Long-run Marginal Cost Research Articles

Collapse of Venezuela's electricity system: Informing revitalization efforts through energy transition opportunities

Venezuela’s electricity sector has been facing a deep crisis. By 2020, the electricity production plummeted to 74.5 TWh, a drastic 43% reduction with respect to the peak of 132.5 TWh registered in 2013. The reasons behind the collapse of Venezuela’s electricity sector are multifactorial and widely described in the literature. However, there is a lack of discussion on how to overcome the electricity crisis, considering the new opportunities provided by the ongoing energy transition paradigm. In this paper, a review of existing views to recover Venezuela’s electricity system is provided. Two public-available detailed plans: the Venezuelan Electricity Sector Recovery Plan (VESRP) and the National Assembly’s Country Plan Electricity (CPE) are described and analyzed in detail. It is concluded that both proposals are pragmatic attempts to restore the reliable hydrothermal model that prevailed until 1998. However, there is a lack of insight about the economic and environmental opportunities of building a decarbonized electricity matrix in account of the existence of huge renewable energy resources. Fulfilling a balance between reconstructing Venezuela’s historic electricity system and building a new decarbonized system is of major significance. Urgent humanitarian needs and the demands of Venezuelan citizens call for the restoration of electricity supplies as fast as possible, but also with a modern system that ensures a low long-run marginal cost that enables competition and ensure economic growth.

Why the sustainable provision of low-carbon electricity needs hybrid markets

Deep decarbonization of energy systems poses considerable challenges to electricity markets and there is a growing consensus that an energy-only design based on short-term marginal cost pricing cannot deliver adequate levels of investment and long-term coordination across actors and sectors. Based on the instructive example of the evolution of European electricity market designs, we discuss several shortcomings of energy-only markets and illustrate how ad-hoc policies that intend to address them have limitations of their own, notably a lack of systemwide coordination. Second, we describe how the sheer scale and nature of deep decarbonization targets requiring massive investment in capital-intensive low-carbon technologies exacerbate these issues. Ambitious emission reduction targets thus require an evolution of market design towards hybrid regimes. Hybrid markets separate long-term investment decisions from short-term operations through a balanced and differentiated use of competitive and regulatory design elements to coordinate and de-risk investment. Finally, a historical analysis of the evolution of different electricity market designs shows how hybrid markets constitute contemporary forms of long-run marginal cost pricing that are appropriate for meeting deep decarbonization targets with reduced uncertainty and hence lower private and social costs.

Sustainable and Efficient Electricity Tariffs – A Case Study of Oman

Price distortion caused by taxes, duties, or subsidies distorts the consumption of various goods and services. When prices become misleading they produce wastage and provide little or no incentive for conservation. Electricity tariffs are subsidized in Gulf countries due to socioeconomic and political reasons but with ongoing petrol prices and the Covid-19 situation, Oman is slowly moving toward removing subsidies. According to the economic theory of efficient pricing, the prices of goods should be set equal to their marginal cost of production. The purpose of this paper is to provide a methodology to estimate long-run marginal cost (LRMC) at the generation level using a traditional generation expansion planning software. The approach is then applied to find LRMC for Oman’s Main Interconnected System (MIS). The LRMC at the level of generation busbar is then taken down to 132-kV, 33-kV, 11-kV, and 415-V. The LRMC calculation has shown that the power sector is highly subsidized.

How would real-time electricity pricing affect the Saudi power sector in the long-run?

This paper shows the effects of real-time electricity pricing (RTP) on the long-run marginal costs of power generation in Saudi Arabia. To do this, it links a multi-sector energy system model with a residential electricity use model. The energy system model contains an economic power dispatch optimization component. The residential framework embeds households, whose decisions are governed by microeconomic principles, in a physical building energy model. The analysis entails liberalizing fuel prices for the power utilities and setting the dynamic prices of electricity equal to the long-run marginal electricity supply costs. The electricity prices are solely offered to households. The key takeaways from this analysis are:•RTP, a form of dynamic electricity pricing, reduces the variability of the marginal costs for Saudi power utilities throughout the day.•Lowered capital spending by the Saudi power sector results from RTP and consequently lower power loads. Moreover, the curtailed investment in power plants would more than cover the costs of residential smart meter replacements.

