Question

Discuss the impact of depreciation cost in cost per unit generation. Provide FOUR (4) items in a coal power plant that incorporate the component of this cost.

Answer 1

Determining the cost per unit (1 kWh) of production of electrical energy is known as the economics of power generation. Demand for electricity at a moderate rate is a driving force for the development and construction of power generating facilities that produce electricity at an acceptable rate to consumers. Terms often used in the subject of economics include interest and depreciation. Constructing a power station involves investing a large amount of capital in the project. This is generally borrowed from banks or other financial institutions and the plant owner has to pay an annual interest on the borrowed amount. As such, when calculating the cost of production of electricity in a facility, the interest payable on the capital investment must be included. The rate of interest depends on market conditions among other factors, and may vary from 4–8% per annum (Mehta and Mehta, 2005).

Depreciation refers to the decrease in the value of the power plant equipment and building due to continuous operation. If the power station equipment were permanent, then interest on the capital investment would be the only cost to be incurred. However, although every power station has a useful life ranging from fifty to sixty years, from the time the power station is constructed, its equipment steadily deteriorates due to wear and tear resulting in a gradual reduction in the value of the plant. This reduction in the value of the facility year on year is known as the annual depreciation. Due to depreciation, a plant has to be replaced by a new one after its useful life ends. Therefore, theoretically, suitable amounts of income must be set aside annually (the so called depreciation charge) in order that by the time the plant retires, the collected amount, by way of depreciation, equals the cost of a replacement facility. It is thus important that while determining the cost of production, annual depreciation charges be included. According to Mehta and Mehta (2005), three of the commonly used methods for determining the annual depreciation charge are the straight line method, the diminishing value method and the sinking fund method.

Below are four items that incorporate the component of unit cost:

1. Fuel Cost(Coal etc) (excluding sale proceeds of steam, ashes etc.)

2.Lubricants and other consumable stores

3.Station supplies and miscellaneous expenses.

4.Wages and gratuities to labour