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A methodological note on the evaluation of new technologies: the case of coal gasification
Enrray Vol. 3. PP. 737-145 0 Pergamon Press Ltd.. 1978.
0~544217811201~7371W2.0010 Printed m Grca! Britain
A METHODOLOGICAL NOTE ON THE EVALUATION OF NEW TECHNOLOGIES: THE CASE OF COAL GASIFICATIONt DAVIDL. KASERMAN Energy Division, Oak Ridge National Laboratory, Oak Ridge, TN 37830.U.S.A (Received 16 March
1978)
Abstract-The traditional methodology of engineering cost analysis employed in the evaluation of emerging technologies implicitly assumes an economic independence between output and factor markets. For certain processes currently under investigation in the energy area (e.g. coal gasification), this assumption is violated. As a result, a bias is introduced into the process evaluation procedure by use of the conventional methodology. This paper proposes and demonstrates a simple revised methodology that incorporates an economic analysis of the relevant cross-market price effect with the engineering cost results to correct this bias.
I. INTRODUCTION
Considerable investments are currently being made by both the public and the private sectors in the development and demonstration of emerging energy technologies. In attempting to allocate limited investment funds among the available technology alternatives, two related but distinguishable questions arise. First, for a given product with a given range of alternative production techniques, what are the relative costs of production among these techniques over the relevant range in the future (i.e. that range of time within which the various processes are likely to be applied)? And second, what are the probabilities that the given techniques will become commercially viable (i.e. profitable) at some point in the future? These two questions are concerned with the expected cost effectiveness and the investment risk associated with these alternative techniques. The answers that are provided should largely determine the outcome of the technology-investment decisions currently being made and, hence, the costs of energy production and utilization in the future. This paper briefly explores the methodology employed in the evaluation of new technologies. It is shown that a potential bias is introduced into the traditional approach of engineering-cost analysis by the failure of some technologies to conform to an implicit assumption used in such an analysis. An amended methodology is presented that combines an economic market analysis with the standard engineering results to correct this bias. This revised methodology is demonstrated by application to two of the more promising techniques for manufacturing synthetic high-Btu gas from coal. It is concluded that previous engineering evaluations have probably been overly optimistic in assessing the commercialization potential of this technology and have likely provided erroneous conclusions regarding the ultimate cost effectiveness of the two particular processes examined. 2. COAL GASIFICATION:
ENGINEERING-COST
ANALYSIS
In essence, the basic process for converting coal to gas requires the addition of hydrogen to the coa1.S This is accomplished by reacting the coal with an air-steam mixture to produce low-caloric gas (approx. 150 Btulscf) or the reaction of coal with an oxygen-steam mixture to produce intermediate-caloric gas (approx. 300 Btulscf). This latter product may then be converted to synthetic natural gas (approx. 950 Btulscf) through further processing.’ This final product is a perfect substitute for natural gas and, in fact, may be commingled with natural gas in existing pipelines. The Federal Power Commission has recently interpreted the Natural Gas Act of 1938 to mean that synthetic natural gas is not subject to FPC regulation unless it is commingled with natural gas in interstate pipelines.* This ruling may, of course, discourage such commingling and could possibly delay the commercialization of coal gasification, +Operated by Union Carbide Corporation under contract W-7405-eng-26 with the U.S. Department of Energy. SThe ratio of hydrogen atoms to carbon atoms in coal is 0.8 to 1. whereas this ratio is 1.75 to I in oil’ and 4 to I in natural gas. 737
D. L. KASERMAN
138
The fundamental technology underlying coal gasification has been in existence for well over 100 years. As early as the 1820s the gas works in eastern cities were manufacturing a low-Btu town gas that was used for illumination and cooking.’ And, as late as the 1920s over 150 companies Were manufacturing coal gasification equipment worldwide.4 Increasing supplies of natural gas available at prices below the cost of manufactured gas, however, led to a rapid decline in coal gasification activity. At present, there are no U.S. firms engaged in the commercial manufacture of synthetic gas from coal, and only two processes are commercially available on world markets.t This trend now appears to be reversing, however, as natural gas shortages and price increases have revived interest in synthetic high-Btu gas production. This interest is reflected in the substantial public investments now being made by the Department of Energy in the demonstration of existing first-generation, high-Btu gasification technology. Concurrent with these demonstrations, basic research and development efforts are being funded for second- and third-generation gasification techniques. As an important part of this overall technology investment program, engineering evaluations are being carried out on the various processes under consideration. The purpose of these evaluations is, of course, to provide information on the cost effectiveness and commercial potential of these alternative processes to help determine appropriate funding levels. The methodology generally employed in these evaluations is fairly straightforward. For each specific process, input requirements are determined at some specified level of output. Prices are obtained for those inputs for which markets exist, and the remaining input costs are estimated by an analysis of the various components embodied in those intermediate products for which markets do not exist. Then, standard assumptions are made concerning depreciation, acceptable rate of return, and financing arrangements and an annualized cost per unit of output (broken down into capital and operating and maintenance costs) is obtained. Comparison of these costs across processes provides a measure of cost effectiveness, while comparison with projected prices of competing end products (here, natural gas) provides an estimate of commercialization potential. Table 1 shows the results of this sort of an analysis for the only two commercial gasification processes currently in existence, the Lurgi and the Koppers-Totzek processes. From these figures, one would conclude that the Koppers-Totzek process is cost effective relative to the Lurgi process by a decrease in product cost of $0.04/106Btu. Further, since the product gas is a perfect substitute for natural gas, one would conclude that high-Btu coal gasification will become commercially feasible when natural gas prices rise to $2.94/106Btu on a free market basisS‘(Table 1). Both of these conclusions, implied by the results of the engineering-cost analysis, are
Table 1. Cost of high-Btu gas from coal, 1975; from Ref. 1. Process Gas production, scf/hr Gas heating value, Btulscf Coal consumption, t/hr Coal heating value, Btu/lb On-stream time, % Total investment, $1000 Total annual costs, $1000 Coal (based on price of $0.75/106 Btu) Utilities Labor and maintenance Overhead and administration Depreciation Product gas cost, $/lo6 Btu
Lurgi 11.5 x lo6
970 1,000 7,000 90 700,000 263,908 91,476 6,700 67,000 6,700 92,032 2.98
Koppers-Totzek 10.4 x lob 960 600 12,000 96 600,000 247,076 99,792 5,700 57,000 5,700 78,884 2.94
tThese are the Lurgi and the Koppers-Totzek processes, which are currently in use in Germany and South Africa. Both of these are so-called first-generation processes, developed in Germany during the Second World War. SNonprice rationing in the natural gas market should have no important effect on this basic conclusion. Consumers that are unable to obtain natural gas at prices that are held fixed below the market-clearing level will switch their demand to the unrationed synthetic gas market; for an analysis of cross-market price effects under rationing see Tobin and Houthakker.’