Forward-looking distribution network charges considering lumpy investments

Many regulators are pushing for more cost-reflective distribution network charges to inform end users of the grid infrastructure costs their behavior causes. Since future investment costs can be avoided by reducing simultaneous peak loads, forward-looking, coincident peak charges are often proposed. Under the assumption of convex network costs, it has been shown that optimal charges signal long-run marginal network costs, triggering an optimal trade-off between network expansion and peak load reduction. In practice, however, network investments are lumpy, requiring engineering methods to estimate ill-defined marginal costs based on long-term peak demand forecasts. In this paper, we derive the optimal forward-looking network charge set by a social welfare maximizing regulator, endogenously considering investment lumpiness and uncertain consumer demand. While the optimal tariff still equals marginal network costs in essence, it now depends on a multitude of network- and demand-related parameters. Our results demonstrate that forward-looking network charges require accurate information on willingness to pay for peak demand, which currently is typically unknown to regulators.

Gas Price Policy Analysis for Fertilizer Industries in Indonesia Based on Netback from Final Product

The industrial sector has an important role in the Indonesian economy. The problem facing the fertilizer industry is the price of gas as a raw material that tends to be expensive for the lower prices of crude oil since 2016. To overcome this problem the government issued Presidential Regulation No. 40/2016 on setting gas prices for the fertilizer industry but this regulation only sets floor gas prices at USD 6/MMBTU to secure revenues of gas producers. Meanwhile, the current sale gas contract for fertilizer applies an escalation. The objectives of this study are to evaluate the netback value of each fertilizer plant and assess the current gas price policy. The netback value is calculated based on the long-run marginal cost of urea production. The result shows that PKT 04 and PKT 05, Pusri 1B, 2B, 3, and 4, PKC 1A and 1B, and PKG have lower netback value than gas price contract, except for PKT plant based on average has the highest netback value, because they use pricing mechanism that linked to oil and product price. From this calculation the current gas price policy needs to be adjusted to keep the fertilizer industry profitably.

Editorial — Water Tariffs and Affordability: The Economics and Policy of Protecting the Poor

We are writing the editorial note to this special issue on “Water Tariffs and Affordability: the Economics and Policy of Protecting the Poor” at a time (July2020) when access to water and sanitation services is more essential than ever. Handwashing is a critical measure to prevent the spread of COVID-19, but access to reliable water and sanitation services (and soap) is far from universal for households and health care facilities across the Global South. The genesis of the special issue on affordability predated the pandemic. A key strategy for adapting to changing water availability and rapid urbanization is a move towards full cost recovery tariffs for water and sanitation services. Volumetric prices that reflect the long-run marginal cost of supply help to incentivize customers to use scarce water resources wisely. Tariffs that recover the full costs of providing improved water and sanitation services also encourage managers to plan for future expansion by deploying capital resources wisely rather than relying on subsidies. Because these services are substantially underpriced in most places, this strategy implies that careful attention must be directed at programs to ensure that poor households can afford to pay their water bills. Achieving access to “safe and affordable” drinking water is target 6.1 of the United Nations’ Sustainable Development Goals to “ensure access to water and sanitation for all”. The SDGs include similar targets for goals in energy, transportation, housing, and education.

The economic value of a centralized approach to distributed resource investment and operation

Distributed energy resources have been almost exclusively deployed and operated under a decentralized decision-making process. In this paper, we assess the evolution of a power system with centrally planned utility-scale generation, transmission, distribution, and distributed resources. We adapt a capacity expansion model to represent both centralized and decentralized decision-making paradigms under various electricity rate structures. This paper shows that a centralized planning approach could save 7% to 37% of total system costs over a 15-year time horizon using a Western United States utility as a case study. We show that centralized decision-making deploys substantially more utility-scale solar and distributed storage compared to a decentralized decision-making paradigm. We demonstrate how a utility could largely overcome the complications of decentralized distributed resource decision-making by incentivizing regulators to develop electricity rates that more closely reflect time- and location-specific, long-run marginal costs. The results from this analysis yield insights that are useful for long-term utility planning and electric utility rate design.

