From Causal Loop Diagram to Stock and Flow Diagram

For the presentation in Ph.D Colloquium

Namsung Ahn

Solbridge International School of BusinessWoosong University. korea

A concise overview of developments in business strategyKey events and publications (Kim Warren, 2005)

1955 1960 1970 1980 1990 2000

Discipline

System dynam-

ics

Resource-based view

Competitivestrategy dy-

namics

Systems Thinking

Scenario planning

Strategy

Corporate planning

Long-rangeplanning

Experiencecurve

SWOT

Productportfoliomatrix

Schwartz:The Art of the

Long View

Value-basedmanagement

Corecompetency

Kaplan &Norton:

The BalancedScore Card

Scenarioplanning

Senge:The FifthDiscipline

Business dynamics

Warren:Competitive

StrategyDynamics

ForresterIndustrialDynamics

Penrose:Theory of

the Growthof the Firm

Meadows:The Limitsto Growth

Ackoff:Redesigningthe future

oMeadows:Beyond

The Limits

Steman:BusinessDynamics

Wernerrfelt:“A resource-based viewof the firm”

Porter:Competitive

Strategy

Valuechain

Practice

Publication

What is systems thinking ?

• System thinking is a way of thinking about and de-scribing dynamic relationships that influence the behavior of systems.

• As a language, systems thinking provides a tool for understanding complexity and dynamic decision making.

• System thinking language is visual and diagram-matic; has a set of precise rules; translates percep-tions into explicit pictures; emphasize closed inter-dependences

• The essence of the discipline of systems thinking lies in a shift of mind: Interconnected Circular re-lationship (Loop) rather than Linear rela-tionship. seeing processes of change rather than snapshots. Approach to see the Structure rather than Event

• The Key in CLD lies in identifying the struc-ture of system. It helps to identify the Pol-icy Leverage and mental models of clients for easy communication

What is systems thinking

?

, tan,

cos, sin,

Interconnection and Interrelation

Level of Understanding

The Iceberg

Events

Patterns

Structures

Because structures generate events and patterns – but are very difficult to see- we can image these three levels as a kind of iceberg, of which events are only the tip.

Because we only see the tip of ice-berg, the events, we often let those drive our decision-making. In reality, however, the events are the results of deeper patterns and systemic structures.

Structures are the ways in which the parts of system are organized. These structures generate the events and patterns we observe

We view the reality from the following multiple levels of perspective

1980s

2000s

Why Boom and Bust Cycle in 1980s?

How can we explain this ? Causal Loop Diagram is enough?

Demand inRenewable by

Utilities

Economics ofRenewable

Order ofRenewable

Economics of Scale,Learning Effect in

Renewable

Vendor's CapacityExpansion inRenewable

+

+

+

+

+

Economy of Scal, Learning Effect Loop

Utility Order Loop

RegulatoryDriver like FIT

ExpectedRenewable

Market such asRPS

Investment inRenewable

EnergyOil Price in

1980s

Financial Crisisin 2008

FIT: Feed in Tariff

RPS: Renewable Portfolio Standard

Economics ofRenewable Energy

Demand ofRenewable

Energy

Order of NewRenewable Energy

Economics ofScale

Cost

Revenue

Investment inR&D

Vendor's CapacityExpansion

GovernmentSubsidies

Developer Order Loop

Learning Effect Loop Loop

R&D Investment Loop

Economy of Scale, Learning Effect in Renewable Energy? It is a “Chicken and Egg” Problem

The industry believes that stan-dardization and “learning curves” coupled with R&D invest-ment will drive cost lower over time.

But there are “Chicken and Egg” problems with this conclusion

CO2 Pricing is very important for Grid Parity

Oil PriceCarbon Pric-ing (CO2 Tax, Cap and Trading)

Technology BreakthroughEconomy of Scale (Busi-ness Model)

Electricity Price

Wind Power Cost

Systems Thinking vs System Dynamics

Systems Thinking

System Dynamics

• Soft Methodology• Qualitative Analysis• Casual Loop Diagram• Peter Senge: “The Fifth Discipline”

• Hard Methodology• Quantitative Analysis• Stock and Flow Diagram• J. Forrester: Industrial Dynamics

System dynamics is grounded in control theory and the modern theory of nonlinear dynamics. It is designed to be a practical tool that policy makers can use to help them solve the pressing problems they confront in their organi-zations.

• One of the most important limitations of causal diagram is their inability to capture the stock and flow structure of systems and to see the dynamics of the system

• Stocks and flows, along with feedback, are the two cen-tral concepts of dynamic systems theory.