739
A methodological note on the evaluation of new technologies
critically founded on the implicit assumption that the prices of all major inputs remain constant. This, in turn, requires that input and output markets be economically independent since an increase in the market price of natural gas must occur before the processes can be profitably applied. Clearly, this assumption is violated in the case of coal-gasification technology because of the substitutability of coal for natural gas. As natural gas prices increase or as shortages become more pervasive, the demand for coal will rise as certain energy consumers are able 20 substitute coal for gas. This increase in coal demand will (assuming less than infinite price elasticities of supply and demand for coal) bid up the price of the coal employed as feedstock in the gasification process. Since product gas costs are functionally related to coal prices (where this relationship is defined by the engineering estimates given above), process costs will rise and the conclusions derived from the engineering results must be revised. 3 AN
ENGlNEERlNG/ECONOMIC
APPROACH
TO
PROCESS
EVALUATION
Graphically, the engineering results define an upward-sloping relationship between the price (or cost) of synthetic high-Btu gas (denoted by PsG) and the price of coal (denoted by PC). The specific relationships implied by the engineering estimates for the two processes are shown in Fig. 1. The intercept of these curves represents the sum of the annualized unit capital and noncoal operating costs for the given process, and the slope is defined by the input coal to output gas ratio on a Btu basis. Mathematically, then, the engineering-cost analysis establishes the following estimates: &($/IO6 Btu) = 1.961+ 1.255 Pc($/106 Btu)
(1)
for the Lurgi gasification process. and Pkr($/106 Btu) = 1.754+ 1.442 P,.($/106 Btu)
(2,
for the Koppers-Totzek process (Fig. I). Since synthetic high-Btu gas and natural gas are perfect substitutes, their market prices must be the same in equilibrium, that is,
PSG= PM?,
(3)
where PNG denotes the market-clearing price of natural gas. Then, the engineering relationships given above could be viewed as defining a set of points in the price-of-coal/price-of-natural-gas plane within which profitable production of synthetic gas may occur. In order to determine whether and at what point actual market prices will enter this feasible set, one must incorporate an estimate of the interfuel price relationship implied by economic theory. Since natural gas and coal are substitute products, this relationship will also be upward sloping.
L
-P&/CO6
BlUl
Fig. 1. Engineering relationship between input coal price and output gas cost.
740
D. L.
KASERMAN
Figure 2 demcnstrates the effect of incorporating a hypothetical cross-market economic relationship in the analysis of cost effectiveness and commercialization potential of the gasification processes under examination. The divergence between processes is due, of course, to differences in input factor intensities. The Lurgi process is relatively capital intensive (with an investment-to-output ratio of 0.06275 $/Btu-hr compared with 0.0600!96 $/Btu-hr for the Koppers-Totzek process), whereas the Koppers-Totzek process is relatively coal intensive (with a coal-to-output ratio of 1442BtulBtu compared with 1.255 for the Lurgi process). Consequently, the Koppers-Totzek process is cost effective at relatively low coal prices (below $l.11/106 Btu), while the Lurgi process is cost effective at relatively high coal prices (above $1.11/106Btu) (Fig. 2). The traditional methodology implies a cost effectiveness differential equal to PIL - PIKmTin favor of the Koppers-Totzek process at existing coal prices equal to P,“. Further, the engineering results by themselves imply that commercialization of this process will occur when natural gas prices rise to PIKmT(from existing levels of PRO). Incorporation of the hypothesized economic relationship, however, alters these conclusions substantially. The cost-effectiveness - PzL in favor of the Lurgi process, comparison is reversed to an expected differential of PZKmT and the estimate of the price of natural gas required for commercialization is raised to PzL.t It should be noted that perfect substitutability between coal and natural gas would imply PNG= PC, or an interfuel price function that lies on a 45” ray through the origin. Since the slope of the engineering relationship must, according to the second law of thermodynamics, be greater than one, this situation would result in a nonintersection of the engineering and the economic relationships. This, in turn, would imply a zero probability of commercial application. Integration of the economic analysis with the engineering results is straightforward. Suppose that the long-run demand for coal is given by the following linear relationship:
Qc"= A + alPc + azP~~,al c 0,a2
>
0,
(4)
where Qc” is the quantity of coal demanded and A, aI and a2 are constants. Also, suppose that the long-run supply of coal is given by Qcs = B + 6P,, S > 0,
(5)
INTERFUEL PRICE FUNCTION KOPPERS -TOTZEK
Fig. 2. Engineering and economic relationships involved in process evaluation. tAn econometric estimate of the interfuel-price function could be used to generate conditional probability estimates for the commercialization potential of a given process. The estimated probability of commercial application conditional on a given market price of natural gas would be equal to that portion of the error-term distribution lying above and to the left of the engineering relationship for that particular process.
