econ 100 1 winter 2012: professor bushnell principles for transmission cost allocation james...
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Econ 100 1Winter 2012: Professor Bushnell
Principles for Transmission Cost Allocation
James Bushnell
University of California, Davis
December, 2013
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Econ 100 2Winter 2012: Professor Bushnell
Outline
• What’s so special about transmission?– Cost structure of energy transportation– Externalities
• Spatial markets– The derived demand for transportation
• Cost recovery vs. efficient pricing– fixed cost pricing vs. marginal cost (congestion) pricing
• Investment and cost recovery
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Econ 100 3Winter 2012: Professor Bushnell
Transportation and Spatial Competition
• The cost and availability of transportation determines the geographic size of a market– Crude oil markets vs. electricity markets
• Cost structure for transportation in energy is unlike most markets – Marginal costs are very low, capital costs are high
– Significant economies of scale;‘Lumpy’ investments
• Transmission assets are immobile– Captive customers and the hold-up problem
• Transportation capacity can be limited– Only matters if storage is costly
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Econ 100 4Winter 2012: Professor Bushnell
Transmission Pricing Policy Fights
• Fight 1: How to charge for use or access to lines with periodic congestion?
• Fight 2: How to charge for recovery of investment costs of constructing lines.
• These have often been confused as the same fight.– With the same answer.– But not in New Zealand!
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Econ 100 5Winter 2012: Professor Bushnell
Spatial Markets with Free Transportation
5
South
PS
QS
7MCS = 2 + qs
5
PN
NorthQN
12
11
MCN = 12
DN DS
Econ 100 6Winter 2012: Professor Bushnell
Spatial Markets with Free Transportation
• With no congestion and no transport cost, we have one combined market
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South
PS
QS
7MCS = 2 + qs
5
PN
NorthQN
12
11
MCN = 12
DN DS
6 10
Econ 100 7Winter 2012: Professor Bushnell
What is the Demand for Transportation?
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Ptransport
Qtransport
5
5
2
3
South to North Transport
Econ 100 8Winter 2012: Professor Bushnell
Congestion as Peak-load Pricing
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Ptransport
Qtransport
5
5
Demand for South to North Transport
MC of S to N Transport
.001 3
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Econ 100 9Winter 2012: Professor Bushnell
Transmission Investment:Why does it have to be so difficult?
• Efficient congestion prices reflect shadow value of a line– Shouldn’t this be a good signal for value of investment?
• Yes!, but…– Shadow prices reflect value of a small expansion– Lumpiness (economies of scale) mean that transmission
projects are almost never small– Think of a new investment that eliminates all congestion
• Network externalities make it difficult to define what “expansion” is– Many projects allow an increase some combinations of injections
while reducing others
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Econ 100 10Winter 2012: Professor Bushnell
Loop Flow?
Power flows in inverse proportion to the impedance (resistance) it faces
Example: Nodes 1 & 2 supply only, node 3 demand only
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3
1
2Capacity = 6
Cap
acity
= 6
z13
z23
Econ 100 11Winter 2012: Professor Bushnell
Loop FlowPower flows in inverse proportion to the impedance
(resistance) it faces
Example: Nodes 1 & 2 supply only, node 3 demand only
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6 Z13 23q1
13q2 6
6 Z23 1
3q1
2
3q2 6
1Z12 13q1
13q2 1
3
1
2
Capacity = 1
Capacity = 6
Cap
acity
= 6
z13z12
z23
Econ 100 12Winter 2012: Professor Bushnell
Feasible Dispatch Sets
• With 2 “radial” lines can send 6 MW from each source
• But can’t send 7 from either source
• 3rd line “expands” some possibilities but eliminates some others
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3
67
q1
q2
z23
z13
z12z12
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Econ 100 13Winter 2012: Professor Bushnell
Feasible Dispatch Sets
• With 2 “radial” lines can send 6 MW from each source
• But can’t send 7 from either source
• 3rd line “expands” some possibilities but eliminates some others
13
3
67
q1
q2
z23
z13
z13
z12z12
z23
43 6
Econ 100 14Winter 2012: Professor Bushnell
Transmission Investment
• Market prices can help induce efficient transmission investment– But don’t hold your breath
• In most cases transmission looks a lot like a natural monopoly– And we can try to apply the principles of
natural monopoly pricing to this context
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Econ 100 15Winter 2012: Professor Bushnell
Cost Recovery Principles
• Classic natural monopoly cost-recovery problem– Marginal cost pricing efficient but doesn’t recover
costs
• Pricing goal should be to minimize deadweight loss– Fixed charges (two-part tariffs)?– Ramsey Pricing?– Is that fair (unfair)?