Electricity tariff reforms, welfare impacts, and energy poverty implications

Like other energy-exporting countries, Brunei Darussalam has pursued an energy pricing policy that sets energy prices below market rates. The country introduced tariff reforms replacing the declining block tariff (DBT) scheme by an increasing block tariff (IBT) structure in 2012. The reform, however, was a rate structure change and not a subsidy removal, and electricity tariffs in the country remained lower than the long-run marginal cost. The study investigated a subsidy removal scenario, setting the tariff rate at the short-run marginal cost which is around 200% higher than the current average tariff rate. The results show that with IBT, welfare losses and the increase in electricity expenditures would be high for non-poor households; for those living in urban areas and for those engaged in white-collar jobs, and it would have been the reverse had the government not introduced tariff rate structure reforms. Under price elasticity scenarios, welfare losses would be high under inelastic than elastic demand case for both IBT and DBT cases. Electricity expenditures, however, would remain below 5% level – far lower than the energy poverty threshold level of 10% of household income. The tariff structure reform, therefore, shielded the lowest-income households from potential impacts of subsidy removal.

A primer on the pricing of electric energy options in Brazil via mean-reverting stochastic processes

Pricing option contracts on electricity remains methodologically challenging, with a lack of clearly defined and robust methods. In particular, little is known about pricing options in Brazilian energy markets, despite their economic significance. Using weekly price data (R$/MWh) on four electrical subsystems from the Chamber for Commercialization of Electrical Energy, we estimate models to price Brazilian electricity energy options. This paper has three objectives: (i) to identify the occurrence of change-points (regime-switching) in time series of Brazilian energy spot prices; (ii) to determine the best Stochastic Differential Equation (SDE) with which to model Brazilian energy spot prices and (iii) to price five types of options used to manage electricity price risk in Brazil. We show that the change-point occurred between 2002 and 2018. During this period, the long-run marginal cost of production was the most affected. Furthermore, we find that the Ornstein–Uhlenbeck/Vasicek stochastic process and resulting SDE best explains electricity prices in Brazil, even with the occurrence of structural changes. Finally, our results indicate that Asian-style options are the least costly option contracts to manage electricity price risk in Brazil.

A CBM development well type optimization method based on the long-run marginal cost

Reasonable optimization of development well type is the prerequisite to realize the economic and effective development of coalbed methane (CBM). However, the existing CBM development well type optimization methods are disadvantageous in many aspects. CBM is a kind of typical unconventional natural gas resource, and its study focuses on single-well evaluation. In this paper, the assessment method and the evaluation index (EI) for CBM development well type optimization based on the long-run marginal cost (LRMC) were constructed on the basis of CBM characteristics from the perspective of economic feasibility. Then, the corresponding decision making criteria were established. Finally, this newly developed method was applied to the well-type optimization of different development blocks in two important CBM development basins in China. And the following research and application results were obtained. First, under the current technical and economic conditions, both directional well and horizontal well are economically feasible to the development of Block A in the Qinshui Basin and Block B in eastern margin of the Ordos Basin, and the economically optimal well type is a horizontal well in Block A and a directional well in Block B. Second, compared with single-well steady daily gas production and single-well investment, the evaluation results on the schemes of different well types present critical value, above which the economic benefit of different schemes are equivalent. Third, EI of different well types is affected by many factors, e.g. geological characteristic of gas reservoirs, single-well production profile, CBM selling price, investment and cost. Therefore, it is necessary to carry out dynamic analysis and update in time based on the change of various influential factors so as to ensure the rationality of decision-making. In conclusion, this newly developed method is intrinsically consistent with traditional evaluation methods, and it is more advantageous with strong operability, intuitive evaluation results and quick and accurate optimization of CBM development well types.

Evaluating a novel tiered scarcity adjusted water budget and pricing structure using a holistic systems modelling approach

Population growth, coupled with declining water availability and changes in climatic conditions underline the need for sustainable and responsive water management instruments. Supply augmentation and demand management are the two main strategies used by water utilities. Water demand management has long been acknowledged as a least-cost strategy to maintain water security. This can be achieved in a variety of ways, including: i) educating consumers to limit their water use; ii) imposing restrictions/penalties; iii) using smart and/or efficient technologies; and iv) pricing mechanisms. Changing water consumption behaviours through pricing or restrictions is challenging as it introduces more social and political issues into the already complex water resources management process. This paper employs a participatory systems modelling approach for: (1) evaluating various forms of a proposed tiered scarcity adjusted water budget and pricing structure, and (2) comparing scenario outcomes against the traditional restriction policy regime. System dynamics modelling was applied since it can explicitly account for the feedbacks, interdependencies, and non-linear relations that inherently characterise the water tariff (price)-demand-revenue system. A combination of empirical water use data, billing data and customer feedback on future projected water bills facilitated the assessment of the suitability and likelihood of the adoption of scarcity-driven tariff options for a medium-sized city within Queensland, Australia. Results showed that the tiered scarcity adjusted water budget and pricing structure presented was preferable to restrictions since it could maintain water security more equitably with the lowest overall long-run marginal cost.