A methodological
note on the evaluation of new technologies
741
where Qcs is the quantity of coal supplied and B and S are constants. In equilibrium, QCD= Qe”. Therefore, eqns (4) and (5) may be solved for PC in terms of PNG.The result is given by PNGI
(6)
which represents the interfuel price function depicted in Fig. 2. For observed values of PC and PNG in the year in which the engineering-cost analysis is conducted (denoted by PC, and PNG,,),the expression (6) may be solved for the constant (A - B) in terms of al, a2,and 6. The resulting expression is (A - B) = (6 - (Y,)pco - a&.&&.
(7)
1975, the year to which the engineering results presented previously apply, P, = 0.89 and PNG,,= 0.86 ($/lo6 Btu). Substituting these values into eqn (7) and the result into kqn (6) we obtain
In
PC = 0.89 t
(8)
as the economic relationship between coal-input prices and natural gas prices. This result, combined with the engineering cost results for a given process and the identity given in expression (3), yields a system of three equations in three unknowns. This system may be solved for the price of natural gas at which the engineering and economic relationships equate for each process under consideration (where the solutions correspond to PzL and PzKmT in Fig. 2). Solving this system for the Lurgi gasification process, we obtain P2” = [3.08- 1.08(&)]/[
l-
1.26(e)].
This expression provides an unbiased estimate of the minimum natural gas price required for commercialization of the Lurgi gasification pr0cess.t The functional relationship between P2” and the economic parameters is obvious from this expression. In particular, we note that lim P,” = 3.08, aa
(10)
lim P,” = 3.08, IX,--m
(11)
lim P,” = 3.08.
(12)
a2-4
Since the engineering-cost results by themselves imply a minimum required natural gas price of 3.08 ($/106Btu) with 1975 coal prices, these results define the conditions under which the traditional methodology is valid. As the input market price elasticity of supply approaches infinity, as the input market price elasticity of demand approaches infinity, or as the cross-price elasticity of demand approaches zero, the results of the engineering-cost analysis provide an tThe solution for the Koppers-Totzek
process is
6zK-r = [3.04-
1.24(&)]/[
I- 1.442(e)]
We focus our attention on the Lurgi process throughout the remainder of the paper because this process appears to be cost effective relative to the Koppers-Totzek process at coal prices that are likely to be in effect during the probable life of a commercial gasification facility.
D. L. KASERMAN
142
unbiased estimate of the minimum natural gas price required for commercialization, and the supplemental economic analysis of cross-market effects becomes unnecessary.t Assuming that the parameter values of the hypothesized economic functions fall between the extremes defined by the above limits and the a prior’ limits imposed by theoretical considerations (i.e. assuming that 0 < 6 < 03, --oc< al < 0, and 0 < a2 < 30)it can be shown that 6,” > 3.08.$ This result implies that, for reasonable values of aI, a2 and 6, the conventional engineering methodology will always provide a downward biased estimate of the minimum price of natural gas required for profitable production of synthetic high-Btu gas from coal. As a result, conclusions drawn regarding the commercialization potential of this emerging technology will be overly optimistic. In the final analysis, of course, the degree of bias that will result cannot be known without actually conducting an econometric estimation of the crucial economic parameters.9 Therefore, unless one has a strong a priori justification for believing that one or more of the relevant parameters approach the limit values given in the expressions (lOJ-(l2). the proposed methodology appears to provide a superior approach to process evaluation. 4. CONCLUSIONS
In this era of .rapidly rising energy prices, the need for a sound technology-investment program is of paramount importance. In attempting to carry out such a program, information on the cost effectiveness and commercialization potential of specific processes weighs heavily in the funding-allocation decisions that affect the ultimate rate and direction of technology advancement. The traditional methodology of engineering-cost analysis generally employed in generating this information provides biased results when applied to those technologies for which the implicit assumption of economic independence between primary input and output markets is violated. A simple amended methodology that integrates the engineering results with an economic analysis of the relevant cross-market price effects corrects this bias. REFERENCES I. M. M. Papic. Can. 1. Chem. Engng 54,413 (1976). 2. Comptroller General of the United States, Report fo rhe Senate Committee on Public Works: Status and Obslacjes to Commercializafion of Coal Liquefaction and Gasification. Government Printing Office, Washington, DC. (1976). 