Luotang Power free essay sample

Luotang Power Company started in 1994 as an idea for a 600 Mega Watt coal-fired power plant in Central China that would be the least polluting of its size in the area. The bid to develop, finance, and operate the plant was won by an American independent power producer. One very important term was that the Loutang Power Company would be contracted on a build, operate, and transfer (BOT) basis and the factory would be given to the Chinese government after 20 years of operation at no cost. The US company provided $500 million in total financing, negotiated a fixed price for a coal supply with moisture content between 4%-6% with Pingdingshan, and contracted with HPPC for a minimum annual electricity purchase of 3,000,000,000 MWh annually, with excess sales at 65% of normal selling price. In 2002, the US independent power company sold its interest in Luotang to Hua Tong Power or â€Å"HT Power†. Commercial operation officially began in 2004. Situation Tan Min Yi, General Manager of Luotang Power Company, is preparing to present the 2011 Report of Operations to the Board of Directors of HT Power. This will be an especially difficult task because the financial reports showed poor performance in 2011 compared to the years prior. Tan knows his company improved both plant availability and fuel economy. He hopes to show the Board that certain price and efficiency factors are skewing the numbers and are out of his control. He will have to break down the volume changes by quality variance, price variance, fuel efficiency variance, and fuel cost variance to most accurately explain the losses. Tan would also propose that he formula for fixed costs be revised to help close the large gap between standard and actual costs. Not only should his presentation prove that his team performed well and that he is worthy of a promotion, but it should help guide HT Power on future power plant investments. Variance Evaluation The Summary of Recent Operating Performance provides the information needed to calculate the price and efficiency variables for Luotang Power Company for 2009-2011. Data Analysis Several conclusions can be drawn from examining the cost and efficiency variance data. Price variance is favorable overall. Price per MWh sold increase for both the normal take and the excess energy sold to HPPC. The sales mix in 2011 played a large part in that success because excess sales at the lower rate (only 65% of original price) were lower. However, all other calculated variances were unfavorable. Poor quantity variance from 2010-2011 was most likely due to HPPC being able to produce some electricity on its own and lower forecasted future demand. As mentioned, the amount sold at the excess rate in 2011 had decreased significantly from 2010. Fuel efficiency, the amount of coal needed to produce a MWh of electricity, also decreased significantly from 2009-2011. This supports Tan’s hypothesis that they are being sold lower quality coal from Pingdingshan. That also explains the unfavorable fuel cost variance. Luotang needs more coal to produce the same amount of electricity than in years past as well as having to pay for storage of coal that needs to be dried out before it can be used. Fixed cost variances were extremely unfavorable. Luotang estimated standard fixed cost per MWh by dividing estimated annual total fixed costs by plant capacity (in MWh per annum previous year). This method creates a large, underestimated variance in the actual depreciation expense and standard by $4,445,900. Fixed operating and maintenance was also underestimated by $5,890,000. Recommendations Coal quality is the major issue to be address to the HT Power Board of Directors. The poor quality of these inputs makes the accuracy of the 2011 Report of Operations so difficult to interpret. A coal supply that is on the lower end of quality, yet still within the accepted range, effects both the fuel efficiency and fuel cost variances. In addition, having to store the coal longer to dry out the excess moisture is costly and a fire hazard. It should be recommended that Luotang implement new ways to effectively manage its coal vendor. That may be to negotiate a smaller quality specification range than 3% or to create some sort of incentive for Pingdingshan to deliver coal on the higher end of that range. They may also leverage their original agreement with the fact that using more coal than originally planned puts Luotang in danger of violating the Chinese and World Bank emission standards. By better managing the quality, Luotang can effectively use less coal decreasing costs and raising profits. Tan Yi should follow his instinct to change the accounting performance system formula for standard fixed costs. The recommendation is his idea of basing fixed costs only to the contractual minimum of 3,000,000 MWh rather than the actual generation from the previous year. Dividing over a smaller denominator would increase the fixed costs per MWh reducing or possibly eliminating the unfavorable variances. Overall, this will improve the reporting and evaluation of the company. This change would also result in excess electricity only including variable costs which would better reward excess sales performance and compensate for its lower price. When considering expansion, a 2000 MWh addition would not be recommended because Luotang cannot guarantee that HPPC will need the additional electricity. Tan needs to make the Board understand that HPPC controls excess sales and makes them almost impossible to forecast accurately. It is in their best interested to recover their investment and maximize the profits on the guaranteed 3,000,000 MWh contract for the remaining years of operation before giving the factory back to the government.