by Miroslav Šebek Former Strategy & Trade Manager of the plant

June 2013

About this presentation

This presentation is dedicated to construction of new unit (called K7) of power plant in Kladno – approx. 20km NW from Prague (capital of The Czech republic).

Author of this presentation was involved in the construction since early strategic considerations in 2008 almost to finishing of the new unit in the spring of 2013.

This presentation neither contains any sensitive data nor reveals business strategy of author’s former employer – it presents only public photos, public results of Czech Grid operator’s tenders and general strategic principles (also public yet frequently ignored).

In 2008 power plant in Kladno consisted of two major lignite units (each 135MWe) build in 90’s, old hardcoal unit (34MWe) from 70’s and two quick start gas unit (45MWe and 60MWe). Its operations were scattered among four companies (ECKG was the most important one), all owned by Swiss power company ATEL Holding. Following merger at 1 January 2009 all the subsidiaries became unitary company Alpiq Generation (CZ) on 1 November 2009. There have been long evident necessity to deal somehow with looming decommissioning of plant’s oldest hardcoal unit. To terminate without replacement or to build expensive new (and bigger) unit? First part of this presentation is about it.

Convention for this presentation: prices in orange fields means prices of year’s baseload futures at PXE (Power Exchange Central Europe) for next year (so it depends on time context of particular slide).

During the year 2008 European power futures for years 2009, 2010 and 2011 followed rally in oil prices and their subsequent fall too. Futures’ prices were already decreasing when Lehman Brohters’s bakruptcy started world financial crisis.

This bubble hasn’t inspired decision on K7 in any way – even preliminary analyses didn’t take place before middle of 2009.

Swiss owner of ECKG merged : Alpiq Group was established in 2009 in Neuchatel Switzerland after the merger of two Swiss energy companies Aare-Tessin Ltd. for Electricity (Atel) and Energie Ouest Suisse (EOS).

Manufacturers of power technology (of boilers and turbines) were invited to provide ECKG’s management team with their preliminary offers which were subsequently compared and analysed.

At the end of 2009 final decision on K7 construction wasn’t made yet.

In March 2010 Board of Alpiq Holding reluctantly approved construction of new unit K7 (135MWe) of power plant in Kladno. The basis for the decision was not of a „bubble growing forever“ character but of an incremental forecasting (see below). Subsequently some negotiations with state and city authorities, power distribution company and grid operator could have begun. Immediate impact on power plant site was zero. Not surprisingly, stream of financial analyses, forecasts and model outputs demanded by Alpiq top management became even more massive after the decision.

Power future’s prices remained almost steady throughout all year 2010 at the level approximately 51 €/MWh.

June 2010 June 2007

14,3% 12,54%

In June 2010 took place major tender of Czech Grid operator on Ancillary services for years 2011 and 2012. While power prices were continuously falling, success in this tender became a matter of survival. Czech dominant player (ČEZ) bought market share by undercutting of its bid prices as much as 40% in some services. ALPIQ was the only competitor of ČEZ who resisted such brutal move owing to its broadly diversified portfolio of services. Obviously such success gave support to fresh (and still revocable) decision on K7 building.

for year 2010 (in MWh) for year 2011 (in MWh)

Relative market share of companies in AnS market Relative market share of companies in AnS market

10.3.2011 31.3.2011

51 €/MWh 57 €/MWh

In the wake of Fukushima disaster Germany immediately terminated operations of its 6 NPP’s. The decision caused immediate sharp rise in European power prices. It’s needless to explain how this surge had added to non-cancellation of K7 project in critical time just before ground breaking. Nonetheless, the impact of Fukushima was temporary – it died out before the end of 2011 year.

2.5.2011

57 €/MWh

Groundbreaking Ceremony of K7 unit took place on 2 May 2011. After the event was Cornerstone placed in entrance of the power plant in Kladno. Nonetheless, factual building was still a few months in uncertain future.

Construction works on site were launched in August 2011 – at first took place construction of new unit’s smokestack. All the construction was in very cramped conditions – not only new unit was under construction but buildings of discharged units had to be demolished and (almost) normal operations of power plant had to be secured at the same time. E.g. company’s parking lot had to became workers’ conveniences and temporary depot of construction machinery and material in one.

13.8.2011 13.9.2011

55 €/MWh 56 €/MWh

At 30 September 2011, soon after beginning of K7 construction, Alpiq CEO suddenly quitted. Thus, Alpiq became headless chicken for as long as 15 months. In this time, retired power plant’s buildings were demolished in order to give space for new boiler building and machine hall.

