"Economic Scenario Analysis Memo to David"
Memo To: David Young, Acting Associate Superintendent From: Patty Richards Date: November 30, 2006 Re: Economic Scenario Analysis – Wood Chip Boiler South Burlington High School and Middle School Introduction Attached please find an economic scenario analysis of the Life Cycle Cost for the South Burlington School District’s Central Wood Chip Boiler project (proposed to heat the High School and Middle School). In an effort to consider a number of future cost factors, including varying fuel cost, the attached analysis starts from the work done by the Vermont Superintendent’s Association, School Energy Management Program and Salem Engineering Inc. The initial life cycle screening indicates the project is eligible for the State’s funding consideration. Attached is supporting analysis from the School Energy Management Program and Salem Engineering. Supplementing this work are 18 economic scenarios to provide case sensitivity to the analysis. The results are summarized below Background Due to rising costs and the South Burlington School District’s desire to control and contain heating costs, a wood chip heating system is being explored. As you can see from the chart below, South Burlington’s natural gas heating costs have risen substantially over the past 6 years. During this same time frame natural gas volumes used by the SBSD have remained relatively flat. In just 5 years natural gas has increased by 139% or almost 30% each year. While FY2007 costs are projected to be equivalent to FY2006 expenses, considerable price volatility and uncertainty of future expenses remain. The root cause of higher natural gas expenses is due to increased wholesale market cost, price volatility and the higher cost for all forms of fossil fuel. 1 Annual Natural Gas Cost High School and Middle School Buildings $160,000 The cost of natural gas has increased by 139% $141,664 $140,361 $140,000 between FY2002 and Fy2006 while the volume of natural gas used has remained relatively flat $120,000 $100,373 $100,000 $91,943 $79,074 $80,000 $65,951 $59,269 $60,000 $40,000 $20,000 $0 FY2001 FY2002 FY2003 FY2004 FY2005 FY2006 FY2007 Projected It should be noted the above chart does not consider the extra expense South Burlington incurs from burning oil during times of natural gas interruption. South Burlington High School and Middle School are on an interruptible natural gas contract which means the local gas utility can stop delivering gas during cold spells or company defined curtailments. In these periods, South Burlington must burn oil, which has higher costs and emissions than natural gas. South Burlington is also concerned about price volatility and its inability to hedge future gas costs due to the nature of the interruptible gas contract. Each year the District has a one-time election to lock in at the prevailing market price for the upcoming 12-month period. If the market happens to be high during its time of election it can be stuck with that price for the entire year. The other alternative is not to lock the price and then float on the market. Again this level of price volatility and uncertainty is very risky for a school district, which has a limited annual budget. Financial uncertainty in the volatile natural gas market, the ability to be turned off during cold snaps, and rising natural gas prices have led to an exploration of a wood chip heating system. Economic Scenario Analysis Predicting future heating costs with certainty is impossible just as predicting the future value of the stock market is impossible. With this in mind running a number of “what if” scenarios was completed to test the cost effectiveness of a wood chip heating system under a number of price point conditions. Three natural gas price cases ($11.46/mcf, $9.168/mcf, and $8.022/mcf) were assumed for both a 90% and 75% state aid reimbursement. The price of $11.46/mcf is the current blended cost for natural gas for the High School and Middle School. This price was decreased by 20% ($9.168) and 30% ($8.022) to see how the economics would play out if the price of natural gas actually declined in the future. Page 2 For each natural gas price case, the future price inflation of fossil fuel and wood chips was stressed between 5% and 0%. A 5%, 3% and 0% fossil fuel