An estimate of the average cumulative royalty yield in the world mobile phone industry: Theory, measurement and results

An influential literature argues that dispersed patent ownership may lead to royalty stacking and excessive running royalties, thus increasing the long-run marginal cost of manufacturing phones and their prices. One set of estimates claims that the royalty stack is on the order of 20–40 percent of the value of the average phone. In order to assess this claim, we estimate the average cumulative royalty yield—the sum total of patent royalty payments earned by licensors, divided by the total value of mobile phones shipped— in the world mobile phone industry between 2007 and 2016.We “follow the money” and identify, with varying accuracy, 39 potential licensors in the smartphone value chain. We find that, of these, only 29 charged royalties in 2016, running from a low of $1.6 million to a high of $7.7 billion, summing to $14.2 billion in total, which compares with $425.1 billion in mobile phone sales. The average cumulative royalty yield in 2016 was 3.3 percent or $7.20 per phone. If we restrict this only to smartphones, the result would be $9.60 per phone, roughly 3.4 percent of the average selling price. A sensitivity analysis shows that even under a very restrictive set of assumptions, the average cumulative royalty yield on a smartphone would not exceed 5.6 percent.

A New Transmission Tariff Allocation Model Based on Bilevel Programming

This paper proposes a flow-based approach for the transmission tariff allocation problem based on the notions of long-run marginal cost (LRMC) and nodal exchange factors (NEFs). A worst-case power flow, expressed in terms of NEFs, is formulated to characterize the system state. Additionally, the NEFs optimal values are determined considering a specific criterion to compute tariffs. The resulting problem is formulated as a bilevel program. The upper level is a worst-case power flow that maximizes line flows taking into account the transmission tariffs computed in the lower level. The criterion considered in the lower level aims to minimize the variation range of transmission tariffs, which is particularly desirable to provide incentives for renewable sources installed far away from load centers. The resulting bilevel problem may have multiple solutions. Here, the uniqueness in tariffs is preserved by solving an alternative problem once both the generation dispatch and the variation range of transmission tariffs are known. Numerical results are provided for a 6-bus system and the IEEE 118-bus system.

Expansion Planning of Electricity Generating System Using the VALORAGUA and WASP-IV Models in Nepal

This paper presents a framework for a possible expansion plan of Nepal’s electricity generation system using VALORAGUA and Wien Automatic System Planning (WASP-IV) models as examples. Given that Nepal seeks to add several hydropower plants to the Integrated National Power System (INPS) in the next few years, this type of planning is crucial. To explore potential expansion plans, the 48 hydropower plants (20 of which are currently operating) within 18 hydro networks and two diesel plants are included, and different options such as the possibility of export, seasonal variations in hydrology, and projected growth rates in gross domestic product are considered. The results illustrate the long run marginal cost (LRMC) and loss of load probability (LoLP) through 2030 in Nepal. It is found that LRMC is 3.50 Nepali Rupees per kilowatt hour at 4.1% of average LoLP. While scrutinizing the results, it is found that LoLP is higher in early stage of projections due to generation capacity limitations from 2014 to 2016. However, by the end of 2017, the LRMC and LoLP begin to decrease significantly. On this premise, the model suggests to introduce large storage plants for hydropower generation and export of that excess energy. Furthermore, a proper implementation of proposed peaking and storage plants to meet rising demand can offset the need to obtain electricity through more expensive and less environmentally-friendly means such as thermal/diesel plants.HYDRO Nepal JournalJournal of Water, Energy and EnvironmentIssue: 19Page: 45-51

How should urban water be priced? – An empirical analysis for the city of Mekelle, Ethiopia

Urban water utilities have focused on setting water prices to cover average costs, usually using increasing block rate designs. In an attempt to contribute to the use of efficient, equitable, and revenue-sufficient pricing, this paper estimates the long-run marginal and average social costs of water supply in Mekelle city using a multi-product translog cost function that incorporates the shadow price of natural water. Findings show that the marginal social costs of providing one m3 of residential and non-residential water are Birr 5.33 and 7.71 (Birr = Ethiopian currency: 1 Euro ≈ 23 Birr), respectively, while the average current prices are Birr 4.46 and 6.10/m3. On the other hand, the average social costs of residential and non-residential water are estimated at Birr 14.34 and 16.36/m3, respectively, implying that marginal social cost-based prices would still lead to a revenue deficit of approximately Birr 9/m3.

