Value of an asset: Why Basin Electric will continue to operate Dakota Gasification Company
Spend a bit of time thinking about your hardest business decision.
Was it always clear it was the right thing to do? What about the moments you questioned yourself, or outside forces made the decision seem foolish? Did you stick it out? Has it paid off?
The nature of the business surrounding Dakota Gasification Company’s Great Plains Synfuels Plant is based on commodity prices. The price of oil and natural gas, the prices that crops are selling for, the price of fertilizer and, though less so, the price of other products like carbon dioxide.
When commodity prices were higher, profits meant Basin Electric was able to return a lot of money to its members. The Great Plains Synfuels Plant has served as a $1.4 billion benefit to its members since 1988, and continues to provide benefits.
However, the most recent 10-year financial forecast shows losses every year.
Basin Electric directors and senior staff have decided the cooperative needs to hang steady with Dakota Gasification Company while maintaining its focus on strategic cost management and continuing to look at other options.
The decision was explained to Basin Electric members during a Members Strategic Direction Meeting in November.
“We wanted to be able to have an open dialogue with our members, where they could ask specific questions we just can’t answer in an open meeting,” says Paul Sukut, Basin Electric CEO and general manager. “We were pleased with how that meeting turned out. It was very well attended, and we took as much time as everyone needed to get questions answered. There is still work to do on this, but I know by going to our cooperative roots, using the business model’s best attributes of transparency and democracy, we are making the best decisions we can.”
Here is a high-level look at why this decision makes sense for Basin Electric’s members.
History of the purchase
Basin Electric bought the Great Plains Synfuels Plant from the U.S. Department of Energy (DOE) as a way to salvage the synergies that had been built between the Synfuels Plant and Antelope Valley Station. The DOE had acquired the plant after the original owners failed.
“At the time the DOE announced its intent to close the plant, Basin Electric was under a great deal of financial stress,” says Mark Foss, Basin Electric senior vice president and general counsel. “The load growth the cooperative had forecasted was not materializing, and Basin Electric had about 2,000 megawatts (MW) of generation. Our peak loads were only at 1,000 MW.”
Basin Electric formed two subsidiaries to make the deal: Dakota Coal Company paid $69 million for the coal rights, Dakota Gas paid $16 million for the natural gas pipeline that reaches to the Northern Border Pipeline, and Basin Electric paid $0. As part of the deal, Basin Electric agreed to forgo production tax credits and go through with a profit-sharing agreement for 15 years.
Basin Electric had interest in keeping the plant operating for several reasons, including those related to member rates. The Synfuels Plant used about 90 MW of electricity when operating at full load. If the plant had closed down at that time, Basin Electric would have had to increase rates by 14 percent, Foss says.
From 1988-2014, Dakota Gas invested $845 million into the plant in capital improvements, all funded with self-generated cash, including the proceeds from a legal settlement concerning the gas pipeline, according to Foss.
Bottom line impacts
While the decision to buy the Synfuels Plant paid off initially, the benefits proved themselves year after year when commodity prices were high.
Of the $1.4 billion in benefit Dakota Gas has had to Basin Electric since 1988, $300 million has been through dividends and bill credits paid to members, and $1.1 billion is in synergies in operations between the various facilities, according to Susan Sorensen, Basin Electric vice president and treasurer.
Sorensen explains that the shared coal supply keeps costs down for other Basin Electric facilities. If the Synfuels Plant would be shut down, the cost of mining coal would need to be absorbed by other users. A shutdown of the Synfuels Plant would increase coal prices for Leland Olds Station and Antelope Valley Station, coal-based power plants near Stanton, ND, and Beulah, ND, respectively.
Also, because the Synfuels Plant shares water and rail services with Antelope Valley Station, those benefits would be shifted over to the power plant.
“Dakota Gas currently pays about 30 percent of the overhead costs at Basin Electric Headquarters,” Sorensen says. “That percentage that is already netted down when considering some costs, like a haul road or computer mainframe, cannot be reduced by selling the asset.”
The Synfuels Plant uses a large amount of electricity, which supports Basin Electric’s margins. Also, the Freedom Mine, which supplies coal to the North Dakota facilities, is a large electricity consumer of Roughrider Electric Cooperative, a Basin Electric Class C member.
Rates and projects
The urea production facility at the Synfuels Plant has had financial challenges for some of the membership. The budget increased over the course of construction due to increases in quantity of materials and costs of labor required to build the facility. The project was further challenged by the quality and timeliness of engineering, and ultimately, staff released the general contractor for sustained poor performance. Once those issues were resolved, the project has consistently met its targets and is set to go into production by the end of January 2018.
Despite those struggles, recent rate increases can’t be attributed to the construction project’s budget.
“Basin Electric’s average member rate went up through 2016 due to several factors,” says Dave Raatz, senior vice president of Resource Planning. “Member growth was increasing across the entire membership, and we were building infrastructure to support that. Especially in the Bakken oil region of western North Dakota and eastern Montana, the growth meant Basin Electric was building generation and transmission to support the reliability of the transmission system.”
The plant will produce 360,000 tons of urea each year. According to Ken Rutter, Basin Electric senior vice president of Marketing and Asset Management, there is 2.2 million tons of demand each year within a 200-mile radius of the plant.
Backing up the decision
While these factors may be enough on their own for Basin Electric to keep the Synfuels Plant operating, staff knows more action needs to be taken.
Through September 2017, Dakota Gas employees have been able to find ways to reduce expenses by $24.5 million.
Once the urea production facility is operating, the Synfuels Plant will need 160 MW of electricity, and is expected to run at a 93-percent capacity factor, according to Dave Sauer, Dakota Gas senior vice president and chief operating officer.
A creative tactic would change the way the power contract between Dakota Gas and Basin Electric is written. Currently, the Synfuels Plant pays a higher-than-market rate. Having the plant pay market rates wouldn’t impact Basin Electric. Also, a plant write-down is being considered, which wouldn’t affect operation of the plant.
Employees of Dakota Gas and Basin Electric continue to search for ways to reduce costs and operate the plant more efficiently. Normal staff attrition has helped reduce the workforce as employees leave due to retirement and other opportunities.
On the Basin Electric side, directors are looking at a revenue deferral plan, which would allow for financial flexibility for future instances like what is happening today. Staff is working to optimize the generation fleet, focus on market exposure, and work on a coal asset strategy.