Project development

The development of projects is a cycle involving three distinct phases: the pre-investment, investment and operational phases. Capital-intensive projects in the electricity supply industry pass through these three phases with each of the first two phases divided into stages of planning, risk evaluation, design engineering and execution [4, 5].

2.2.1 The pre-investment stage

The pre-investment stage begins with the identification of the need for the project (demand that has to be satisfied by new generation facilities, or a bulk supply sub-station, or an investment opportunity from an independent power supplier). This preliminary identification is followed by a pre-feasibility study, which is viewed as an intermediate stage between the identification of the project and a detailed fea-sibility study. In the pre-feafea-sibility study, a detailed review of the need for the project and demand for its output is undertaken, as well as of the possibilities and alternatives (site, size, fuels, etc.) and also risks. Therefore, at this phase, a lot of support studies are undertaken: market and demand, fuel supply, cooling water, location studies including soil mechanics, environmental impact assessment, as well as financial and economic analysis into the selection of the least-cost facilities, technologies and location, and profitability of the project.

2.2.1.1 The feasibility study

The feasibility study should provide all data and details necessary to take a decision to invest in the project. The feasibility study defines and critically examines the results of the studies undertaken in the pre-feasibility stage (demand, technical, financial, economic and environmental). The results of the feasibility stage are a project where all the background features have been well defined: size and location of the facilities, technical details, fuels, network features, and environmental impact and how to deal with it, timing of the project, and implementation schedule.

The financial and economic parts of the feasibility study cover the required investment and its sources, the expected financial and economic costs and returns.

It is not possible to draw a clear dividing line between the pre-feasibility and the feasibility studies. The pre-feasibility study is concerned with defining the alternatives (demand, location, size, technology, fuels, costs and environmental impact), while the feasibility study defines the project in a manner that allows implementation to proceed. A typical outline of a feasibility study is shown in Table 2.1.

Table 2.1 Typical outline of a feasibility study [4]

1. Introduction 2. The sectoral setting

(a) The industrial (electrical power engineering) sector and linkages to the rest of the economy

(b) The sub-sector (e.g. the generation sub-sector) (c) Issues and problems

(d) Proposals for change

3. The market, pricing and distribution (a) The market

(i) Historic supply and consumption (ii) Projected demand and supply (iii) Market for the proposed project (b) Transmission, distribution and marketing

(h) Environmental and social impact and measures for environmental preservation 6. Capital cost and financing plan

(a) Capital cost

(b) Working capital requirements (c) Financing plan

(d) Procurement

(e) Allocation of financing and disbursement 7. Financial analysis

(g) Major risks and risk analysis 8. Economic justification

(a) Economic analysis and economic rate of return (b) Linkages and employment

(c) Technology development and transfer (d) Foreign exchange availability and effects (e) Regional development impact

9. Agreements

Considerations in project evaluation 27

The feasibility study for large electrical projects (like building a new large power station or a major bulk transmission network and substations) has not only to be confined to the project, but also to look into what we call ‘system affects’ the electrical power sector in which the project will be operating (through undertaking power system analysis), the future demand and market for electrical power. The feasibility study has to undertake an engineering analysis that looks into the tech-nologies, the scope of the project, its timing and implementation arrangements, its management and manpower requirements and its financial and economic viability, and also its environmental impacts [6].

In this book, we are mainly concerned with the financial and economic eva-luation of projects to ensure their viability. However, it is essential to understand the impact of the other five considerations in electrical power project feasibility:

1. the sector;

2. the market (demand);

3. technology and engineering analysis;

4. management and manpower; and 5. environmental impact and costs.

These are briefly dealt with below to introduce the project evaluator to the different aspects that need to be considered before undertaking a project. In such capital-intensive projects, the financial plan is of vital importance; it has to ensure that there are enough funds to carry out the project to completion. Funds are needed not only to finance the project cost, but also to provide the working capital and pay for interest during construction, and for ancillary costs and expenses. In most such expensive projects, besides the capital (equity) from the project owner, there are usually large loans provided by banks, financial institutions and development agencies. All of these needs to be investigated, arranged and coordinated in the financial plan.

2.2.1.2 Project appraisal

Apart from the project pre-feasibility and feasibility studies that are carried out by the project owners, more evaluation, which is termed ‘project appraisal’, is executed by the financiers (other than equity owners) such as lending banks or development funds.

The idea of appraisal is to satisfy the financiers as to the accuracy and soundness of the feasibility study. Appraisal usually deals in depth with macro-economic matters, environmental impact and externalities. These are costs and benefits that are outside the confines of the project itself, but affect other objectives or policies of the country.

Appraisal work is greatly assisted by having a properly prepared feasibility study that covers every facet of the project. However, appraisal goes beyond feasibility into considering policies, regulations, and other macro-economic considerations and externalities. Appraisal undertakes a thorough economic (social) evaluation of the project costs and benefits, as well as carries out detailed sensitivity and risk analysis;

this is to ensure the financial and economic viability of the project.

The project appraisal, particularly when carried out by regional international development agencies or independent evaluators, leads to a thorough critical evalua-tion of the project and the sector. It often comes out with suggesevalua-tions and proposals

that improve the project’s setup and enhance the future performance of the sector.

Some of these proposals are crucial to the success of the project, so that they are treated as covenants and are incorporated in the financing and loan agreements, and the effectiveness of the loan agreements and its disbursement is conditional on the prior honouring of such covenants. Therefore, appraisal not only is beneficial for the project but also can lead to sector reforms that have a bearing on the economy and the way it is managed. It can affect tariffs, management and importation laws and can also lead to restructuring. This is the case in many developing economies that badly need to finance their power sector and have to borrow extensively from lending development institutions (like the World Bank) for this purpose, or introduce IPPs.

