Introduction to power station economics.

A power station is built due to deliver or provides power to different consumers to meet their requirements or demand. But, obviously, generation & distribution of power to its consumers is not free. So that, while designing and building a power station, power engineers give their efforts to  achieve overall economy to minimize per unit cost of generation may as low as possible due to ensure reliable service and make profit for the generation company. These generating stations, known as central station generators, are often located in remote areas, far from the point of consumption.

As we discuss about the economics of power generation which is largely a matter of costing and there are several factors which influence the production cost such as cost of land and equipment, depreciation of equipment, interest on capital investment etc. That's why we need a careful study to calculate the cost of production. But before entering in details of power station economics we need to know following terms which I will use in my next posts.

• Interest:  In simple meaning interest is a payment made by a borrower to the lender for the money borrowed and is expressed as a rate percent per year.

A power generating station is constructed by investing a huge capital. This money is generally borrowed from banks or other financial institutions and the supply company has to pay the annual interest on this amount. Even if company has spent out of its reserve funds, the interest must be still allowed for, since this amount could have earned interest if deposited in a bank. Therefore, while calculating the cost of production of electrical energy, the interest payable on the capital investment must be included.

• Depreciation: Depreciation is a method of allocating some cost of a tangible long term asset over its useful life and thus, refers to the decrease in value of the asset (except land) during its lifetime. 

Depreciation is only calculated when the asset fulfills the following requirements:

1. The Depreciable assets have a limited useful life,
2. The useful life of the asset is more than one year,
3. The assets should not be the sales inventory i.e. it should be used in production of goods and services to run a business

If the power station equipment were to last forever, then interest on the capital investment would have been the only charge to be made. However, in actual practice, every power station has a useful life ranging from fifty to sixty years. From the time the power station is installed, its equipment steadily deteriorates due to wear and tear so that there is a gradual reduction in the value of the plant. This reduction in the value of plant every year is known as annual depreciation. Due to depreciation, the plant has to be replaced by the new one after its useful life. Therefore, suitable amount must be set aside every year so that by the time the plant retires, the collected amount by way of depreciation equals the cost of replacement. It becomes obvious that while determining the cost of production, annual depreciation charges must be included.