Economic analysis of a small-sized combined heat and power plant using forest biomass in the Republic of Korea

ABSTRACT Economic analysis was conducted on the feasibility of operating a small-sized (500kW/hour) gasification power plant producing heat and electricity in a rural town surrounded by forests in the Republic of Korea. Cost factors that were considered over the plant's 20-year life included wood procurement, a wood grab loader, a chipper, a chip dryer, a gasifier, a generator, land and building, wages, and office management. All the cost factors were calculated based on the 2016 market values for logs, information from machine manufacturers, and a literature review. Revenues were estimated from selling heat and electricity using the 2016 average prices that were sourced from Korea District Heating Corporation and Korea Power Exchange, respectively. Using a spreadsheet program, cash flows for costs and revenues were arranged to calculate net present value, internal rate of return, and payback period of the plant. Also, sensitivity analyses were performed on the cost of wood procurement and revenues from selling heat and electricity, which were the most significant factors affecting the economic feasibility. The results, as reinforced by the sensitivity analysis, suggest an investment in the small-sized gasification power plant may be attractive from a financial standpoint, especially if the owners are in a position to get additional revenue from heat sales and to take advantage of Renewable Energy Credits.


Introduction
The Republic of Korea (Korea) imports 96% of the energy it consumes from other countries, and renewable energy such as bioenergy and hydropower represented only 4.6% of the country's total primary energy in 2015 (Korea Energy Agency 2016). In 2008 the government announced the "Third National Energy Master Plan" to induce industrialization of renewable energy in the country with a goal of supplying 11% of the total energy demand from renewable resources by 2020 (Korea Presidential Committee on Green Growth 2009).
To support the plan, the government began enforcing "Renewable Portfolio Standards (RPS)" in 2012, by which a utility company supplying over 500 MW per hour of electricity must produce at least 2% of its total electricity supply using renewable energy sources. Also, renewable energy certificates (REC), which can be traded in the market, were introduced to support the RPS policy (Korea Energy Agency 2012). The number of REC traders increased from 5957 in 2014 to 12,458 in 2015, and to 16,890 in 2016(Korea Power Exchange 2017. Meanwhile, forest biomass is recognized as one of Korea's major renewable energy resources, being available in almost all rural regions of the country. The forest area is 6370 thousand hectares, which represents 63.6% of the country's total land area. The potential amount of forest biomass that could be supplied through commercial or non-commercial harvest was estimated to reach about 1.3 million tons per year (Korea Forest Research Institute 2014).
With the rich forest biomass resources, efforts have been focused on development of diverse forest biomass conversion technologies (Ince et al. 2011), one of which is a small-sized combined heat and power generator using a gasification process that was developed in Korea (Choi et al. 2005;Lee 2009;Seo 2013). This effort was hoped to be especially promising for rural areas surrounded by forests in which electricity for heating and cooking is produced from non-renewable resources such as coal and gas, and is supplied from other areas. If electric power and heat energy were produced using the locally-supplied forest biomass, then heating and cooking costs would potentially be less than if the energy is sourced from other areas.
Economic analysis is a good tool for a potential owner of a small gasification power plant to evaluate the plant's potential economic performance and to identify variables critical to its success. Therefore, the objectives of the study were: (i) to analyze the economic feasibility of installing and operating a smallsized combined heat and power generator (500 kW/hour) using forest biomass; (ii) to provide basic data that can be used to assess the potential of biomass energy supply for mountain villages in Korea; and (iii) to create a flexible and powerful spreadsheet-based model that analysts could use to insert their own assumptions to do a preliminary financial feasibility analysis of a small-scale combined heat and power generator.

Method
Overview of economic analysis A generation system capable of producing 500kW per hour of electricity was developed by Samyang Eco-energy Co in CONTACT Dusong Cha dscha@kangwon.ac.kr Korea. An installation of this power plant in a rural town was hypothesized and its major cost factors: wood procurement; storing and chipping; chip drying; gasification; and electricity generation were incorporated into an economic analysis. Costs incurred at each stage of the process were estimated and applied to the analysis. Added in the cost analysis were expenses for ancillary facilities, finance, and operation as showed in Figure 1. Selling prices of electric power and heat produced from the process were used as revenue. All costs and selling revenues were sourced from 2016 market prices, information from machine manufacturers, and a literature review.
Each piece of equipment needing replacement over the 20year planning period was replaced at the end of its operating life at its original cost plus inflation. At the end of the planning period, equipment book values based on straight-line depreciation were used for terminal valuations.
Net present value (NPV), internal rate of return (IRR), and payback period (PP) were calculated based over a 20year cycle, which was the generator's estimated life. Sensitivity analyses were also conducted for the cost of forest biomass procurement and selling prices of electric power and heat. Our generic models were prepared in a Microsoft®Office (Redmond, WA) Excel workbook file.