It is not intended to detail each facet of project evaluation and appraisal, since these are detailed elsewhere [7–9]. The emphasis will rather be on the financial and economic (also environmental) evaluation. However, here are some of the aspects and activities that are investigated in the feasibility study and appraisals.

The sector

A study of the power sector involves a study of its development, organisation and its linkages to the rest of the economy, the institutions working in the sector and reg-ulatory setup. In addition, the legislation, regulations and incentive structure inside the sector (that are likely to affect the project) are involved. The tariffs, their structure and their prospect of change and the regulatory system for setting them are included in the study, as are the sector policies and strategies, their effect and the interaction of the project with these. Taxation and importation tariffs and policies are examined for their impact on the project, and also the regulatory system to ensure protecting the rights and duties of the players in the sector. During appraisals there may appear certain shortcomings in the sector or in the regulatory system that warrant pointing out.

The market (demand)

This deals with power demand, its past development, present growth and future demand forecasts, and how the project will enable satisfying these. Project eva-luation looks beyond the project into the system and how the electrical power system, as a whole, interacts with the project and with the availability of the new supplies and network. The demand study also looks into the shape of the demand, its timing, how it fits the load curve and prospects for its modification. It also looks into the tariffs that apply, and whether the tariffs are satisfactory, and whether the project will affect these. In the case of system strengthening projects, the study involves an assessment of the existing detrimental financial and economic effects of the supply interruption and its consequences. Future demand and market eva-luation involve predictions and, correspondingly, a measure of risk assessment that is important in the financial evaluation and in choosing the right technologies and sizes that minimise the financial risk.

Technical and engineering analyses

These are covered by the detailed studies referred to in the pre-feasibility stage. The feasibility study highlights the least-cost solution to satisfy the project objectives (usually satisfying the demand). Appraisal ascertains that the proposed technical Considerations in project evaluation 29

solutions are truly the least-cost ones and that costs, timing, and implementation schedules are satisfactory. The engineering analysis looks into the project timing and implementation schedule. The technical and engineering analyses are related to the financial and economic analysis, since these are intended to evaluate the tech-nical and engineering alternative that satisfies the demand at the least cost.

Management and manpower

This refers to the availability of technical and managerial staff to man the facilities and ensure their proper operation, maintenance and management of supporting facilities: stores and inventories, transport, provision of services, etc. It also defines their availability and costs, the training requirements for the staff and the impli-cation of all this on project costs.

The environmental impacts

Environmental impacts need to study and ascertain the environmental impacts of the project. Also to look into the future prospects for environmental regulation, pricing and limitations of emissions, choice of fuels and their cleanness [10].

2.2.2 The investment phase

Once the project is fully defined, successfully evaluated and appraised and the finance is available, the next phase of project implementation – the investment phase – begins. This has many stages:

● carrying out the organisational, legal and financial measures to implement the project;

● basic, as well as detailed, engineering work;

● land acquisition;

● tendering, evaluation of bids and contracting;

● construction work and installation;

● recruitment and training of personnel; and

● plant commissioning and start-up.

Good project planning and management must ensure the proper implementation of all the above stages well before the project start-up. Delays or gaps in imple-mentation or management can cause increased costs or other damage to the utility, the investors and consumers. Execution schedules of different sections of the project need to be closely prepared, coordinated and monitored. Typically, a net-work plan with identification of the critical path needs to be drawn out for the procurement, implementation, testing and commissioning of large projects. Various methods have been developed for the effective and balanced organisation of the investment phase, such as the critical path method (CPM) and the project evalua-tion and review technique (PERT).

This phase involves disbursement and investment expenditures which need careful assessment and evaluation. Such expenditures occur in the earliest years of project implementation and are not significantly reduced by discounting. Therefore, they have considerable effect on the project’s financial viability. Their effect can be

more important than future financial flows (which occur at the later stages of project operation) whose importance is greatly diluted by discounting. Such disbursements and investment expenditures have to match the financing plan of the investment phase.

2.2.3 The operational phase

If the project is well planned and executed in the pre-investment and investment phases, respectively, a few problems in the operational phase will be encountered, other than the teething problems that are not uncommon in most new facilities. The success of the project and its benefits (profitability), of course, depend not only on good engineering and management, but also on sound financial and economic evaluation during the pre-feasibility and appraisal stages. This sound financial and economic evaluation is the subject of the next few chapters.

Electrical power facilities have a long useful operational life. To ensure that such facilities will survive their useful life demands proper operation and efficient maintenance that can involve high expenditure. All this is to be considered during the evaluation stage. However, as mentioned above, the effect of expenditures in later years of the project operation can have limited significance in evaluation owing to discounting, particularly if high discount rates are applied. It is, however, necessary to define the expected useful life of the project at the evaluation stage.

This can be greatly influenced by prospects of technological change and obsoles-cence, as well as by changes in the fuel market and environmental legislation in the case of power generation. Such unexpected outcomes can be taken care of during risk analysis (see Chapters 15 and 16).

2.2.4 Post-operation evaluation

It is useful, at a later stage, after project completion, to revisit the project to compare the performance and results with project estimates. This mainly applies to demand, cost, execution time and evaluation of impacts, as well as returns. Such post-operation evaluation is routinely carried out by major leading international development agencies, such as the World Bank. However, it also needs to be carried out by utilities and investors. A post-evaluation will educate the project planners and decision makers and widen their scope for future project preparation to minimise pitfalls and risks in the preparation of other similar future projects. Unfortunately, other than for development agencies, not much post-operation evaluation is carried out. Post-operation evaluation is vital to enhance experience and reduce future risks.