The Pricing model for Transmission and Distribution Tariff Under Different Voltage Levels Based on the Long-run Marginal Cost Method

An incremental load model during peak load period in which both load rate and simultaneity of load is given. To mitigate the influence of irregular putting into operation of transmission and distribution equipment on fluctuation of marginal cost of transmission and distribution, an annuity calculation method of average incremental cost is proposed, and a calculation model based on long-term marginal cost, which can rationally share the expense of voltage classes, is built. According to incremental load during peak load period and the final average incremental cost to be borne by different voltage classes, the transmission and distribution prices for different voltage classes are calculated. Case study on longterm marginal cost of a certain regional power network is carried out, and calculation results show that the proposed transmission and distribution pricing method can reflect economic trend in the future and is favorable to eliminate crosssubsidies as well as make the electricity prices borne by various consumers in different voltage classes more fair and reasonable.

Computation of strict long-run marginal cost for different HV consumers

In this paper the strict long-run marginal cost (LRMC) for the ratemaking of High Voltage (HV) consumers is computed, along with the constituent parts of LRMC, namely the marginal capacity cost and the marginal operating cost. The computation is performed using the perturbation approach, employing a generation expansion planning model in order to compute the optimal generation capacity expansion program that could cover the future increased demand. The perturbation is performed using realistic data from five HV consumers in Greece, which are used as demand increments for the overall system demand. The attained LRMCs are compared and conclusions are drawn regarding the effect of the consumption profile on the LRMC. A sensitivity analysis is performed considering an increasing demand increment for each HV consumer, in order to evaluate the effect of the increment magnitude on the LRMCs. Moreover, the Marginal Capacity Cost and the Marginal Operating Cost are computed in all cases. All tests are performed using the Greek electricity market, and the planning period for the LRMC computation is 20 years.

Estimation of the marginal cost of road wear as a basis for charging freight vehicles

In Australia one option for improved freight vehicle productivity, as part of major road reform, is increasing the allowable freight vehicle axle loads above current load limits and reduce the transport cost per tonne-km. This can also potentially reduce greenhouse gas (GHG) emissions by reducing the number of freight vehicle movements for a given freight task. Decisions regarding increased axle loads on the existing road infrastructure can be founded on the marginal cost of road wear as the basis of a price for increasing axle loads. These prices can provide a clear signal for targeting maintenance and rehabilitation funding and works provided the revenue raised by the price is directly linked to the funding.The Freight Axle Limits Investigation Tool (FAMLIT) is a pavement life-cycle costing model that can be used to estimate load-wear-cost (LWC) relationships for a range of typical roads and pavement types for six heavy vehicle axle groups. Loads were incrementally increased above current load limits to estimate the LWC relationships. Life-cycle road wear costs were based on the present value (PV) of the routine and periodic maintenance and rehabilitation costs associated with managing each road type within agreed functional and structural conditions. The PVs of these costs were subsequently converted into equivalent annual uniform costs (EAUC) which were used to form LWC relationships with axle load (tonne-km) and standard axle repetitions (SAR-km), providing alternative independent variables. The marginal cost of road wear was determined by the first derivative of the LWC relationships.The estimated marginal road wear costs, in both short-run marginal cost (SRMC) form and long-run marginal cost (LRMC) form were found to vary across a range of road types and were highly dependent on the pavement/subgrade strength and traffic load. The marginal costs based on the LWC relationship using SAR-km as the independent variable were a constant value until axle group loads were increased significantly above current limits.

Comparative Analysis of Several Transmission Pricing Methods

This paper analyses several common transmission pricing methods of marginal cost and embedded cost deeply. It analyses pricing models of several transmission pricing methods, long-run marginal cost (LRMC) method, MW-Mile method, sensitivity method, flow tracing method, contract path method and stamp method. It also gives a comprehensive comparison of characteristics and limitations of these pricing methods, discusses their applicable conditions in aspects of fairness, economic, financial balance, transparency, operability and others, and makes a quantitative research of comparison based on a case, and verifies the results.