3. N. P. Cochran, Scient. Am. 234,24 (1976). 4. A. L. Hammond, Science 193,750 (1976). 5. J. Tobin and H. S. Houthakker. Rev. Econ. Stud. 18. 140 (1951). 6. W. Lin. R. L. Spore and E. A. Nephew, 3. En&on. Econ. Manag. 3.236 (1976). 7. National Petroleum Council, U.S. Enegy Outlook: Coal Availability, A Report by the Coal Task Group of the Other Energy Resources Submittee of the National Petroleum Council’s Committee on U.S. Energy Outlook, Washington, D.C. (1973). 8. U.S. Federal Energy Administration, National Energy Outlook. Government Printing O&e, Washington, D.C. (1976). 9. M. B. Zimmerman, Long-Run Mineral Supply: The Case of Coal in the United States, unpublished Ph.D. dissertation, Department of Economics, Massachusetts Institute of Technology (1975). IO. M. B. Zimmerman, The Supply of Coal in the Long Run: The Case of Eastern Deep Coal, Energy Laboratory Rep. No. MIT-EL 75-021, Massachusetts Institute of Technology Energy Laboratory (1975). I I. M. B. Zimmerman, Bell 1. Econ. 8,41 (1977). 12. R. L. Gordon, Economic analysis of coal supply: an assessment of existing studies. Electric Power Research Institute, 3412 Hillview Avenue. Palo Alto, California (1976). tit is valid to make these statements in terms of elasticities because the approaching of these parameters to the limiting values is sufficient for the approaching of the respective elasticities to these same limiting values. Sunder these assumptions, a*/(6 - a,) > 0, and the slope of the economic relationship in the price-of-coallprice-ofnatural-gas plane is positive [see eqn (S)]. We want to show that [3.08-I.+-)]/[I-1.26(e)]>3.08. Multiplying
both sides by the denominator
of the 1.h.s.. 3.08-1.08
,“;, (-)
>3.08-3.88
(12 ( 6-a,
)
Subtracting 3.08 from both sides and dividing by a*/(6 -a,) yields 1.08 < 3.88 and the proof is thus complete. #The Appendix to this paper provides some information on the potential size of this bias and its relationship to the values of the economic parameters based on a simulation performed with a constant-elasticity economic model using parameter values inferred from a review of existing studies of the coal market.
A methodological
note on the evaluation
743
of new technologies
APPENDIX Some simulation results with an exponential economic model Let the demand and supply curves for coal be given by
and Qc” = BPcs, 6 ->0 respectively.
Then,
Ib)
in equilibrium, PC = (A,B)“‘6-““PNG0Z1(6-U,).
Using
1975 prices for coal and natural gas to identify
the constant
(C)
A/B and substituting
into eqn (ct. we obtain
P, = 0.89(0.86)- o~l~L--o,~P~~nzll6~o,~ as our interfuel price relationship. The engineering-cost relationship
for the Lurgi
gasification P&
[see expression
(I) in the text].
In equilibrium,
process
= 1.961+
is given by
1.255Pc
P NC= Psc. Employing
(P&o.86)“2’(6-“‘)-
(d)
0.89SPNG
Cc) this identity
with expressions
(d) and (e). we obtain
+ 1.756 = 0.
(f)
which implicitly defines $2’. the price of natural gas at which the Lurgi process becomes profitable. Expression (f) cannot be solved analytically. It can be solved by numerical techniques, however, for given values of (I,. o2, and S (the own price elasticity of demand, the cross-price elasticity of demand, and the own price elasticity of supply of coal, respectively). Figures 3-6 present graphically the results of this simulation for a broad range of these parameter values (Figs. 34). The available literature provides little guidance in selecting likely values for these parameters, The results obtained by Lin et a/.6 imply that a, = -0.685 and a2 = 0.126, but these estimates apply only to Appalachian coal. For the national
-
7
6
0
0.5
1.0
i.5
2.0
2.5
3.0
3.5
s Fig. 3. Solution
for PzL with a, =-0.25
and ~=0.30,
0.25. 0.20, 0.15, 0.10, 0.05
4.0
D. I,. KASEKMAN
0.5
0
i.0
4.5
2.0 a
2.5
3.0
3.5
4.0
Fig. 4. Solution for 6,” with al - -0.50 and aI= 0.30.0.25, 0.20,0.15,0.10,0.05.
I
I
1
f
I
1
6
5
6;
9
I-
3
2 0
0.5
4.0
(.5
I 2.0
i
I
2.5
3.0
3.5
8 Fig. 5. Solution for $2” with al = -0.75 and q = 0.30,0.25,0.2O,O.I5,
0.10,0.05.
4.0
145
A metholological note on the evaluation of new technologies 7
t6
-
c
-
4 t
-
I-
2/ 0
0.5
4.0
4.5
2.0
2.5
3.0
3.5
4.0
6
Fig. 6. Solution for &’ with a, = - 1.00 and a2 = 0.30, 0.25. 0.20, 0.15, 0.10. 0.05.
market, long-run demand elasticities may differ considerably. With regard to 6, the evidence is mixed. Several studies’.’ have implied that, within the foreseeable future, the price elasticity of coal supply is essentially infinite. If true, this would imply that P,” = 3.08 (f/IO6Btu). Considerable doubt has been cast on this conclusion, however, by the recent work of Zimmerman”’ and others.‘* Clearly, much work remains to be done in modeling the coal market before a complete appraisal of the cost effectiveness and commercial potential of high-Btu gasification techniques can be carried out.