Investment cost analysis
The cost analysis includes two major parts: cost incurred from the energy production process; and supporting cost items and revenues from selling heat and electricity. We hypothesized installation of this power plant in a rural town that could be supplied with forest biomass from nearby mountains. We assumed that all the power and heat produced from the plant would be sold to the residents in the rural town. Table 1 summarizes investment costs at every stage of the process and details are as follows.
Forest biomass procurement Forest biomass procurement cost was determined based on a final consumer price for logs in 2016 (Korea Forestry Promotion Institute 2016) and assumed to include costs for felling, processing, yard, and transportation of logs.

Storage and chipping
Logs are moved to a wood depot and chipped after purchasing them. Wood grab loader and chipping machine costs were included for moving and chipping the materials. Their operating costs were classified into fuel costs, and maintenance and repair expenses. The latter were assumed to be 50% of their depreciation costs (Brinker et al. 1989). These operating costs were assumed to increase by 5% per year. These machines were assumed to have 10-year operating lives.

Wood chip drying
Maintenance and repair expense of a dryer was assumed to be 1% of the purchase and increase by 5% per year, but its fuel cost was assumed to be zero as 40% of its heat production is self-consumed for drying. The dryer was assumed to have a 10-year operating life.

Gasifier
Annual maintenance and repair expense of a gasifier was assumed to be 1% of the purchase and increase by 5% per year, but its fuel cost to be zero as 10% of electric power production is self-consumed for operating over its 20-year life.

Generator
Annual maintenance and repair expense of a generator was assumed to be 4% of the purchase and increase by 5% per year, but its fuel cost to be zero as gas produced from a generator is used for its operating. The generator was assumed to have a 7-year operating life.

Land and construction
Land area for the plant was 2500 m 2 in the study and construction cost was for the whole facility of the plant and included costs for office, access road, fence, and pavement work. Annual maintenance and repair expense was assumed to be 1% of the construction cost and increase by 5% per year. Land is not depreciable under South Korean tax law. The terminal value of the land was its original cost plus inflation. The buildings were depreciated over 20 years using straight line depreciation. It was assumed that the plant and office would have no residual value at the end of the 20-year project life.
Labor and office management Labor cost (i.e., wages and benefits) was based on eight fulltime workers (8 hours per day), including one for moving and chipping logs, one for management and administration, and six for power plant operation with a three shift system. Also, insurance expense was applied at 0.4% of the facility cost. Other miscellaneous expenses included water and electric power charges etc.

Financing
Financing includes both debt and equity. To reduce the earlystage negative cash flow do to the initial investment, it was assumed there was a bank loan of ₩1,500,000 thousand (Korean won) at a nominal (i.e., including inflation) fixed interest rate of 6% and a 10-year redemption period. The model allows this interest rate to be set directly or as a function of the inflation rate, if desired. The bank's loan initiation If income 0.2 billion won, then national tax is 10 If 0.2 billion won < income 2billion won, then national tax is 20 Local tax If income 0.2 billion won, then local tax is 1 If 0.2 billion won < income 2 billion won, then local tax is 2 fee was paid only at the start of the loan, which represented 47% of total initial investment.
Loans are commonly repaid in Korea using constant principal repayments, which means that the interest payments and total loan payments vary each year. This was the method incorporated into the model. However, to allow flexibility in financing and repayment options, the spreadsheet model is constructed so that the loan may also be repaid using constant loan repayments, which means that the interest payments and loan principal repayments vary with each loan payment, but that each total annual loan payment is identical. In both cases, while interest expenses are deducted from revenue for tax purposes, principal repayments are not deducted.
The before finance and tax weighted average cost of capital is the minimum acceptable return rate on equity investment in the plant, which was set at 10.0%. This is a pre-tax nominal rate; that is, it includes inflation. It is the before finance and tax discount rate that was used in the discounted cash flow analysis. The before tax weighted average cost of capital (8.0%) was calculated by weighting the equity discount rate (10.0%) by the portion of equity in the initial financing and the bank's loan interest rate (6.0%) by the portion of debt in the initial financing. The after tax weighted average cost of capital (7.3%) was calculated by adding the cost of equity to the after tax cost of debt with both costs weighted according to the initial equity-debt mix.