• A major strength of the stock and flow representation is the clear distinction between the physical flows through the stock and flow network and the information feedbacks that couple the stocks to the flows and close the loops in the system

System Dynamics

• Stocks create delays by accumulating the dif-ference between inflow and outflow.

• Stocks decouple rates of flow and create dis-equilibrium dynamics in systems.

• Failure to understand the difference between stocks and flows often leads to underestimate time delays, a short term focus, and policy re-sistance

Why the distinction between stocks and flow is important?

Challenges in Renewable Energy (Problem Statement)

• The penetration of renewable energy in Korean electricity market

• The impact of renewable energy on wholesale electricity price

• The total cost of Subsidy to renewable energy

• How to bring up wind power industry as an engine of green growth

Impact of CO2 Pricing on Market Clearing Price

ElectricityGeneration

Generation from MustRun Units (Hydro,

Nuclear)

ElectricityPrice

Fraction ofOperation in Fossil

Technologies

Generation fromFossil Technologies

ExpectedProfit

Construction ofCC and CoalGeenration from New

CC and Coal

+

+

- +

+

+

Cost of FossilTechnologies

+

+

-

Marginal Cost ofExisting Units

Generation fromrenewable energy

Construction ofrenewable energy

Degree of FIT

+

+

+Total Cost of FIT

Causal Loop Diagram for Renewable Energy penetration in Korean market

FIT

Behavior decision theory

Each producer can estimate, albeit imperfectly, whether a new investment is profitable. As long as producers believe new capacity will be profitable, new producers will enter the market. When the industry is expected to be unprofitable, producers seek to reduce their capacity and some will exit.

The utilization decision responds to the expected profitability of current operations. In case that the current market price is expected higher than the marginal cost of existing plants, producer starts to operate the existing plants for sale.

Business Dynamics, John Sternman, 1998

Behavior of Power Plant Investors

Energy Price

Heat Rate forMarginal Coal

Plant

Price ofImported Coal

Variable O&MCost of Coal

Fuel Cost ofMarginal Coal

Unit

GenerationImported Coal

Fraction of Coal in Operation

Imported CoalCapacity

UnderConstruction

Retirement

The Theory of Investor Behavior on Existing Capacity Utilization

The Theory of Investor Behavior on New Investment

-3

128

0

62

5

52.9

15

44.3

29

33

Investors Expected RM (%)

Market Assessment

application

approvals

constructioncompletion

CCs UnderReview

CCs in the SiteBank

CCs UnderConstruction

CCs on Line

constructionstart

The estimated market price is compared to the estimatedcost of a CC to determine the fraction of investors withpermits that will start construction. In this example, the

construction starts would probably be zero

Investors estimate thelevelized cost of a new CC.This assessment includes afixed charge rate and and

estimate of future gas prices.If gas prices are expected at3.82$/MMBTU, for example,

the full cost might beestimated at 37.17$/mwh

Investors prepare an assessment ofthe capacity that will be available

in the future. They estimate outageof thermal units, and they assume

average weather for hydrogeneration. As an example, theymay foresee 150GW of capacity

ExpectedReserve Marginwould be 15% in

this example

Investors prepare an assessmentof peak demand around the time

that a new CC would come online. Their forecast is based on the

growth over the past few years.As an example, they may foresee

130GW of peak demand

1

Fraction Starting Construction

Cost Assessment

Supply Assessment Demand Assessment

Investors estimate the future market pricebased on their estimate of the future reservemargin. They have production costing models

which will lead to higher market prices.A nonlinear curve is used to represent their

market assessment.As an example, they may foresee 15%

reserve, and they use the curve to estimate the future price at 44.3$/mwh

In case of Renewable Energy

• The same Behavior decision theory can be applied

• The current market price and the degree of FIT are crucial to the profit of investors in renewable energy