0~544217811201~7371W2.0010 Printed m Grca! Britain
A METHODOLOGICAL NOTE ON THE EVALUATION OF NEW TECHNOLOGIES: THE CASE OF COAL GASIFICATIONt DAVIDL. KASERMAN Energy Division, Oak Ridge National Laboratory, Oak Ridge, TN 37830.U.S.A (Received 16 March
1978)
Abstract-The traditional methodology of engineering cost analysis employed in the evaluation of emerging technologies implicitly assumes an economic independence between output and factor markets. For certain processes currently under investigation in the energy area (e.g. coal gasification), this assumption is violated. As a result, a bias is introduced into the process evaluation procedure by use of the conventional methodology. This paper proposes and demonstrates a simple revised methodology that incorporates an economic analysis of the relevant cross-market price effect with the engineering cost results to correct this bias.
I. INTRODUCTION
Considerable investments are currently being made by both the public and the private sectors in the development and demonstration of emerging energy technologies. In attempting to allocate limited investment funds among the available technology alternatives, two related but distinguishable questions arise. First, for a given product with a given range of alternative production techniques, what are the relative costs of production among these techniques over the relevant range in the future (i.e. that range of time within which the various processes are likely to be applied)? And second, what are the probabilities that the given techniques will become commercially viable (i.e. profitable) at some point in the future? These two questions are concerned with the expected cost effectiveness and the investment risk associated with these alternative techniques. The answers that are provided should largely determine the outcome of the technology-investment decisions currently being made and, hence, the costs of energy production and utilization in the future. This paper briefly explores the methodology employed in the evaluation of new technologies. It is shown that a potential bias is introduced into the traditional approach of engineering-cost analysis by the failure of some technologies to conform to an implicit assumption used in such an analysis. An amended methodology is presented that combines an economic market analysis with the standard engineering results to correct this bias. This revised methodology is demonstrated by application to two of the more promising techniques for manufacturing synthetic high-Btu gas from coal. It is concluded that previous engineering evaluations have probably been overly optimistic in assessing the commercialization potential of this technology and have likely provided erroneous conclusions regarding the ultimate cost effectiveness of the two particular processes examined. 2. COAL GASIFICATION:
ENGINEERING-COST
ANALYSIS
In essence, the basic process for converting coal to gas requires the addition of hydrogen to the coa1.S This is accomplished by reacting the coal with an air-steam mixture to produce low-caloric gas (approx. 150 Btulscf) or the reaction of coal with an oxygen-steam mixture to produce intermediate-caloric gas (approx. 300 Btulscf). This latter product may then be converted to synthetic natural gas (approx. 950 Btulscf) through further processing.’ This final product is a perfect substitute for natural gas and, in fact, may be commingled with natural gas in existing pipelines. The Federal Power Commission has recently interpreted the Natural Gas Act of 1938 to mean that synthetic natural gas is not subject to FPC regulation unless it is commingled with natural gas in interstate pipelines.* This ruling may, of course, discourage such commingling and could possibly delay the commercialization of coal gasification, +Operated by Union Carbide Corporation under contract W-7405-eng-26 with the U.S. Department of Energy. SThe ratio of hydrogen atoms to carbon atoms in coal is 0.8 to 1. whereas this ratio is 1.75 to I in oil’ and 4 to I in natural gas. 737
D. L. KASERMAN
138
The fundamental technology underlying coal gasification has been in existence for well over 100 years. As early as the 1820s the gas works in eastern cities were manufacturing a low-Btu town gas that was used for illumination and cooking.’ And, as late as the 1920s over 150 companies Were manufacturing coal gasification equipment worldwide.4 Increasing supplies of natural gas available at prices below the cost of manufactured gas, however, led to a rapid decline in coal gasification activity. At present, there are no U.S. firms engaged in the commercial manufacture of synthetic gas from coal, and only two processes are commercially available on world markets.t This trend now appears to be reversing, however, as natural gas shortages and price increases have revived interest in synthetic high-Btu gas production. This interest is reflected in the substantial public investments now being made by the Department of Energy in the demonstration of existing first-generation, high-Btu gasification technology. Concurrent with these demonstrations, basic research and development efforts are being funded for second- and third-generation gasification techniques. As an important part of this overall technology investment program, engineering evaluations are being carried out on the various processes under consideration. The purpose of these evaluations is, of course, to provide information on the cost effectiveness and commercial potential of these alternative processes to help determine appropriate funding levels. The methodology generally employed in these evaluations is fairly straightforward. For each specific process, input requirements are determined at some specified level of output. Prices are obtained for those inputs for which markets exist, and the remaining input costs are estimated by an analysis of the various components embodied in those intermediate products for which markets do not exist. Then, standard assumptions are made concerning depreciation, acceptable rate of return, and financing arrangements and an annualized cost per unit of output (broken down into capital and operating and maintenance costs) is obtained. Comparison of these costs across processes provides a measure of cost effectiveness, while comparison with projected prices of competing end products (here, natural gas) provides an estimate of commercialization potential. Table 1 shows the results of this sort of an analysis for the only two commercial gasification processes currently in existence, the Lurgi and the Koppers-Totzek processes. From these figures, one would conclude that the Koppers-Totzek process is cost effective relative to the Lurgi process by a decrease in product cost of $0.04/106Btu. Further, since the product gas is a perfect substitute for natural gas, one would conclude that high-Btu coal gasification will become commercially feasible when natural gas prices rise to $2.94/106Btu on a free market basisS‘(Table 1). Both of these conclusions, implied by the results of the engineering-cost analysis, are
Table 1. Cost of high-Btu gas from coal, 1975; from Ref. 1. Process Gas production, scf/hr Gas heating value, Btulscf Coal consumption, t/hr Coal heating value, Btu/lb On-stream time, % Total investment, $1000 Total annual costs, $1000 Coal (based on price of $0.75/106 Btu) Utilities Labor and maintenance Overhead and administration Depreciation Product gas cost, $/lo6 Btu
Lurgi 11.5 x lo6
970 1,000 7,000 90 700,000 263,908 91,476 6,700 67,000 6,700 92,032 2.98
Koppers-Totzek 10.4 x lob 960 600 12,000 96 600,000 247,076 99,792 5,700 57,000 5,700 78,884 2.94
tThese are the Lurgi and the Koppers-Totzek processes, which are currently in use in Germany and South Africa. Both of these are so-called first-generation processes, developed in Germany during the Second World War. SNonprice rationing in the natural gas market should have no important effect on this basic conclusion. Consumers that are unable to obtain natural gas at prices that are held fixed below the market-clearing level will switch their demand to the unrationed synthetic gas market; for an analysis of cross-market price effects under rationing see Tobin and Houthakker.’