Tax
National and local income taxes were incorporated at the rates of 10% and 1% respectively when income was ₩0 to ₩0.2 billion, and 20% and 2% when income was between ₩0.2 billion and ₩2 billion.

Revenue analysis
The primary market for heat and electricity produced from the power plant was assumed to be the rural town in which it was built. Table 2 shows annual revenues from heat and power production and details are as follows.
Revenues from selling electricity power Before calculating electricity sales revenue per year, a calculation was needed for the unit selling price of power, which comprises the system marginal price (SMP) of electricity and the market price of a REC. The (SMP) is an official power price of the Korea Power Exchange. To promote the use of renewable energy, the government enacted RPS)in 2014, under which a plant producing power from renewable sources such as biomass and water can issue the REC that can be traded in the market. When a forest biomass REC is sold to Korea Electric Power Corporation (KEPCO), the REC is provided with a 1.5 weight factor (i.e. £ 1.5) above the SMP to determine its market price (Korea Ministry of Trade, Industry and Energy 2014). This REC weighting factor helps to make the production of biomass-generated energy financially feasible.

Revenues from selling heat
The combined heat and power generator of this study produced 1436 Mcal of heat energy as well as 500kW of electricity per hour. Unlike electricity, selling heat requires facilities to be built for sending heat to households, which usually involves high costs. The unit selling price of heat for household was collected from Korea District Heating Corporation and used in the cost analysis, although to realize these heat sales revenues, additional distribution infrastructural investment may be required.

Other assumptions used for the economic analysis
The other assumptions are as follows: -Inflation was 3% and fixed over a 20-year project period.
-A working capital fund required for running the plant was set at 2% of total annual revenue and recovered at the end of year 20. -Capital costs including wood grab loader, chipper, dryer, gasifier, generator, construction, and land begin at year 0 and other costs including forest biomass, labor and office management, interest, and reserved fund begin at year 1. -Straight-line depreciation is used for all depreciable assets. -No capital gains taxes were assumed. Also, no tax allowances were made for capital loss carry backs or carry forwards.

Development of a cash flow model
The cash-flow model includes a number of parameters that are related to basic economic assumptions and investment financing options. The basic economic assumptions include the economic life of the project, and inflation rates for costs and revenue over the project period. It should be noted that inflation does not change the bank interest rate charged on the loan, unless that rate has been set as a function of inflation. Similarly, the inflation rate does not change the depreciation expenses as they become fixed when assets are purchased. To illustrate the model, the cash flow calculations extended out for 20 years (Figure 2). The cash flow model is divided into four major sections, which allow an analyst to focus on specific cash flows to determine the impacts of changes in various variables or options: I. Capital cash flows: include land, buildings, and equipment that are replaced as necessary. Capital cash flows also include investments in working capital. Note in this section that equipment is replaced at the end of its economic life and that estimated salvage values are increased by the inflation rate. If equipment economic lives are changed, the  alterations will be reflected in an automaticallyupdated cash flow table. II. Operating cash flows: are the day-to-day revenues and expenses that must be recovered in order for the business to operate over the short term. III. Financing cash flows: consist of cash flows related to any debt that is taken on to help pay for the capital assets. They are divided into the initial loan, which is a positive cash flow, tax-deductible interest expenses, and loan principal repayments. IV. Taxes: based on taxable income.
In the cash flow table, three rows are highlighted in yellow that represent the most important net cash flows: before finance and tax; before tax; and after tax.
To aid in feasibility analysis, pro forma income statements are also calculated and are shown (Figure 3). In the pro forma income statements, only revenues and expenses are shown. Earnings before interest, taxes, depreciation, and amortization (EBITDA) is shown, along with earnings before interest and taxes (EBIT), earnings before taxes, and finally net income (loss).
All financial measures are computed three ways: before finance and tax; before tax; and after tax. NPVs and the payback period are both computed using the three highlighted nominal cash flows and the three costs of capital (10.0%, 8.0%, and 7.3%, respectively). The payback period is the year in which the accumulated cash flow, including a capital charge based on the respective cost of capital, turns positive. If the accumulated cash flow does not turn positive over the 20-year planning period, then an "Infeasible" message is returned, indicating that the capital and the minimum required return on capital are never completely paid back. IRRs are computed both on the basis of nominal cash flows that include inflation, and on a real won basis, which are over and above inflation.