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Econ 100 16Winter 2012: Professor Bushnell
Average Cost Pricing Creates DWL
Q16
$
Q
A
B
Fixed Costs to Recover
PA = PB
Econ 100 17Winter 2012: Professor Bushnell
Ramsey Pricing reduces DWL
Q17
$
Q
A
BFixed Costs to Recover
PA
PB
Econ 100 18Winter 2012: Professor Bushnell
Beneficiaries Pay
• From Wikipedia
• From “IntelligentUtility.com”The “beneficiaries pay” theorem adopted by FERC is
unaccompanied by a definition of the range of potential transmission benefits or how to calculate them in individual cases.
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“User pays, or beneficiary pays, is a pricing approach based on the idea that the most efficient allocation of resources occurs when consumers pay the full costs of the goods that they consume.”
Econ 100 19Winter 2012: Professor Bushnell
Ramsey Pricing reduces DWL
Q19
$
Q
A
BFixed Costs to Recover
PA
PB
Econ 100 20Winter 2012: Professor Bushnell
Transmission Chickens and Eggs
• For sunk (think unavoidable) transmission costs, this is a monopoly cost allocation issue.
• But what if generation location decisions cause transmission to be built?– New transmission not unavoidable
– Dispersed cost recover creates ability to partially “free-ride” on the network by off loading costs on other users
• Can create incentives to locate in inefficient places
• This perspective is one motivation for a “beneficiaries pay” (also “exacerbators”) approach.
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Econ 100 21Winter 2012: Professor Bushnell
Ex-Ante vs. Ex-post Determination of Benefits
• Very difficult to predict benefits for the next 20 years– Even the process of prediction can drag out
proceedings
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Econ 100 22Winter 2012: Professor Bushnell
Difficulties in Measuring Benefits
• Some benefits hard to quantify– Competitive gains - avoiding market power or restrictive
regulations– Reliability gains?– Value of insurance against extreme events (e.g. drought,
hurricane, national security, natural disasters)
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Econ 100 23Winter 2012: Professor Bushnell
Difficulties in Measuring Benefits
• Transmission is extremely long-lived asset– Costs of existing generation may change considerably– New generation difficult to predict
• How to incorporate impact of transmission investment on new entry?
– Demand growth patterns will evolve– No single entity controls these changes - decisions are
amongst diverse market actors• Some benefits hard to quantify
– Competitive gains - avoiding market power or restrictive regulations
– Reliability gains?– Value of insurance against extreme events (e.g. drought,
hurricane, national security, natural disasters)
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Econ 100 24Winter 2012: Professor Bushnell
Linking Two Symmetric Markets
North QN
South QS
Flow = QN - QSLine Capacity = k
Inverse demand in each market = P(Q)
• When the line has a very small capacity: Two Monopolies
• When line has a very large capacity: Duopoly, but no flow on the line
• How large is “large” and how small is “small”?
• When line has a “medium” capacity: limited competition
Econ 100 25Winter 2012: Professor Bushnell
Ex-Ante vs. Ex-post Determination of Benefits
• Very difficult to predict benefits for the next 20 years– Even the process of prediction can drag out
proceedings
• Ex-post “tracking” of benefits solves the prediction problem– But it makes the cost allocation endogenous (e.g.
driven by) the actions of those using the network– Risks distorting behavior with charges sunk costs
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Econ 100 26Winter 2012: Professor Bushnell
Marginal and Infra-MarginalAllocation
• One approach to cost recovery would be to claw back proportional surplus from users of the network– In principle this is first degree price discrimination– Close to Ramsey pricing in principle
• If a firm is infra-marginal they would be ineleastic to the proposed charge (e.g. will not change their behavior)
• In practice, can a claw-back not change behavior?• The trade-offs between precision and blunting
endogenous incentives
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Econ 100 27Winter 2012: Professor Bushnell
Summary
• Transmission exhibits many natural monopoly characteristics
• Efficient pricing is important but usually insufficient to recover investment costs
• Average cost pricing can inefficiently discourage usage of the network– What is the elasticity of the beneficiary?
• Choice of pricing paradigm needs to be reconciled with investment approach– If generation leads transmission – beneficiaries pay– If transmission leads generation – ramsey pricing –
• How close is that to beneficiaries pay?• How practical is it to recover benefits without disrupting behavior?
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