Electricity Marginal Cost Pricing

Packed with case studies and practical real-world examples, Electricity Marginal Cost Pricing Principles allows regulators, engineers and energy economists to choose the pricing model that best fits their individual market.

Written by an author with 13 years of practical experience, the book begins with a clear and rigorous explanation of the theory of efficient pricing and how it impacts investor-owned, publicly-owned, and cooperatively-owned utilities using tried and true methods such as multiple-output, functional form, and multiproduct cost models. The author then moves on to include self-contained chapters on applying estimating cost models, including a cubic cost specification and policy implications while supplying actual data and examples to allow regulators, energy economists, and engineers to get a feel for the methods with which efficient prices are derived in today’s challenging electricity market.

• A guide to cost issues surrounding the generation, transmission, and distribution of electricity
• Clearly explains cost models which can yield the marginal cost of supplying electricity to end-users
• Real-world examples that are practical, meaningful, and easy to understand
• Explans the policy implications of each example
• Provide suggestions to aid in the formation of the optimal market price

Power Engineers, Electrical Engineers, Energy Engineers, Energy Economist, Environmental Engineers, Mechanical Engineers, and Industrial Engineers

Preface

Acknowledgements

Chapter 1. Introduction

Introduction

Competitive Paradigm

Marginal Cost Pricing Doctrine

A Brief Overview of the United States Electric Market

Objective Functions: The Players

Reducing Carbon Emissions

Regulation of Investor-Owned Electric Utilities in the United States

Internalizing the Cost of Reducing Carbon Emissions

Optimal Rate/Tariff Design and Tax Credits to Promote Efficient Use of Energy and a Reduction in Carbon Emissions

Tariff Design and Rate-Making Issues

Conclusion

Chapter 2. The Theory of Natural Monopoly and Literature Review

The Natural Monopoly Conundrum

Defining Natural Monopoly

Economies of Scale

Efficient Industry Structure

Conclusion

Chapter 3. U.S. Electric Markets, Structure, and Regulations

Introduction

The U.S. Electric Industry Structure

Deregulation

Market Participants

Vertically Integrated Model

Industry Restructuring and the Competitive Electric Market

Regulation of the Electric Utility Industry

Looking Forward: Renewable Resources and Generating Technologies

Future of the Electric Industry

Chapter 4. The Economics (and Econometrics) of Cost Modeling

General Cost Model

The Econometrics of Cost Modeling: An Overview

A Brief History of Cost Models and Applications to the Electric Industry

Conclusion

Appendix

Chapter 5. Cost Models

Introduction

Determination of an Appropriate Objective Function: A Brief Overview of the Literature

Rural Electric Cooperatives

Differences between Coops and IOUs

Literature Review: Cost Studies on Rural Electric Cooperatives

Data

Review of the Literature: Cost Function Estimation in the Electric Utility Industry

Nerlove’s Cobb–Douglas Cost Model

Further Considerations

End of Section Exercises: Basic Cost Model versus Nerlove Cost Model

Flexible Functional Forms

Translogarithmic Cost Function

Cost-Share Equations

A Priori Expectations

Discussion of Estimation Results: Single-Output Translog Cost Equation

Substitution Elasticities among Inputs: Hicks–Allen Partial Elasticities of Substitution

Price Elasticities

Homotheticity

End of Section Exercises: Translogarithmic Cost Function

Multiproduct Cost Functions

Literature Review

Multiproduct Cost Models

Multiproduct Cost Concepts (Revisited)

Product-Specific Economies of Scale

Quadratic Cost Functions

A Properly Specified Quadratic Cost Function

Reasons That the Quadratic Form Is the “Best” Suited for Modeling Industry Structure

End of Section Exercises

Cubic Cost Models

Multiple-Output Models

More Complex Multiple-Output Models

Other Issues

Measures of Efficiency for Multiple-Output Models

Ray Cost Output Elasticity

Degree-of-Scale Economies

Product-Specific Economies of Scale

Economies of Scope

Cost Complementarity

Conclusion

End of Section Exercises: Multiple-Output Cost Models

Appendix: Generalized Method of Moments (GMM)

Appendix: Proofs

Chapter 6. Case Study

Introduction

Theory of Efficient Pricing

Study Design

Reasons that Cooperatively-Owned Utilities Are Different

Literature Review

Estimating Cost Models

Data

Cost Models

Estimation Results

Efficiency Measures

Discussion of Figure 6.4—Average Incremental Cost and Marginal Cost

General Implications of Estimation Results

Conclusion

Appendix A: Panel Data

Appendix B: Heteroscedasticity-Consistent Covariance Matrix Estimation

Chapter 7. Case Study

Cobb–Douglas Cost Model

Elasticities of Substitution for Cobb–Douglas

Translogarithmic Cost Function

Substitution Elasticities for the Translog Form: Hicks–Allen Partial Elasticities of Substitution

Price Elasticities

Generalized Leontief Cost Function

Empirical Estimation

Iterated Zellner-Efficient Estimator

Generalized Leontief Cost Function—Elasticities

Quadratic Cost Model

Nonlinear Quadratic Cost Model

Elasticities

Morishima Elasticities of Substitution

Conclusion

Appendix: Quasiconcavity in Input Prices

Chapter 8. Efficient Pricing of Electricity

Introduction

Theory Of Efficient Prices

Debate on the Optimal Pricing of Electricity: A Brief History

Rate Design

More About Rate Design: In Theory

Overview of Rate Design Process

Efficient Public Utility Pricing

Ramsey Prices: A Second-Best Option4

Ramsey Pricing—The Second-Best Option

Another Option: Average Cost Pricing

Two-Part Tariffs

Two-Part Tariff with Different Customer Classes

Multipart Tariffs

Nonuniform Pricing: Block Rates

Time-of-use Rates

A Brief History of Time-Of-Use Pricing

Real-Time Pricing

Understanding Electric Utility Customers

Assessment of Rate Structure Options

Conclusion

Chapter 9. Price and Substitution Elasticities of Demand: How Are They Used and What Do They Measure?

Introduction

Price Elasticity of Demand

A Brief Review of the Literature: Energy Demand, Elasticities Of Demand In Energy Markets, And Functional Forms

Price And Substitution Elasticities

Dynamic Models

Structural Models

Expenditure System Models

Econometric Issues: Identification and Systems Bias

Simultaneous Equations

Consistent Parameter Estimation

More Advanced Estimation Methods

Additional Econometric Issues (Berndt, 1991)

A Brief Survey of the Literature: Price Elasticity of Demand

Substitution Elasticities

Federal Legislation

Technology—the “Smart Grid”—How It Works

Elasticities

More Complex Models: Price And Substitution Elasticities Using Constant Elasticity of Substitution Model

Overview of Results—Faruqui And Sergici Study

Conclusion

For Interested Readers

Recommended Reading

Chapter 10. Time-of-Use Case Study

Introduction

The Electricity Crisis: Summer 2000

Chapter Overview

Literature Review

Effect of Time-Of-Use Pricing On Peak Utility Load

Recent Experience in California

The California Debacle: A Decade Later

Using Real-Time Pricing to Estimate Price Elasticity of Demand

Further Implications of the Residential Responsive Pricing Pilot

Peak-Load Pricing

Substitution Elasticities

Elasticities of Substitution

Conclusion

Recommended Reading

References

Index