739
A methodological note on the evaluation of new technologies
critically founded on the implicit assumption that the prices of all major inputs remain constant. This, in turn, requires that input and output markets be economically independent since an increase in the market price of natural gas must occur before the processes can be profitably applied. Clearly, this assumption is violated in the case of coal-gasification technology because of the substitutability of coal for natural gas. As natural gas prices increase or as shortages become more pervasive, the demand for coal will rise as certain energy consumers are able 20 substitute coal for gas. This increase in coal demand will (assuming less than infinite price elasticities of supply and demand for coal) bid up the price of the coal employed as feedstock in the gasification process. Since product gas costs are functionally related to coal prices (where this relationship is defined by the engineering estimates given above), process costs will rise and the conclusions derived from the engineering results must be revised. 3 AN
ENGlNEERlNG/ECONOMIC
APPROACH
TO
PROCESS
EVALUATION
Graphically, the engineering results define an upward-sloping relationship between the price (or cost) of synthetic high-Btu gas (denoted by PsG) and the price of coal (denoted by PC). The specific relationships implied by the engineering estimates for the two processes are shown in Fig. 1. The intercept of these curves represents the sum of the annualized unit capital and noncoal operating costs for the given process, and the slope is defined by the input coal to output gas ratio on a Btu basis. Mathematically, then, the engineering-cost analysis establishes the following estimates: &($/IO6 Btu) = 1.961+ 1.255 Pc($/106 Btu)
(1)
for the Lurgi gasification process. and Pkr($/106 Btu) = 1.754+ 1.442 P,.($/106 Btu)
(2,
for the Koppers-Totzek process (Fig. I). Since synthetic high-Btu gas and natural gas are perfect substitutes, their market prices must be the same in equilibrium, that is,
PSG= PM?,
(3)
where PNG denotes the market-clearing price of natural gas. Then, the engineering relationships given above could be viewed as defining a set of points in the price-of-coal/price-of-natural-gas plane within which profitable production of synthetic gas may occur. In order to determine whether and at what point actual market prices will enter this feasible set, one must incorporate an estimate of the interfuel price relationship implied by economic theory. Since natural gas and coal are substitute products, this relationship will also be upward sloping.
L
-P&/CO6
BlUl
Fig. 1. Engineering relationship between input coal price and output gas cost.
740
D. L.
KASERMAN
Figure 2 demcnstrates the effect of incorporating a hypothetical cross-market economic relationship in the analysis of cost effectiveness and commercialization potential of the gasification processes under examination. The divergence between processes is due, of course, to differences in input factor intensities. The Lurgi process is relatively capital intensive (with an investment-to-output ratio of 0.06275 $/Btu-hr compared with 0.0600!96 $/Btu-hr for the Koppers-Totzek process), whereas the Koppers-Totzek process is relatively coal intensive (with a coal-to-output ratio of 1442BtulBtu compared with 1.255 for the Lurgi process). Consequently, the Koppers-Totzek process is cost effective at relatively low coal prices (below $l.11/106 Btu), while the Lurgi process is cost effective at relatively high coal prices (above $1.11/106Btu) (Fig. 2). The traditional methodology implies a cost effectiveness differential equal to PIL - PIKmTin favor of the Koppers-Totzek process at existing coal prices equal to P,“. Further, the engineering results by themselves imply that commercialization of this process will occur when natural gas prices rise to PIKmT(from existing levels of PRO). Incorporation of the hypothesized economic relationship, however, alters these conclusions substantially. The cost-effectiveness - PzL in favor of the Lurgi process, comparison is reversed to an expected differential of PZKmT and the estimate of the price of natural gas required for commercialization is raised to PzL.t It should be noted that perfect substitutability between coal and natural gas would imply PNG= PC, or an interfuel price function that lies on a 45” ray through the origin. Since the slope of the engineering relationship must, according to the second law of thermodynamics, be greater than one, this situation would result in a nonintersection of the engineering and the economic relationships. This, in turn, would imply a zero probability of commercial application. Integration of the economic analysis with the engineering results is straightforward. Suppose that the long-run demand for coal is given by the following linear relationship:
Qc"= A + alPc + azP~~,al c 0,a2
>
0,
(4)
where Qc” is the quantity of coal demanded and A, aI and a2 are constants. Also, suppose that the long-run supply of coal is given by Qcs = B + 6P,, S > 0,
(5)
INTERFUEL PRICE FUNCTION KOPPERS -TOTZEK
Fig. 2. Engineering and economic relationships involved in process evaluation. tAn econometric estimate of the interfuel-price function could be used to generate conditional probability estimates for the commercialization potential of a given process. The estimated probability of commercial application conditional on a given market price of natural gas would be equal to that portion of the error-term distribution lying above and to the left of the engineering relationship for that particular process.
