Electricity Cost Modeling Calculations

345 Pages·2010·3.49 MB·English

by  Monica Greer

ELECTRICITY COST
MODELING
CALCULATIONS
ELECTRICITY COST
MODELING
CALCULATIONS
MONICA GREER
AMSTERDAM (cid:129) BOSTON (cid:129) HEIDELBERG (cid:129) LONDON
NEW YORK (cid:129) OXFORD (cid:129) PARIS (cid:129) SAN DIEGO
SAN FRANCISCO (cid:129) SINGAPORE (cid:129) SYDNEY (cid:129) TOKYO
Academic Press is an imprint of Elsevier
Academic PressisanimprintofElsevier
30Corporate Drive,Suite 400,Burlington,MA01803,USA
TheBoulevard, LangfordLane,Kidlington, Oxford,OX5 1GB,UK
# MonicaGreer,2011.PublishedbyElsevierInc.Allrightsreserved.
Exception: Chapter3,by ChrisBlazek,is#ElsevierInc,2011.
Nopartofthispublication maybereproduced ortransmitted inany formorbyany
means, electronicormechanical, includingphotocopying, recording,or anyinformation
storageand retrievalsystem, withoutpermissioninwriting fromthepublisher.Detailson
howtoseekpermission,furtherinformationaboutthePublisher’spermissionspoliciesand
ourarrangements withorganizations suchastheCopyrightClearance Centerandthe
CopyrightLicensingAgency,canbefoundatourwebsite:www.elsevier.com/permissions.
Thisbookandtheindividualcontributionscontainedinitareprotectedundercopyright
bythePublisher(other than asmaybenotedherein).
Notices
Knowledge andbest practiceinthisfieldareconstantlychanging. Asnewresearchand
experiencebroadenourunderstanding,changesinresearchmethods,professionalpractices,
or medicaltreatment maybecomenecessary.
Practitionersand researchersmustalwaysrelyontheirownexperienceandknowledge
inevaluatingand usinganyinformation,methods, compounds,or experimentsdescribed
herein. Inusingsuchinformation ormethodstheyshouldbemindfulof theirownsafety
andthesafetyofothers,includingpartiesforwhomtheyhaveaprofessionalresponsibility.
Tothefullestextent ofthelaw,neitherthePublisher northeauthors, contributors,
or editors,assumeany liabilityforanyinjury and/ordamagetopersons orpropertyasa
matter ofproductsliability, negligenceorotherwise,or fromanyuseoroperationofany
methods, products,instructions,or ideascontainedinthematerial herein.
Library ofCongress Cataloging-in-Publication Data
Greer, Monica.
Electricitycostmodeling calculations/MonicaGreer.
p.cm.
Includesbibliographical referencesand index.
ISBN978 1 85617 726 9
1. Electricutilities United States Costs Mathematical models.2. Electric
utilities Rates Estimates United States. 3. Electric powerconsumption United
States Forecasting Mathematics. 4. Electricpower plants Load Mathematical
models. I. Title.
HD9685.U5G7552011
333.79 dc22
2010012954
BritishLibrary Cataloguing-in-Publication Data
A catalogue recordforthisbookisavailablefromtheBritishLibrary.
For informationonall AcademicPresspublications,
visit ourwebsite:www.elsevierdirect.com
PrintedintheUnitedStatesof America
10 11 12 13 14 15 9 8 7 6 5 4 3 2 1
PREFACE
I decided to work toward my doctorate in economics because I was fasci
nated by the subject of economics and had a professor who truly inspired
me. I especially enjoyed the theory of market structure, in particular
monopoly theory and natural monopolies.
While working on my master’s degree at Indiana University, I was
intrigued by the attempt of the Indianapolis Power and Light Company’s
(IPL’s) attempt to takeover the then Public Service of Indiana (PSI, which
became Cinergy and is now Duke). IPL was sort of the “donut hole,”
serving the metropolis of Indianapolis, while PSI served the surrounding
area (the “donut”). My thinking was that it would be more efficient if
one entity served the entire service territory rather than the two separate
entities (in other words, one served the entire “donut”). Subsequently,
my master’s thesis examined cases in which horizontal mergers between
utilities could be welfare enhancing, which essentially boiled down to cost
modeling and the savings that could be realized from such mergers.
In 1996, the Federal Energy Regulatory Commission (FERC) Orders
888 and 889 were passed. FERC Orders 888 and 889 were implemented
tofacilitatewholesalecompetitioninthebulkpowersupplymarket.More
specifically, Order 888 addresses the issues of open access to the transmis
sion network, giving FERC the jurisdiction over all transmission issues,
especially pricing. Order 889 requires utilities to establish electronic sys
tems to share information about available transmission capacity. These
are discussed in more detail in the chapter on regulation (Chapter 3).
While thinking about a dissertation topic, I began to study the cost
models that supported the electric industry, which were typically under
some sort of price regulation (since electric utilities were deemed “natural
monopolies,” as discussed in Chapter 2 of this book). What I found was
that these cost models were lacking, not only did they inappropriately
assume that distributed electricity was a single output but they also were
not true cost models in the sense that they did not conform to the proper
ties to which a true cost model should conform (this is discussed in
subsequentchapters).Asaresult,inmydissertation,Idevelopedanappro
priately specified cost model, which is quadratic in output and detailed in
Chapter 4 and in the case studies presented in Chapters 7 and 8.
ix
x Preface
More recently, I began thinking about the structure of prices and the
appropriate specificationofthecost functionsemployedto modelthepro
duction(and distribution)ofelectricity;that is,atotal costfunctionshould
be cubic in output, experiencing regions of increasing, constant, and
decreasing returns to scale. Only in this form can appropriately shaped
average and marginal cost curves result, the latter of which could then
be used to price electricity efficiently, which means that price reflects the
