop in wind turbine and tower costs in combination with a slowdown in orders. As a result, those specific costs should remain depressed in the near term. And although the federal government is now rewarding all renewable energy projects with stimulus funds, the financial uncertainty that preceded that influx of money did take a notable toll on the sector.

Costs for combined-cycle and simple-cycle gas plants have also declined. They had been down as much as 6 percent largely as a consequence of reduced commodity prices and materials costs. Less energy demand has also put more power projects on hold, which will place further downward pressure on construction costs. Duke Energy, for example, has been forced to delay a 640-megawatt combined-cycle plant, although once it commits, the utility expects to reduce its building expenses.

Coal-plant costs have also fallen by the same levels. Although Cambridge said that the upfront costs associated with regulatory controls would affect pricing, it added that such oversight may make those coal facilities less desirable and thus bring down their construction costs even more. The firm said that the decline in nuclear plant costs slowed during the year, falling by 1 percent because of the lower materials costs and additional manufacturing capability for key components. Despite an active pipeline, falling steel prices will make a dent in nuclear construction costs.

The reprieve won't last long. As developing nations grow their economies, they will try to secure all the necessary raw materials to build power plants. Meantime, the developed world will be replacing older-generation units with newer ones, which will drive up the prices for cement, cooper and steel.

Labor costs are destined to increase as older and more-experienced skilled employees exit the workforce. A shortage of electrical engineers, for example, would increase their value.

“Construction costs are projected to fall further this year – 4 to 6 percent – but as the economy rebounds, we will see cost recovering in the first and second quarters of 2010,” said Pritish Patel, director of capital cost analysis for Cambridge. “Recovery would be a few percent to begin with, but as the economy strengthens and oil demand improves, upstream construction markets are projected to see further escalations.”

Although the current demand for power has stalled, the government is projecting the need for new energy supplies to be at least 23 percent greater in 20 years than they are now. According to the Energy Information Administration, the nation needs about 50,000 megawatts by 2014 and 258,000 megawatts by 2030. The Brattle Group said $505 billion in new generation investment will be needed in the next two decades. And that need comes atop a projected national decline in electricity reserve margins through 2015.

Increasing energy efficiency and demand response, noted the Brattle Group, could offset part of that need. But those kinds of investments would not totally overcome the need to build additional power plants. As such, utilities can do other things to try and help keep down their building costs. Among the most prevalent: computer modeling that allows developers to simulate a variety of construction scenarios.

Consider a 1,000-megawatt advanced, pressurized, light-water reactor nuclear plant that is to be developed by Westinghouse and its subcontractors in conjunction with the U.S. Department of Energy and the Electric Power Research Institute. Although those developers have hit some snafus, they maintain that the prototype could be built in 36 months, which is much less time – and money – than similar projects.

To reach that goal, they have installed computer modeling software so that they can build a virtual construction project. The aim is to get the plant operating and generating income faster. That would then benefit the utilities and their customers while the builders of such plants would be able to free up their own cash much sooner. Such planning will become critical, given the upsurge in licensing applications and the limited number of suppliers that would service that potential need.

“We help everyday planners identify the people and the materials – in addition to the time – needed to build a particular part of the plant and anticipate a shortage of either so they can adapt and continue to make progress,” said Keith Denton, vice president of global power for Intergraph, which developed the software used by Westinghouse. “That's where this game will be won or lost, we believe.”

Other software makers such as Autodesk and Bentley are focused on more efficient plant designs that would allow utilities to use less material or to share data among those involved in the building process. Still other companies such as Axion International are offering construction products that they say help utilities replace the more expensive items with those that are more eco-friendly. It's all about creating new efficiencies.

The continued rise in the cost of materials has halted for now. But those prices will invariably stabilize and then head back up. Under any circumstance, the long-term expectation is that the global population will grow and the need for cleaner, cheaper and more reliable electricity will also expand. That becomes possible once the economy improves, credit eases and investor confidence returns. At that point, construction can begin anew, particularly as older plants start to be retired.

Utilities must then avoid a scenario whereby the prohibitive cost of raw materials would impede growth and delay projects. Those companies are, after all, in business to provide a vital public service. Project developers, though, have access to critical tools and strategies that can help them battle potential cost overruns. If they are able to reduce the resources that go into construction, then they will ultimately benefit the very consumers who would fund it all.

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