A methodological
note on the evaluation of new technologies
741
where Qcs is the quantity of coal supplied and B and S are constants. In equilibrium, QCD= Qe”. Therefore, eqns (4) and (5) may be solved for PC in terms of PNG.The result is given by PNGI
(6)
which represents the interfuel price function depicted in Fig. 2. For observed values of PC and PNG in the year in which the engineering-cost analysis is conducted (denoted by PC, and PNG,,),the expression (6) may be solved for the constant (A - B) in terms of al, a2,and 6. The resulting expression is (A - B) = (6 - (Y,)pco - a&.&&.
(7)
1975, the year to which the engineering results presented previously apply, P, = 0.89 and PNG,,= 0.86 ($/lo6 Btu). Substituting these values into eqn (7) and the result into kqn (6) we obtain
In
PC = 0.89 t
(8)
as the economic relationship between coal-input prices and natural gas prices. This result, combined with the engineering cost results for a given process and the identity given in expression (3), yields a system of three equations in three unknowns. This system may be solved for the price of natural gas at which the engineering and economic relationships equate for each process under consideration (where the solutions correspond to PzL and PzKmT in Fig. 2). Solving this system for the Lurgi gasification process, we obtain P2” = [3.08- 1.08(&)]/[
l-
1.26(e)].
This expression provides an unbiased estimate of the minimum natural gas price required for commercialization of the Lurgi gasification pr0cess.t The functional relationship between P2” and the economic parameters is obvious from this expression. In particular, we note that lim P,” = 3.08, aa
(10)
lim P,” = 3.08, IX,--m
(11)
lim P,” = 3.08.
(12)
a2-4
Since the engineering-cost results by themselves imply a minimum required natural gas price of 3.08 ($/106Btu) with 1975 coal prices, these results define the conditions under which the traditional methodology is valid. As the input market price elasticity of supply approaches infinity, as the input market price elasticity of demand approaches infinity, or as the cross-price elasticity of demand approaches zero, the results of the engineering-cost analysis provide an tThe solution for the Koppers-Totzek
process is
6zK-r = [3.04-
1.24(&)]/[
I- 1.442(e)]
We focus our attention on the Lurgi process throughout the remainder of the paper because this process appears to be cost effective relative to the Koppers-Totzek process at coal prices that are likely to be in effect during the probable life of a commercial gasification facility.
D. L. KASERMAN
142
unbiased estimate of the minimum natural gas price required for commercialization, and the supplemental economic analysis of cross-market effects becomes unnecessary.t Assuming that the parameter values of the hypothesized economic functions fall between the extremes defined by the above limits and the a prior’ limits imposed by theoretical considerations (i.e. assuming that 0 < 6 < 03, --oc< al < 0, and 0 < a2 < 30)it can be shown that 6,” > 3.08.$ This result implies that, for reasonable values of aI, a2 and 6, the conventional engineering methodology will always provide a downward biased estimate of the minimum price of natural gas required for profitable production of synthetic high-Btu gas from coal. As a result, conclusions drawn regarding the commercialization potential of this emerging technology will be overly optimistic. In the final analysis, of course, the degree of bias that will result cannot be known without actually conducting an econometric estimation of the crucial economic parameters.9 Therefore, unless one has a strong a priori justification for believing that one or more of the relevant parameters approach the limit values given in the expressions (lOJ-(l2). the proposed methodology appears to provide a superior approach to process evaluation. 4. CONCLUSIONS
In this era of .rapidly rising energy prices, the need for a sound technology-investment program is of paramount importance. In attempting to carry out such a program, information on the cost effectiveness and commercialization potential of specific processes weighs heavily in the funding-allocation decisions that affect the ultimate rate and direction of technology advancement. The traditional methodology of engineering-cost analysis generally employed in generating this information provides biased results when applied to those technologies for which the implicit assumption of economic independence between primary input and output markets is violated. A simple amended methodology that integrates the engineering results with an economic analysis of the relevant cross-market price effects corrects this bias. REFERENCES I. M. M. Papic. Can. 1. Chem. Engng 54,413 (1976). 2. Comptroller General of the United States, Report fo rhe Senate Committee on Public Works: Status and Obslacjes to Commercializafion of Coal Liquefaction and Gasification. Government Printing Office, Washington, DC. (1976). 