13.9.2011 17.10.2011

56 €/MWh 54 €/MWh

In the winter of 2011-12 first structures of new boiler building altered skyline. At the same time falling power prices made Alpiq top management anxious again… At this time a cancellation of K7 project would have been very expensive, but the loss still would have been far from total… At 1 November 2011 Alpiq Generation (CZ) merged with its smaller sister company Alpiq Zlín, remaining its name unchanged.

17.10.2011 27.1.2012

54 €/MWh 50 €/MWh

Throughout this period of late winter of 2011-12 construction of boiler building made substantial progress.

27.1.2012 27.3.2012

50 €/MWh 50 €/MWh

In the spring of 2012 cooling tower of new unit began to rise behind boiler building. The frame of the boiler building was finished in May and parts of actual boiler were begun to be installed inside. Power prices restored their downward direction that time.

27.3.2012 29.5.2012

50 €/MWh 48 €/MWh

K7 cooling tower was completed in August 2012. Also all large parts of the boiler had already been installed in boiler building by the end of August 2012. Finally, first beams of K7’s turbine hall emerged that time.

29.5.2012 18.8.2012

48 €/MWh 48 €/MWh

First beam of K7’s turbine hall

In June 2012 took place next major Grid operator’s tender on Ancillary services for years 2013 and 2014. Our competitors were probably so busy with their backstage arrangement on the tender that they totally overlooked K7 construction (with its 150m smokestack and 100m cooling tower!) posing big threat for them. Thus, Alpiq strenghten again its position at the market. It was already too late to do anything with K7 even if we would have failed in the tender but good news are always welcome...

June 2012 June 2010

14,3%

18,42%

for year 2011 (in MWh) for year 2014 (in MWh)

Relative market share of companies in AnS market Relative market share of companies in AnS market

In September of 2012 sheathing works on boiler building began. Main frame of turbine hall was constructed before the end of October. Shocking news came in October to Kladno from provisional Alpiq top management : “We are going to try to sell you for the best price”. Thinking behind is unknown for author, if any have ever been... See pictures below. Would you give a fortune for a power plant under construction when many others (in operation!) would be for sale and power prices would go from bad to worse?

18.8.2012 25.10.2012

48 €/MWh 47 €/MWh

In November and December of 2012 sheathing works on boiler building and turbine hall were underway. Also some inner equipment of turbine hall was installed (not turbine yet). Looming end of the 2012 caused next drop in power prices which was driven by expected overcapacity of CO2 allowances in new period of Kyoto’s Protocol – NAP III (2013-2020).

25.10.2012 27.12.2012

47 €/MWh 44 €/MWh

On 1st January began tenure of new regular CEO of Alpiq Holding with no immediate impact on power plant in Kladno. All the company lived with preparation of its sale, vendors due dilligence, data room preparation for investors etc...

27.12.2013 3.3.2013

44 €/MWh 41 €/MWh

When author quitted in Alpiq (at 31 March 2013) only finishing works on sheating were still underway. Turbine was installed in April and start-up test were subsequently launched. Mind boogling attempt to sell unfinished power plant for good price in unfavourable market situation faded out with no comment from Alpiq top management…

3.3.2013 1.5.2013

41 €/MWh 38 €/MWh

Current power price at level 38 €/MWh really doesn’t look very nice for future profitability of new unit. Would be 90 €/MWh better?

No, because there is NO direct link between past and future prices of any

commodity ! So called “technical analysis” is just an astrology of modern times. So called “forecasting” is usually no more than lengthening of lines.

Note: Such ghostly data structures on future also constituted substantial part of vendors due dilligence (carried out by Ernst&Young) for potential investors during the attempt (mentioned few slides before) to sell the power plant in Kladno.

Nobody has never even analysed or asked whether the new unit (and whole power

plant too) is technically good fit for future shape of European power industry. Small, flexible, modern, lignite-burning, CO2producing, relatively simple, close to Czech capital, with medium variable costs, experienced&relatively stable crew – what does it mean for its future value?

Reputable Professor Richard P. Rumelt promotes his view of strategy creation as surfing waves of change.

Take a look at some of these waves advancing now through European power industry on next slides...

