University of Technology Sydney Faculty of Engineering and Information Technology Energy Planning and Policy Program 49021 EVALUATION OF INFRASTRUCTURE INVESTMENTS Assignment 3 Set: 24 May 2017 Due: 9 June 2017 PART A (25 marks) (Source: Adapted from Stokey and Zeckhauser, 1978) A hydroelectric power plant on the Swan River has been ordered to build a fish ladder so that salmon can swim upstream beyond its dam. Three firms have submitted designs and cost estimates for the ladder. Design A is the most expensive. It will cost $8.4 million and will take three years to build. A ladder of this type is already in successful operation in Bush Valley. Design B is apparently similar, although it cuts a few corners to save construction time and money. It will cost $7.4 million and will take two years to build. We say ‘apparently’ because although to the human eye it appears to capture the essential design features, the ichthyologists are reluctant to guarantee absolutely that the salmon will agree. They (the ichthyologists, that is) estimate the probability of success at 0.9. If for some reason the fish refuse to climb the ladder, the problem will become obvious by the end of the first year of operation. Modification that will unquestionably satisfy the salmon can then be carried out at an additional cost of $2.8 million and a further delay of a year. Design C is an altogether different type of ladder. The ichthyologists believe that it has only a 0.7 chance of success. It is far less expensive ($5.6 million) and will take only a year to build. It will take additional year determine whether or not it works. If it does not work, it will have to abandon and a ladder of type A or B will then have to be built. Although no fish ladders of type C are now in operation, one is currently under construction in Spring Valley, and by a year from now it will be known whether or not it is successful. If it works there, we can confidently expect it to work here. Environmental and recreational benefits from a successful ladder are estimated at $1 million a year, whichever type of ladder it may be. The design of the ladder must be approved by a state agency. The agency quite reasonably decides that its goal should be to minimize total cost, on the theory that costs to the utility will eventually wind up on the customers’ bills by way of rate increases, and the losses in environmental and recreational benefits due to construction delays will be borne by substantially the same group. In an unusual departure from common practice, the agency discounts costs at 8 percent and benefits at 12 percent per year. It is anticipated that construction costs will rise at the rate of 10 percent per year. • Assuming that the three ladders will last equally long, and that the corporation is risk neutral, what is the best course of action? (For convenience, assume that construction costs are incurred when a ladder comes on line.) • What could be the reasons for the agency to discount costs and benefits at different rates? (no more than two dot points with each dot point no more than two lines)• Will your recommendation change if the agency discounted both costs and benefits at the same rate, i.e., 10 percent? (Yes or No – one word only). Why? (no more than three lines) PART B (25 marks) This question refers to the example on page 24 of the class notes for the third module. At what rate of discount will the electricity company be indifferent between ‘building a small plant’ and building a small plant’? (Please show your workings in an appendix). PART C (25 marks) As a top policy analyst for the government of your state, you have been asked to evaluate three diverse government programs dealing with conservation of energy. The programs are: A. Energy Development & Demonstration (EDD) Program: This program would support the development and demonstration of energy conservation projects appropriate for your state. B. Resource Diversification Promotion (RDP) Program: It would encourage the development of alternative energy sources e.g. solar. It would offer a direct financial rebate program for purchases of systems using solar energy. C. Accelerated Gas Promotion (AGP) Program: This program aims at increasing the use of natural gas. It would provide low interest loans for installing gas-run systems. Realizing the need to incorporate diverse criteria of evaluation in choosing which of these programs to implement, you decide to apply a multi-attribute decision analysis (MADA) approach. Working with your energy ministry, you carry out an assessment of two of your top energy decision makers to determine which attributes they think are the most important. You then carry out an analysis of the three proposed programs to estimate the level of each of the four attributes if the program were implemented. Your results are given below in Table 1. Table 1 Attributes & Levels Attribute Measure EDD RDP AGP 1 Net cost of energy provided to user c/unit 16 14 10 2 Potential for job creation Jobs 275 5 125 3 Potential maximum energy savings Mn units/years 0.71 0.24 1.0 4 Program cost to government Mn $ 0.11 1.0 2.0 2Unfortunately some of the estimates in the above table are quite uncertain. You should assume that the job creation for EDD program is known to plus of minus 50%; the potential energy savings for EDD program are also known only with 30% precision. Then, in an hour of their time, you are able to elicit their preference structure for these attributes. The scaling constants for their single attribute function are given below in Table 2 for decision makers I & II. Table 2. Scaling Constants Scaling Constants Attribute Measure Decision Maker I Decision Maker II 1 Net cost of energy provided to user c/unit 0.4 0.28 2 Potential for job creation Jobs 0.12 0.27 3 Potential maximum energy savings Mn units/years 0.31 0.19 4 Program cost to government Mn $ 0.17 0.26 • Your assignment is now to determine the preference of the each of the two decision makers for the program, i.e., which of the program would he/she prefer if he/she behaved “rationally”. • As one sensitivity study (in reality you would conduct many of them), determine if your results change if you assumed that Decision Maker II were extremely risk prone with respect to government program costs. PART D (25 marks) Develop a philosophical critique of the following concepts/approaches in the context of evaluating large energy projects (no more two dot points with each dot point no more than three lines, for each concept/approach): a) Utility b) Decision Trees c) Multiattribute Decision Analysis 3