price inflation factor was used to adjust the future price of natural gas and oil. This allows us to see what happens in the financial analysis if fossil fuel increases at a rate of 5% each year. This same effect was then applied at 3% and 0%. Wood chip costs have historically not risen as much as fossil fuel so future costs of wood chips were inflated by 3% and 0%. Scenarios at 90% State Funding (SBSD's Net Capital Cost = $192,000) Based on current cost for gas 20% discount on current cost for gas 30% discount on current cost for gas Price of Gas ($/mcf) $ 11.460 $ 11.460 $ 11.460 9.168 9.168 9.168 8.022 8.022 8.022 Price of Wood 47 47 47 47 47 47 47 47 47 Inflation for Gas 5.0% 3.0% 0.0% 5.0% 3.0% 0.0% 5.0% 3.0% 0.0% Inflation for wood 3.0% 3.0% 0.0% 3.0% 3.0% 0.0% 3.0% 3.0% 0.0% NPV of Project $ 1,865,049 $ 1,047,841 $ 672,193 $ 1,176,447 $ 519,562 $ 301,700 $ 832,146 $ 255,423 $ 116,454 Years Payback 3.46 3.67 3.85 5.76 6.74 7.56 8.27 11.60 15.65 IRR 34% 29% 26% 22% 17% 13% 17% 11% 8% Assuming 90% State Aid all three natural gas price cases resulted in positive Net Present Value Savings (NPV)1 and cost effective Internal Rate of Returns (IRR)2. The best savings case assumed today’s gas costs of $11.46/mcf, $47/ton wood costs, 5% fossil fuel inflation and 3% wood inflation (dollar savings $1,865,049, payback 3.46 years, and IRR 34%). Even at the middle case of $9.168/mcf natural gas and 3% inflation applied to both wood and fossil fuel resulted in a positive dollar savings of $519,562 a 6.74 year payback and 17% IRR. Assuming 75% State Aid and natural gas price cases of $11.46/mcf and $9.168/mcf the Project NPV remained positive ranging from $1,577,049 to $13,700 savings. As you can see as gas prices are assumed to decline the dollar savings decreases substantially. The last case of $8.022/mcf natural gas and assuming 3% and 0% fuel inflation resulted in negative dollar savings (this means it would be cheaper to stay with natural gas in these scenarios and not invest in the woodchip project). It is important to note that regardless of your projection of future natural gas prices it will take the school district 4 years of gas at $11.46/mcf or above to recover its capital and other costs for the project. If natural gas supplies are stressed by an active hurricane year or other supply disruption, the price of 1 NPV measures a future stream of cash flows in today’s dollars and discounted for the time value of money. The “NPV of Project” equals future natural gas costs minus total wood chip project costs (SBSD’s capital cost + wood chip fuel + residual natural gas and oil + O&M + contingency). A positive “NPV of Project” indicates amount of money saved from wood chip project. A negative “NPV of Project” indicates amount of money lost as a result of wood chip project. 2 IRR is a method of ranking project proposals using the rate of return for a project. Any project with an IRR less than the rate of borrowing should be rejected because it means it costs more to finance the project than the project brings in dollar value. Page 3 gas is projected to be higher than $11.46. This analysis does not factor in the prospect of natural gas being higher than current prices. If natural gas prices are higher than $11.46 (before inflation) the savings are more substantial and the payback is of course shorter. The other issue to note is that no interest expenses has been factored into the above tables. The above numbers assume no cost of borrowing money to fund the project. By assuming SBSD borrows short term by way of a “State Aid Anticipation Note” and long term from a 20-year bond (see discussion below for more information on borrowing options) for its capital portion of the project, the result is a decrease in the NPV savings values. At 90% state aid funding level the NPV is decreased in all cases by $192,997. Therefore savings drop in the first case from $1,865,049 to $1,672,053. Each case thereafter the NPV decreases by $192,997. When factoring in interest expense the cut off based on project NPV is $8.022 gas and 0% inflation. At 75% state aid the NPV dropped by $138,228 in each case by adding in the cost of borrowing. Therefore the best case dropped from $1,577,049 savings to $1,438,821 savings. When factoring in interest expense the cut off based on