A wave is same for all surfers but what it actually does with a particular surfer depends totally on his/her weight, experience, equipment, exhaustion, readiness, prescience etc. Some surfers may enjoy white-knuckle ride, others may have embarassing bath and the biggest losers may even be drown. Surfers trying to ignore a particular wave or changes in its behavior will also probably miss happy end...

So called „Green energy“ is just a tick on the body of classic power industry. It can’t survive without controllable and stable (=classic) sources, but at the same time it may kill them. Frequenly omitted point: Europeans vitally need power, so they MUST eventually kill the tick.

Such subsidized green tick does principally two bad things: 1) It devours investment which would otherwise go to classic sources. 2) Huge amount of subsidised energy presses down wholesales prices of power.

Second order effects of the two bad things above are following: 1) Investors are deterred from investment into classic power industry, so existing

classical sources became rare and indispensable. 2) Growing unpredictability of green sources demands growing flexibility of remanining

classic sources.

It results in one third order effect: big and insufficiently flexible sources will die first – even if they have low variable costs.

Statistical analysis of grid frequency in The Czech Republic – normal month

Statistical analysis of grid frequency in The Czech Republic – anomal month

Source: Czech Grid Operator

Growing number of unregulated sources in Europe makes power grid instable and hard to keep its standard frequency 50Hz. Major blackout is looming… You can imagine value of small but quick start power plant close to capital city in this dark case...

• Customers have improved in financial crisis their power management a great deal!

• They are no more willing to pay big penalties for missing or untaken power. • Naturally, they are also no more willing to share fruits of their careful planning

with a cascade of middlemen.

Source: Czech electricity market operator

No matter how is it called or veiled, quality of technical graduates in Europe decreases rapidly. Causes of this state are not so much important for this presentation as its impacts which are (at least) following:

1) Sophisticated power facilities can be still constructed, but not operated in conscious mode. So they have to be operated in ‘trained apes’ mode with major forfeiting of value added in favour of servicing companies or individuals possessing the necessary high skills. Sometimes power company even becomes real hostage of its high skilled partners.

2) Experience in company can’t be transferred from senior workers to their junior colleagues – the gap is too large for non-pedagogues.

3) Very low rate of innovations and initiatives in such company – it’s hard to improve a machinery which is in fact unfamiliar to me...

Power companies have always been harassed by politicians. This is neither new nor wave.

In fact, this wave should be rather called

However, since the start of world financial crisis in 2008, power companies have become (for politicians) : 1) Scapegoats. Simply, voters are poor, because power companies are allegedly rich. 2) Substitute targets (instead of banks which are feared by politicians). 3) Opportunities to present bold action – like Germany’s nuclear shut. 4) Subjects of new and strange taxes – like gift tax on free Kyoto’s CO2 allowances 5) Feeding-racks – Boards and some parts of top management of power companies

are infested with retired politicians, family members of active politicians or their puppets. With no expertise in the industry, they inflict big damages on the firms.

SHALE GAS

Nord Stream

TRANSGAS

NABUCCO

South Stream (Failed)

Nord Stream

South Stream

NABUCCO (failed)

TRANSGAS

Outline of gas sourcing of CEE region as it

was expected few years ago. Everybody who has betted on such development (even in COAL plant’s strategic considerations), is now in nasty troubles .

Outline of gas sourcing of CEE region as it

it expected now. Russian dominance in CEE is now obvious.

Surfers or alpinists frequently use phrases like „conquer a wave“ or „battle with a mountain“. It’s harmless in their case.

On opposite, attempts of business leaders to battle with a wave of change are not such innocent. To make matters worse, such attempts are usually accompanied by unineterest in competitors. Ultimately, their company is drowned.

All my presentations on strategy and corporate culture

Personal planning of strategist http://www.slideshare.net/kerimek/personnal-planning-of-strategist

My glosses to famous Sun Tzu’s The Art of War http://www.slideshare.net/kerimek/the-art-of-war-glosses

Surprising roots of bad organizational culture http://www.slideshare.net/kerimek/roots-of-badculture

Surprising roots of bad organizational culture – shortened version

http://www.slideshare.net/kerimek/roots-of-bad-culture-shortened-version

Strategic management as group of human beings http://www.slideshare.net/kerimek/strategic-management-as-group-of-human-beings

Enlargement of a small power plant http://www.slideshare.net/kerimek/enlargement-of-a-small-power-plant-project-and-strategy

Thank you for your attention!

Looking forward to your feedback, you can use my e-mail

miroslav.sebek@seznam.cz

or send me message at LinkedIn