New OffshoreWind underconstruction

NewOffshoreWind

CapacityOffshore Windconstruction

starts

OffshoreWindcomplete

construction

Wind Constructiondelay in yearsDelayed

Windcompleted

Construction of New Offshore Wind Capacity

<Construction Startsto keep pace>

OffshoreWind startsif keeping pace

<OK to startConstruction?>

<Offshore windexpected cap factor>

<Market ShareOffshore Wind>

Offshore Switch

Example: SFD for the Wind Power Capacity Acquisition Supply Line

Market Shares of NewConstruction

return

<biomass totallevelized cost>

<CCs totallevelized cost>

<Coal totallevelized cost>

<Offshorewind total

levelized cost>

Cs

Ccc

Ccoal

Cw

construction marketshares diversity

parameter

L

Cs to L

Ccc toL

Ccoal to L

Cw to L

Sum of Cost to Lpower

Market ShareSolar

Market ShareCCs

Market ShareCoal

Market ShareOffshore Wind

<Fuel Cell totallevelized cost>

Cmhy Cmhy to LMarket Share Fuel

Cell

<Cs>

<Ccc>

<Ccoal>

<Cw>

<Cmhy>

Weighted Aver Costof New Capacity

<Solar totallevelized cost>

CbCb to L

Market sharebiomass

<OffshoreSwitch>

Market Shares of New Construction

Market Prices ($/mwh)

100

80

60

40

20

0

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016Year

Price : FITPrice simulated in previous Qr : FITPrice simulated over previous Yr : FITWeighted Aver Cost of New Capacity : FIT

Feed in Tariffs & the Gov. Estimate of the SMP

100

50

0

2004 2006 2008 2010 2012 2014 2016Year

Feed In Tariff for Biomass : FITFeed in Tariff for Mini Hydro : FITFeed in Tariff for Wind : FITGovernment estimate of SMP : FIT

Market Shares of New Constrution

1

0.5

0

2004 2006 2008 2010 2012 2014 2016Year

Market Share CCs : FITMarket Share Coal : FITMarket Share Wind : FITMarket Share Mini Hydro : FITMarket Share Biomass : FIT

Capacity Under Construction (endogenous)

10,000

7,500

5,000

2,500

0

2004 2006 2008 2010 2012 2014 2016Year

New CCs under construction : FITNew Coal under construction : FITNew Wind under construction : FITNew Mini Hydro under construction : FITNew Biomass under construction : FIT

Renewable Gen. as Fr of Total

0.4

0.3

0.2

0.1

0

2004 2006 2008 2010 2012 2014 2016Year

Fr of Gen from FIT Renewables : FIT

Cumulative Cost of Wholesale Electricity and the FIT

400,000

300,000

200,000

100,000

0

2004 2006 2008 2010 2012 2014 2016Year

Cumulative Cost of Wholesale Electricity and the FIT : Base CaseCumulative Cost of Wholesale Electricity and the FIT : FITCumulative Cost of Wholesale Electricity and the FIT : 3 % annual growthCumulative Cost of Wholesale Electricity and the FIT : Gas CCs

Change in Government Policy for Renewable Energy: RPS Adaptation instead of FIT from 2012

In case of Wind Power,

• Government policy is pursuing Wind Market expansion and bring up the Competitive Wind TBN Ven-dors in Korea

• Domestic market is developed to have generation companies fulfill their obligations of RPS and for the test bed for domestic vendors

• REC (Renewable Energy Certificate) is being developed to compensate the economics of Renewable En-ergy Producers

RPS

FIT

Oil Price

REC

REC (Renewable Energy Credit), RECs (Renewable Energy Certificates), Green Tags, TRCs (Tradable Renewable Credits), Renewable Energy Attributes

Economics ofRenewable

Market Share ofRenewable

Economics ofFossil Fuel

Investment inRenewable

Order ofRenewable

Energy

Economies of Scale,Scope, Learning Effectin Wind Power Vendor

Unit Cost ofRenewable

+

+

+

+

+

-

Market Size inRenewable

2008

2010

2012

2014

2016

2018

2020

2022

2024

2026

2028

2030

0

5

10

15

20

25

30

35

40

45

50Annual Capacity Addition (GW)

Total Wind Capacity (GW)

2006

2008

2010

2012

2014

2016

2018

2020

2022

2024

2026

2028

2030

0

2

4

6

8

10

12

14Wind Target (GW-Year)

RPS Target (GW-Year)

Analysis Wind Power Market Environment in Korea : Total Installation and Annual MW addition

Drivers

• RPS Enforcement to Genera-tion Companies: 3% of total Generation until 2012 and 10% until 2030 (Government Police Goal)

• Possible Supply Technology for this requirement is Off-shoring Wind Power

Insights

• Annual 400MW addition in 2010, annual 800MW new addition in 2012.

