8.1: Overview

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Overview

By this point in the course, we have discussed the market structures and institutions that govern price dynamics and behavior in the major energy commodity markets - crude oil and refined petroleum products; natural gas; and electricity. We are now going to shift our focus down one level from the market to the individual firm or project. The next series of lessons, starting with this one, will develop quantitative tools that will allow you to prepare an assessment of the profitability of an energy project, whether that project falls into a conventional energy category (e.g., a natural gas power plant) or a sustainable energy category (e.g., solar hot water heating). While our focus here will be on profitability as a performance metric for project evaluation, it is possible to use other performance metrics (such as life-cycle impacts; embedded energy or water). In the investment world, these alternative metrics are used far less frequently in project evaluation.

This lesson will build up to the construction of the "pro forma" financial statement for a single energy project. Along the way, we will learn a little about the unique language of accounting (and why Enron gave accounting a bad name); what "depreciation" means to a tax accountant; and how a "10K" is not just a road race.

Learning Outcomes

By the end of this lesson, you should be able to:

differentiate debits (assets) from credits (liabilities) in an accounting statement and verify the fundamental accounting identity;
explain the process of financial depreciation and calculate depreciation using several different methods;
explain book-value accounting versus mark-to-market accounting;
build a "pro forma" financial statement consisting of a profit-and-loss sheet and a cash flow sheet.

Additional Readings:

Basic accounting concepts and the items on the pro forma income and cash flow statements will be explained using the following resources

Accounting Basics
A Primer on Financial Statements
"Primer on Financial Accounting," by Alison Kirby Jones (especially the second part on income and cash flow)
C. William Thomas, "The Rise and Fall of Enron," Journal of Accountancy, April 2002.

What is due for Lesson 8?

This lesson will take us one week to complete. Please refer to the Course Calendar in Canvas for specific due dates. Specific directions for the assignment can be found within this lesson. This week's assignment asks you to prepare a simple pro forma P&L and cash flow statement for a power plant. Please pay attention to the instructions regarding submission through the Lesson 08 Drop Box in Canvas.

Submit a spreadsheet document with the answer to the Lesson 8 question to the Lesson 08 Drop Box.

Questions?

If you have any questions, please post them to our Questions about EME 801? discussion forum (not email), located in the Lesson 00 module in Canvas. I will check that discussion forum daily to respond. While you are there, feel free to post your own responses if you, too, are able to help out a classmate.