Reference no: EM13918988

Case Problem: DUKE ENERGY COAL ALLOCATION*

Duke Energy manufactures and distributes electricity to customers in the United States and Latin America. Duke recently purchased Cinergy Corporation, which has generating facilities and energy customers in Indiana, Kentucky, and Ohio. For these customers Cin- ergy has been spending $725 to $750 million each year for the fuel needed to operate its coal-fired and gas-fired power plants; 92% to 95% of the fuel used is coal. In this region, Duke Energy uses 10 coal-burning generating plants: five located inland and five located on the Ohio River. Some plants have more than one generating unit. Duke Energy uses 28-29 million tons of coal per year at a cost of approximately $2 million every day in this region.

The company purchases coal using fixed-tonnage or variable-tonnage contracts from mines in Indiana (49%), West Virginia (20%), Ohio (12%), Kentucky (11%), Illinois (5%), and Pennsylvania (3%). The company must purchase all of the coal contracted for on fixed-tonnage contracts, but on variable-tonnage contracts it can purchase varying amounts up to the limit specified in the contract. The coal is shipped from the mines to Duke Energy's generating facilities in Ohio, Kentucky, and Indiana. The cost of coal varies from $19 to $35 per ton and transportation/delivery charges range from $1.50 to $5.00 per ton.

A model is used to determine the megawatt-hours (mWh) of electricity that each gen- erating unit is expected to produce and to provide a measure of each generating unit's effi- ciency, referred to as the heat rate. The heat rate is the total BTUs required to produce      1 kilowatt-hour (kWh) of electrical power.

Coal Allocation Model

Duke Energy uses a linear programming model, called the coal allocation model, to allo- cate coal to its generating facilities. The objective of the coal allocation model is to deter- mine the lowest-cost method for purchasing and distributing coal to the generating units. The supply/availability of the coal is determined by the contracts with the various mines, and the demand for coal at the generating units is determined indirectly by the megawatt- hours of electricity each unit must produce.

The cost to process coal, called the add-on cost, depends upon the characteristics of the coal (moisture content, ash content, BTU content, sulfur content, and grindability) and the efficiency of the generating unit. The add-on cost plus the transportation cost are added to the purchase cost of the coal to determine the total cost to purchase and use the coal.

Current Problem

Duke Energy signed three fixed-tonnage contracts and four variable-tonnage contracts. The company would like to determine the least-cost way to allocate the coal available through these contracts to five generating units. The relevant data for the three fixed-tonnage con- tracts are as follows:

Supplier	Number of Tons Contracted For	Cost ($/ton)	BTUs/lb
RAG	350,000	22	13,000
Peabody Coal Sales	300,000	26	13,300
American Coal Sales	275,000	22	12,600

For example, the contract signed with RAG requires Duke Energy to purchase 350,000 tons of coal at a price of $22 per ton; each pound of this particular coal provides 13,000 BTUs.

The data for the four variable-tonnage contracts follow:

Supplier	Number of Tons Available	Cost ($/ton)	BTUs/lb
Consol, Inc.	200,000	32	12,250
Cyprus Amax	175,000	35	12,000
Addington Mining	200,000	31	12,000
Waterloo	180,000	33	11,300

For example, the contract with Consol, Inc., enables Duke Energy to purchase up to 200,000 tons of coal at a cost of $32 per ton; each pound of this coal provides 12,250 BTUs.

The number of megawatt-hours of electricity that each generating unit must produce and the heat rate provided are as follows:

Generating Unit	Electricity Produced (mWh)	Heat Rate (BTUs per kWh)
Miami Fort Unit 5	550,000	10,500
Miami Fort Unit 7	500,000	10,200
Beckjord Unit 1	650,000	10,100
East Bend Unit 2	750,000	10,000
Zimmer Unit 1	1,100,000	10,000

For example, Miami Fort Unit 5 must produce 550,000 megawatt-hours of electricity, and 10,500 BTUs are needed to produce each kilowatt-hour.

The transportation cost and the add-on cost in dollars per ton are shown here:

 

Supplier	Miami Fort Unit 5	Miami Fort Unit 7	Beckjord Unit 1	East Bend Unit 2	Zimmer Unit 1
RAG	5.00	5.00	4.75	5.00	4.75
Peabody	3.75	3.75	3.50	3.75	3.50
American	3.00	3.00	2.75	3.00	2.75
Consol	3.25	3.25	2.85	3.25	2.85
Cyprus	5.00	5.00	4.75	5.00	4.75
Addington	2.25	2.25	2.00	2.25	2.00
Waterloo	2.00	2.00	1.60	2.00	1.60

Supplier	Miami Fort Unit 5	Miami Fort Unit 7	Beckjord Unit 1	East Bend Unit 2	Zimmer Unit 1
RAG	10.00	10.00	10.00	5.00	6.00
Peabody	10.00	10.00	11.00	6.00	7.00
American	13.00	13.00	15.00	9.00	9.00
Consol	10.00	10.00	11.00	7.00	7.00
Cyprus	10.00	10.00	10.00	5.00	6.00
Addington	5.00	5.00	6.00	4.00	4.00
Waterloo	11.00	11.00	11.00	7.00	9.00

Managerial Report

Prepare a report that summarizes your recommendations regarding Duke Energy's coal allocation problem. Be sure to include information and analysis for the  following  issues:

1. Determine how much coal to purchase from each of the mining companies and how it should be allocated to the generating units. What is the cost to purchase, deliver, and process the coal?

2. Compute the average cost of coal in cents per million BTUs for each generating unit (a measure of the cost of fuel for the generating units).

3. Compute the average number of BTUs per pound of coal received at each generat- ing unit (a measure of the energy efficiency of the coal received at each unit).

4. Suppose that Duke Energy can purchase an additional 80,000 tons of coal from American Coal Sales as an "all or nothing deal" for $30 per ton. Should Duke Energy purchase the additional 80,000 tons of coal?

5. Suppose that Duke Energy learns that the energy content of the coal from Cyprus Amax is actually 13,000 BTUs per pound. Should Duke Energy revise its procure- ment plan?

6. Duke Energy has learned from its trading group that Duke Energy can sell 50,000 megawatt-hours of electricity over the grid (to other electricity suppliers) at a price of $30 per megawatt-hour. Should Duke Energy sell the electricity? If so, which generating units should produce the additional electricity?