• Annual 3-4GW Capacity addi-tion after 2020 will be needed

Korean Wind Turbine Supplier

• Lack of Track Record• No Experience to Export

Challenges to Export• Active Investment by

Ship Building Companies• M&A and Share Acquisi-

tion

World shipbuilding production by Top10 ship-yard

Sungdong Shipbuilding

Imabari Shipbuilding

Univesal Shipbuilding

Mitsubishi Heavy Industries

Dalian Shipbuilding

STX Shipbuilding

Hyundai Mipo shipbuilding

Daewoo Shipbuilding & Marine Engineering

Samsung Heavy Industries

Hyundai Heavy Industries

0 5000000 10000000 15000000 20000000

2441922

2603960

3013563

3079591

3380429

4668399

4877129

8965768

10726338

17285660

Top10 shipyard CGT

Date by Dec 31th, 2007

Shipyard will build Chinese wind plant (April 02, 2010)

Korea’s Hyundai Heavy Industries Co. said yesterday it had signed a deal with a Chinese state-run power company to set up a joint venture to produce turbines for wind power generators in China.

The world’s leading shipbuilder clinched the deal with Datang Shandong Power Generation Co., an af-filiate of China Datang Corp.

The joint venture will be funded 80 percent by Hyundai Heavy and the rest by the Chinese power firm, the shipbuilder said.

The plant, to be built in Weihai, China’s Shandong Province, is projected to start producing turbines with a generating capacity of 2 megawatts in January 2011, Hyundai Heavy said.

Shipbuilder signs Canada power deal (March 09, 2010)

Daewoo Shipbuilding & Marine Engineering Co., a Korean shipyard, said yesterday that it plans to establish a joint venture with the Canadian province of Nova Scotia to build a wind farm.

The Korean firm will hold a 51-percent stake in the venture, with the remainder to be owned by Nova Scotia. The farm will call for the production of 600 wind turbine blades and 250 towers annually. In August last year, the shipyard took over DeWind Inc., a U.S. wind power company, as part of efforts to diversify its revenue sources amid falling orders.

• Huge Capital Investment equal to $10 Billion in 2012, $48 Billion until 2030 in Wind Industry until 2012 is required in Korean Wind Market

• In the wind TBN supply prospective, new ship build-ing companies such as Samsung, Hyundae, Daewoo, and STX will play a major role to supply domestic off-shoring TBN and export Wind TBN to foreign de-mands.

• The government policy to catch two rabbits using two feedback loops will be optimistic because of the implementation of RPS and REC.

Results expected from the Government Policy

Key Issues arising from the government renewable energy Policy

• Can wind power industry play a major role in green growth?

• How to overcome the difficulties expected from the follower position?

• Is government policy to support wind power industry such as RPS (test bed) effective?

• What kind of business model do we need to model this policy?

Factors to affect TBN Choice

• Exchange Rate• Vertical Integration• Economies of Scale• Manufacturing Efficiency

• Economies of Scale• Production Portfolio (Core Model + Track Record)

• TBN Design Spec.• Various TBN Model (Site Specification)

• Production• Supply Chain Effectiveness• Economies of Scale• Manufacturing Efficiency

• 2-3 years Warranty• O&M Warranty

• Control System• Machine Efficiency

Wind IPP’s Economics Factors

• Government Policies such as FIT, Goal, Subsidies

• Wind Velocity

• Technical Performance

• Power Sale Price ($/kWh)

• Investment Volume

• Grid Connection

• Land Lease

• Capital Cost (Equity- ROE- Expectation& Debt- Interest Rate)

• O & M Service

• Insurance

• Administration (technical& Financial/ Insurances/ taxes + Fees)

Attractiveness ofWind Power

K-Model

Market Shareof Wind Power

Demand of WindPower in Domestic

Market

Construction of WindPower in Domestic

Market

Wind Power Cost Dueto Economies of Scale

Wind TBNK-Model Order

Wind TBN Cost due toEconomies of Scale, Learning

Effect, R&D Investment

Attractiveness of OtherWind TBN Models

+

+

+

--

+

-

-Track Record ofWind TBN K-Model

+

+

Demand inForeign Market

Market Share inGlobal Market

+

+

+

Wind TBNsunder

Approval

Wind TBNsunder

Construction

Wind TBNsunder

OperationApplicationRate

ApprovalRate

ConstructionCompletion Rate

RetirementRate

Network SizeAttractiveness

InnovationAttractiveness

Attractivenessof K-Model

Order Rate inDomestic Market

Unit Cost

<Unit Cost>

ReferneceUnit Cost

Sensitivity ofInnovation

Attractiveness

Sensitivity ofAttractiveness toNetwork Effect

Wind TBNs with noNetwork Effect

LearningIncreasing

Rate ofLearning

Capital Cost

O&M Cost LearningCurve

Strength ofLearning Curve

Initial CumulativeOperation Experience

Learing Effecton Cost