Sensitivity analysis
Of greater concern was the sensitivity of the financial feasibility of running the plant to changes in important factors determining costs and revenues. Several types of sensitivity analyses were built into the model through the adjustment of sensitivity factors to make it easy for users to get a sense of the importance of various cost and revenue assumptions. These are percentages that are multiplied by the costs or revenues so that an analyst can see the impact of percentage changes in these variables on the overall financial return measures. This method was used to test for changes in forest biomass prices and revenue from sales of heat. This method was also used to examine the sensitivity of financial returns to changes in REC prices, which easily fluctuate according to supply and demand and constitute a major portion of the electricity selling price.

Result and discussion
Financial feasibility of running a small-sized combined heat and power plant Table 3, taken from the model's results, shows the financial feasibility of a small-sized combined heat and power plant. The project's IRR was 12.3% after accounting for inflation and income taxes, given the assumptions used.
Revenue that would be earned from selling electricity and heat over the 20-year planning period discounted at the 7.3% after tax cost of capital totaled ₩18,441 million. On an annualized basis it came to ₩1779 million. After-tax profits in addition to the after-tax cost of capital represented about 8.3% of the total discounted revenue. Forest biomass procurement was the largest single cost and represented 34.0% of the total revenue, followed by other operating costs (32.9%), and net capital costs (20.4%) (Figure 4).
It is noteworthy that, in this example, the loan financing was not a net cost, but rather resulted in a small net benefit (₩74 million). This was because the bank interest rate (6.0%) was less than the before finance and tax equity cost of capital (10.0%) and the project was earning a rate of return that was greater than the loan rate. The result was positive financial gearing that increased the equity rates of return, which were shown by the before tax and after tax IRRs that were higher than the before finance and tax IRRs.

Sensitivity analysis on key cost and revenue variables
The quickest way of measuring the importance of costs in a business enterprise is to divide them by sales revenue. The larger the percentage of costs in relation to total sales revenues, the more sensitive net profits (or losses) will be to changes in those costs. Our analysis showed that forest biomass procurement costs were the largest component of total capital costs and that capital costs, while significant at 20.4%, are less important than operating costs in determining the plant's profitability (Figure 4).

Sensitivity analysis by forest biomass price change
As the forest biomass price per unit increased from 60% to 150% of its base value, NPV before finance and tax discounted at 10.0% decreased from ₩3.3 billion to -₩1.3 billion and real IRR from 20.0% to 0.3%. Payback period increased from 4 years at 60% to 20 years at 120% but it was infeasible after 130% ( Figure 5). If the forest biomass price per unit increases to over 130%, it means that renewably-generated electricity would not receive any marketplace premium over any other electricity. In this case, NPVs or IRRs turn negative and the payback period becomes infeasiblethat is, the project's capital costs are never paid back.
NPV before tax discounted at 8.0% decreased from ₩4.4 billion to -₩0.9 billion and real IRR from 30.4% to -0.5%, while payback period increased from 2 years at 60% to 20 years at 130% and was infeasible after 140%. NPV after tax discounted at 7.3% decreased from ₩3.5 billion to -₩0.9 billion and real IRR from 23.0% to -0.7%, while the payback period increased from 6 years at 60% to 20 years at 130% and was infeasible after 140%.
Sensitivity analysis by change of REC price As the revenue from power selling per unit changed from 60% to 150% of its base value, NPV before finance and tax discounted at 10.0% increased from -₩1.6 billion to ₩4.9 billion and real IRR from -2.0% to 25.7%, while payback period decreased from 17 years at 90% to 5 years at 150% and was infeasible before 80% ( Figure 6). NPV before tax discounted at 8.0% increased from -₩1.4 billion to ₩6.3 billion and real IRR from -3.3% to 41.0%, while payback period decreased from 20 years at 80% to 3 years at 150% and was infeasible before 70%. NPV after tax discounted at 7.3% increased from -₩1.4 billion to ₩5.1 billion and real IRR from -3.3% to 31.3%, while payback period decreased from 20 years at 80% to 3 years at 150% and was infeasible before 70%.
Sensitivity analysis by revenue change from selling heat Unlike power, selling heat is relatively limited and uncertain because it requires additional and expensive distribution infrastructure (i.e., pipes) to send heat to consumers. However, heat sales are critical to the facility's overall economics. The revenue from selling heat was assumed to change from 60% to 150% of its base value for the analysis. The result was that NPV before finance and tax discounted at 10.0% increased from -₩0.6 billion to ₩3.5 billion and real IRR  Figure 4. A small-sized and combined heat and power plant discounted after-tax costs and NPV as a portion of discounted revenue.
from -2.0% to 25.7%, while the payback period decreased from 20 years at 80% to 6 years at 150% (Table 4). NPV before tax discounted at 8.0% increased from -₩0.1 billion to ₩3.7 billion and real IRR from 4.1% to 32.1%, while the payback period decreased from 20 years at 70% to 4 years at 150%. NPV after tax discounted at 7.3% increased from -₩0.2 billion to ₩3.8 billion and real IRR from 3.4% to 24.3%, while the payback period decreased from 19 years at 70% to 4 years at 150%. Note that at revenue recovery rates on heat of 60% or less of our base case, the payback period becomes infeasible; that is, the capital investment is never recovered (Table 4).