project NPV is at $9.168/mcf gas and 0% inflation. Scenarios at 75% State Funding (SBSD's Net Capital Cost = $480,000) Based on current cost for gas 20% discount on current cost for gas 30% discount on current cost for gas Price of Gas ($/mcf) $ 11.460 $ 11.460 $ 11.460 9.168 9.168 9.168 8.022 8.022 8.022 Price of Wood 47 47 47 47 47 47 47 47 47 Inflation for Gas 5.0% 3.0% 0.0% 5.0% 3.0% 0.0% 5.0% 3.0% 0.0% Inflation for wood 3.0% 3.0% 0.0% 3.0% 3.0% 0.0% 3.0% 3.0% 0.0% NPV of Project $ 1,577,049 $ 759,841 $ 384,193 $ 888,447 $ 231,562 $ 13,700 $ 544,146 $ (32,577) $ (171,546) Years Payback 7.43 8.52 9.75 11.11 14.85 20.32 14.35 23.83 29.31 IRR 17% 13% 10% 12% 8% 5% 9% 5% 3% Borrowing Options SBSD has two options to fund the capital related needs of the woodchip project. Option 1: Ask Voters to Redirect Use of 2005 Bond Proceeds (Admin Bldg and HS Renovations) This option entails incurring no new debt. Rather this would allow SBSD to use already existing money that is not currently in use. To do so would involve asking voters to reauthorize use of the 2005 bond proceeds for the wood chip heating project. In 2005 voters approved $2.795 million to build an Administration building and to provide renovations at the High School for class and cafeteria space. Due to rejection of state aid for the Administration Page 4 Building and uncertainty of the project moving forward, it has been suggested that this fund could be used for the wood chip boiler. Per discussions with legal counsel (Paul Giuliani) the SBSD can ask voters to reauthorize use of the 2005 bond. This option would make use of existing funds and therefore result in no impact on the tax rate. Once state aid is received those funds can be set up to create a debt retirement fund and pay for the P&I portion of the funds reimbursed by the state. Option 2: Incur New Debt In this case voters would need to authorize SBSD to incur two forms of debt. The debt can be characterized as short term and long term. The short-term debt portion would cover the amount of funds projected to be paid back from State Aid and would be called a “State Aid Anticipation Note.” This note would be obtained from a local bank at prevailing interest rates. The second form of borrowing, or long-term debt, would be obtained from the Vermont Municipal bond bank and would cover the SBSD’s portion that is not covered by state aid. This form of borrowing is assumed to be for 20 years and is not allowed to be prepaid in advance. Therefore, the District is on the hook for the interest portion of the debt for the full 20 years. The project if voted by 12/31/2006 is projected to qualify for 90% state aid. Therefore if the project cost is $1,920,000, SBSD’s projected state aid is $1,728,000 (assuming a 90% funding scenario). However there is a lag period between SBSD spending the money on building the project and SBSD getting a check from the State. Due to the number of wood chip projects being planned in Vermont, state aid reimbursement is projected to be delayed due to fiscal constraints on the state’s capital fund. In the analysis it was assumed at the end of year 3 the state aid contribution would be received from the State. In this example, SBSD would borrow $1,728,000 short term from a local lending institution or bank as a “State Aid Anticipation Note.” If State Aid is received sooner than the end of year three, SBSD can pay off the short-term debt in advance and avoid further interest expenses. The remaining project cost of $192,000 (10% of $1,920,000) would be borrowed from the Vermont Municipal Bond Bank for 20 years. The reason to go with the bond bank is to take advantage of lower interest rates, but then SBSD is obligated to pay for the debt over the full 20 years of the bond (there is no option to pay off the debt in advance and avoid future interest expenses). Therefore option 2 involves two sources of debt (one short term and one long term) and the interest expense is an added cost stream to Page 5 assume for the project. Both a 90% state aid and 75% state aid scenario were considered for the analysis. The cost of interest decreases the project NPV savings in both cases. At 90% state aid each NPV savings value decreased by $192,997. At 75% state aid the interest expense decreased the NPV values by $138,228. Page 6