marginal cost of supplying power at a given time. As such, only under
these conditions can the true variable (i.e., marginal) cost of supplying
electricity beestimated,acostthatincreaseswith output,sincehigher cost
generatingunits comeonline toprovideservice.FigureP.1displayssuch a
cost function. This cubic form yields the average and marginal cost curves
depicted in Figure P.2.
Only the proper specification of costs facilitates the appropriate pricing
of electricity that truly incentivizes producers to invest in new generating
technologies and demand side management and consumers to invest in
energy efficiency and become more conservative, so that a real reduction
in greenhouse gases canoccur and real climate change is possible. To date,
this is the missing link: This problem is not just a supply side or demand
side issue;itisafundamental issue,whichessentially hasbeen ignoredthus
far. And that is the purpose of this book: effecting a real change in the
methodology by which rates are set and costs are modeled so as to precip
itate the changes that need to be made to combat global warming of the
planet on which we live.
C (Y) Total Cost
Inflection
Point
Y* Y
FigureP.1 Anappropriatelyshapedtotalcostfunction.Acostfunctionthatiscubicin
output(Y).Y(cid:1)denotestheinflectionpoint,whichisthepointatwhichreturnstoscale
go fromincreasingtodecreasing.
Preface xi
C = f(Y)
AC = f(Y)
MC = f(Y)
Y* Y
Figure P.2 Average and marginal cost curves. At output levels Y < Y(cid:1), increasing
returns to scale are indicated by declining average costs, AC ¼ f(Y). At Y ¼ Y(cid:1),
returns to scale are constant (and average cost ¼ marginal cost). Beyond this level
of output, Y > Y(cid:1), diminishing returns to production set in (i.e., marginal cost
increases withoutput) anddecreasingreturnstoscaleareexperienced.
Withallthissaid, themotivationofthis bookemanates frommydesire
to effect a change in the way that rates are set in the United States (and
possibly in other places that have similarly set rate structures or regula
tions). Having worked for a public utility commission (and a regulated,
investor ownedutility),itfrustratesmeasaneconomisttoseethatthetrue
cost of service is not the mechanism by which rates are set; rather, other
forces (such as politics,demand elasticities, and the ability to hire attorneys
to argue on behalf of their customers, namely industrial users) influence
the rate making process.
SOME BASIC ECONOMIC THEORY
Fundamentally, it has been ingrained in me that consumers (and produ
cers)respond to prices,which should reflect thecost of providinga partic
ular service, in this case electricity. To wit, Figure P.3 depicts the
equilibrium price (P(cid:1)) and output (Y(cid:1)), which are set by the interaction
of supply (or marginal cost, MC) and demand.
Granted, we are not discussing a perfectly competitive market. That
being said, thisparadigm should not bedismissedoutright, as there areles
sons to be learned here. First and foremost, price should always be a func
tionofcost,whichisnotnecessarilythecase.Ithasbeenmyexperiencein
the electric industry that the price (or the rate charged to end users) has
xii Preface
P
Supply (MC)
P*
Demand
Y* Y
Figure P.3 Market equilibrium. My apologies. Basic in nature, this figure merely
representsthelawsofsupply anddemand.
little to do with the cost of providing such service but rather tends to be a
function of other factors, politics among them.
Several years ago, I had the first flavor of the politics of regulation for
electric utilities. As the economist at a state regulatory commission (in a
state with predominately coal fired generation), I struggled to understand
the logic behind the methodology of how rates were set and how costs
were allocated among the various customer classes. I still struggle with this
today, which is expounded on in this manuscript.
The bottom line is that the antiquated methodology under which rates
have been set in the United States (and possibly other countries using the
same rate making processes) are archaic; they do little (if anything) to pro
vide the proper incentives to end users to use energy wisely.
A NEW REGULATORY PARADIGM
With all of this said, I recently attended a conference on climate change
sponsored by the National Association of Regulatory Utility Commis
sioners. There, I was pleased to hear talk of a new “regulatory paradigm,”
which includes a departure from the traditional methodology by which
rates have been set in this country. Needless to say, I was very pleased to
hear this. If we are to achieve a reduction in the amount of greenhouse
gases being emitted into the atmosphere, such a new paradigm must tran
spire; both producers and consumers must be incentivized to pursue
energyefficiency,demand sidemanagement,andconservation,ingeneral.
Preface xiii
Renewable resources must be a part of the generation mix and the way
that investor owned utilities provide returns to shareholders be changed.
Utility investment in renewables (or avoided costs) should allow a higher
return to investors, while those in the fossil fuel fired generation return
a lower return, since the latter produce the very greenhouse gas emissions
that wreak havoc on the environment. Finally, it is time to pay the piper,
and this is everyone’s responsibility.
ACKNOWLEDGMENTS
This book has been quite an endeavor and would not have been possible
withoutthelovingsupportofmyfamily:myhusbandDavidand“daughter”
AliAnne;myparents,DavidandHelen,whoinstilledinmethevalueofan
educationandastrongworkethic;andmyGraduateschoolProfessors,who
believedinmeandencouragedmewhentimesweretough.Theyare:Subir
Chakrabarti,ParthaDeb,DavidFreshwater,RoyGardner,andFrankScott.
xv