Conclusion
Economic analysis was conducted for a small-sized (500kW/ hour) combined heat and power plant with a 20-year life that would provide a rural town surrounded by forested mountains with heat and power using forest biomass. Cost factors that were considered in the analysis included wood procurement, a wood grab loader, a chipper, a chip dryer, a gasifier, a generator, land and building, wages, and office management. All the cost factors were calculated based on the 2016 market values for logs, machine manufacturers' prices, and a literature review. Revenues were estimated from selling heat and electricity using the 2016 average prices that were sourced from Korea District Heating Corporation and Korea Power Exchange, respectively. Using a spreadsheet program, cash flows for costs and revenues were arranged to calculate net present value, internal rate of return and payback period of the plant. Calculations were done three ways: before finance and tax; before tax; and after tax. Also, sensitivity analyses were performed on the cost of wood procurement, and revenues from selling heat and electricity, which were the most significant factors affecting the economic feasibility. The results showed that the project was not so promising and internal rate of return was about 12.3% after tax. As a percentage of the total revenue over the 20-years project, wood purchasing cost was the largest item representing 34.3% of the revenue, followed by other operating costs (33.1%), net capital costs (20.5%), and net profit (8.3%).
Sensitivity analysis by forest biomass price showed that NPV after tax discounted at 7.3% decreased from ₩3.5 billion to -₩0.9 billion and real IRR from 23.0% to -0.7% as the forest biomass price per unit was changed from 60% to 150% of its base value. While the payback period increased from 6 years at 60% to 20 years at 130% and was infeasible after 140%. As the REC price increased from 60% to 150% of its base value, NPV after tax discounted at 7.3% increased from -₩1.4 billion to ₩5.1 billion and real IRR from -3.3% to 31.3%, while payback period decreased from 20 years at 80% to 3 years at 150% but was infeasible before 70%. When the revenue from heat selling was assumed to increase from 60% to 150% of its base value, NPV after tax discounted at 7.3% increased from -₩0.2 billion to ₩3.8 billion and real IRR from 3.4% to 24.3%, while payback period decreased from 19 years at 70% to 4 years at 150%.
For such an investment to succeed, a sustained and affordable supply of forest biomass from around mountain villages is the most important prerequisite for operating the plant, and development of an optimized timber harvest system is needed through evaluation of the usable forest resource and annual timber harvest planning (Han et al. 2011). Also note that the plant's economic viability depends on the amount of heat sales. Ideally a plant would be located where the piping already exists to distribute a plant's excess heat, because costs can be high to install such infrastructure. Finally, a biomass gasification plant's financial feasibility will depend on premiums paid for renewably-generated electricity, especially if extra margin weightings exist for biomass-generated electricity, because without the continuance of these premiums, a small-sized combined heat and power biomass gasification plant in the Republic of Korea would likely not be economic.

Disclosure statement
No potential conflict of interest was reported by the authors. Note: inf = infeasible.