3. N. P. Cochran, Scient. Am. 234,24 (1976). 4. A. L. Hammond, Science 193,750 (1976). 5. J. Tobin and H. S. Houthakker. Rev. Econ. Stud. 18. 140 (1951). 6. W. Lin. R. L. Spore and E. A. Nephew, 3. En&on. Econ. Manag. 3.236 (1976). 7. National Petroleum Council, U.S. Enegy Outlook: Coal Availability, A Report by the Coal Task Group of the Other Energy Resources Submittee of the National Petroleum Council’s Committee on U.S. Energy Outlook, Washington, D.C. (1973). 8. U.S. Federal Energy Administration, National Energy Outlook. Government Printing O&e, Washington, D.C. (1976). 9. M. B. Zimmerman, Long-Run Mineral Supply: The Case of Coal in the United States, unpublished Ph.D. dissertation, Department of Economics, Massachusetts Institute of Technology (1975). IO. M. B. Zimmerman, The Supply of Coal in the Long Run: The Case of Eastern Deep Coal, Energy Laboratory Rep. No. MIT-EL 75-021, Massachusetts Institute of Technology Energy Laboratory (1975). I I. M. B. Zimmerman, Bell 1. Econ. 8,41 (1977). 12. R. L. Gordon, Economic analysis of coal supply: an assessment of existing studies. Electric Power Research Institute, 3412 Hillview Avenue. Palo Alto, California (1976). tit is valid to make these statements in terms of elasticities because the approaching of these parameters to the limiting values is sufficient for the approaching of the respective elasticities to these same limiting values. Sunder these assumptions, a*/(6 - a,) > 0, and the slope of the economic relationship in the price-of-coallprice-ofnatural-gas plane is positive [see eqn (S)]. We want to show that [3.08-I.+-)]/[I-1.26(e)]>3.08. Multiplying
both sides by the denominator
of the 1.h.s.. 3.08-1.08
,“;, (-)
>3.08-3.88
(12 ( 6-a,
)
Subtracting 3.08 from both sides and dividing by a*/(6 -a,) yields 1.08 < 3.88 and the proof is thus complete. #The Appendix to this paper provides some information on the potential size of this bias and its relationship to the values of the economic parameters based on a simulation performed with a constant-elasticity economic model using parameter values inferred from a review of existing studies of the coal market.
A methodological
note on the evaluation
743
of new technologies
APPENDIX Some simulation results with an exponential economic model Let the demand and supply curves for coal be given by
and Qc” = BPcs, 6 ->0 respectively.
Then,
Ib)
in equilibrium, PC = (A,B)“‘6-““PNG0Z1(6-U,).
Using
1975 prices for coal and natural gas to identify
the constant
(C)
A/B and substituting
into eqn (ct. we obtain
P, = 0.89(0.86)- o~l~L--o,~P~~nzll6~o,~ as our interfuel price relationship. The engineering-cost relationship
for the Lurgi
gasification P&
[see expression
(I) in the text].
In equilibrium,
process
= 1.961+
is given by
1.255Pc
P NC= Psc. Employing
(P&o.86)“2’(6-“‘)-
(d)
0.89SPNG
Cc) this identity
with expressions
(d) and (e). we obtain
+ 1.756 = 0.
(f)
which implicitly defines $2’. the price of natural gas at which the Lurgi process becomes profitable. Expression (f) cannot be solved analytically. It can be solved by numerical techniques, however, for given values of (I,. o2, and S (the own price elasticity of demand, the cross-price elasticity of demand, and the own price elasticity of supply of coal, respectively). Figures 3-6 present graphically the results of this simulation for a broad range of these parameter values (Figs. 34). The available literature provides little guidance in selecting likely values for these parameters, The results obtained by Lin et a/.6 imply that a, = -0.685 and a2 = 0.126, but these estimates apply only to Appalachian coal. For the national
-
7
6
0
0.5
1.0
i.5
2.0
2.5
3.0
3.5
s Fig. 3. Solution
for PzL with a, =-0.25
and ~=0.30,
0.25. 0.20, 0.15, 0.10, 0.05
4.0
D. I,. KASEKMAN
0.5
0
i.0
4.5
2.0 a
2.5
3.0
3.5
4.0
Fig. 4. Solution for 6,” with al - -0.50 and aI= 0.30.0.25, 0.20,0.15,0.10,0.05.
I
I
1
f
I
1
6
5
6;
9
I-
3
2 0
0.5
4.0
(.5
I 2.0
i
I
2.5
3.0
3.5
8 Fig. 5. Solution for $2” with al = -0.75 and q = 0.30,0.25,0.2O,O.I5,
0.10,0.05.
4.0
145
A metholological note on the evaluation of new technologies 7
t6
-
c
-
4 t
-
I-
2/ 0
0.5
4.0
4.5
2.0
2.5
3.0
3.5
4.0
6
Fig. 6. Solution for &’ with a, = - 1.00 and a2 = 0.30, 0.25. 0.20, 0.15, 0.10. 0.05.
market, long-run demand elasticities may differ considerably. With regard to 6, the evidence is mixed. Several studies’.’ have implied that, within the foreseeable future, the price elasticity of coal supply is essentially infinite. If true, this would imply that P,” = 3.08 (f/IO6Btu). Considerable doubt has been cast on this conclusion, however, by the recent work of Zimmerman”’ and others.‘* Clearly, much work remains to be done in modeling the coal market before a complete appraisal of the cost effectiveness and commercial potential of high-Btu gasification techniques can be carried out.