Electricity Cost Modeling Calculations

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Electricity Cost Modeling Calculation: Regulations, Technology, and the Role of Renewable Energy, Second Edition delivers an updated view on pricing models, regulation, technology and the role renewable energy is starting to take in electricity. Starting with fundamental concepts on market structure and the increase in international regulations, the book includes cubic cost modeling cases and updated literature reviews for deeper research. Other sections cover more advanced quantitative methods such as load forecasting, updated rate designs, and the marginal cost of electricity in the United States. Includes applications will help reduce greenhouse gas emissions, thus making the reference relevant for today’s power markets.

This book gives today’s engineers a practical guide on the latest techniques in electricity pricing and applications for today’s markets.

Provides readers with updated, international regulations and the role of renewable energy sources
Bridges the gap between foundational concepts and advanced quantitative aspects, including updated practical case studies
Helps readers understand the appropriate rate/tariff structure for efficient use of electricity and renewable options

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Front Cover 2
Electricity Cost Modeling Calculations: Regulations, Technology, and the Role of Renewable Energy 5
Copyright 6
Contents 7
Preface 13
- Some Basic Economic Theory 15
- A New Regulatory Paradigm 16
Chapter 1: Introduction 19
- 1.1. Introduction 19
- 1.2. ``Going Green´´ 21
- 1.3. And Talking About ``Going Green´´ 24
- 1.4. And Speaking of Economics 25
- 1.5. The Marginal-Cost Pricing Doctrine 26
  - B. The Theory (2) 26

Front Cover 2
Electricity Cost Modeling Calculations: Regulations, Technology, and the Role of Renewable Energy 5
Copyright 6
Contents 7
Preface 13
- Some Basic Economic Theory 15
- A New Regulatory Paradigm 16
Chapter 1: Introduction 19
- 1.1. Introduction 19
- 1.2. ``Going Green´´ 21
- 1.3. And Talking About ``Going Green´´ 24
- 1.4. And Speaking of Economics 25
- 1.5. The Marginal-Cost Pricing Doctrine 26
  - B. The Theory (2) 26
- 1.6. A Brief Overview of the United States Electric Market 27
  - The Structure of the United States Electricity Industry 27
    - The Players and Their Incentives 27
  - Objective Functions: The Players 28
    - Investor-Owned Utilities: Profit Maximization 28
    - Publicly Owned Firms 29
    - Cooperatively Owned Firms 30
    - Regulation of Investor-Owned Electric Utilities in the United States 31
    - Other 31
    - The United States Electric Power Industry-Regulation 31
  - ASIDE: Issues With Rate-of-Return Regulation-The Averch-Johnson Effect 32
- 1.7. Internalizing the Cost of Reducing Carbon Emissions-The Marginal Social Cost 35
  - Policy Measures 35
  - Update From First Edition 37
- 1.8. Optimal Rate/Tariff Design and Tax Credits to Promote Efficient Use of Energy and a Reduction in Carbon Emissions 38
  - Tariff Design and Rate-Making Issues 40
  - Marginal-Cost Pricing for Electric Utilities 40
- 1.9. Conclusion 40
- References 42
Chapter 2: The Sustainability of a (Natural) Monopoly 43
- 2.1. Defining Natural Monopoly 44
  - For a Single-Output Market 45
  - Average Cost 46
- 2.2. Economies of Scale 47
- 2.3. Examples 48
  - Efficient Industry Structure 50
  - Degree of Scale Economies 51
- 2.4. Economies of Scale Applied to the Electric Utility Industry 51
- 2.5. Literature Review-Economies of Scale in Generation 52
- 2.6. Economies of Scale and Density in Transmission and Distribution 54
- 2.7. Network Economies 55
- 2.8. For a Multiple-Output Natural Monopoly 57
- 2.9. Multiproduct Natural Monopoly 57
- 2.10. Ray Average Costs 58
- 2.12. Product-Specific Economies of Scale 59
- 2.11. Degree of Scale Economies 59
  - Cost Concepts Applicable to Multiproduct Cases for Nonproportionate Changes in Output 59
- 2.13. Economies of Scope 61
- 2.14. Subadditivity of the Cost Function 62
- 2.15. Trans-ray Convexity 63
- 2.16. Literature Review: Electricity as a Multiple-Output Industry and Related Concepts 65
- 2.17. Economies of Vertical Integration and Separability 67
- 2.18. Vertical Integration of Electric Utilities 68
- 2.19. Defining Vertical Integration 69
  - Separability 69
- 2.20. Relevant Literature Review-Vertical Integration and Separability 70
- 2.21. Bringing It All Together: Vertical and Horizontal Scope Economies in the Regulated U.S. Electric Power Industry (Jo ... 71
- 2.22. Summary 73
- 2.23. The Sustainability of a (Natural) Monopoly 73
- 2.24. Arguments for Competition in the Electric Utility Industry-A Brief History and Literature Review 74
  - Arguments for a Single Supplier of Electricity: Regulators 76
- 2.25. The Theory of Sustainability 79
- 2.26. Sustainability of Natural Monopoly-The Theory 80
  - Single-Product Natural Monopoly 80
  - Multiproduct Market Sustainability 83
- 2.27. ASIDE: Game Theory-A (Very) Brief Overview 84
- 2.28. On the Behavior of Costs for Sustainability of a Monopoly 84
  - On the Issue of Sustainable Prices 87
- 2.29. The Theory of Contestable Markets: The Case of Electricity Markets 88
- 2.30. Real-World Examples of the Theory of Contestable Markets (TCMs): From Markets With High Entry Barriers to Competition 90
  - A Brief History and Literature Review of Contestable Markets: The Airline Industry 91
  - Case in Point: Southwest Airlines 92
  - History of the Telecommunications Industry 94
  - The Telecommunications Industry 94
  - The Electric Industry 98
  - The Energy Policy Act of 1992 99
  - FERC Orders 888 and 889 (1996) 101
  - Mergers and Acquisitions 102
- 2.31. Conclusion 104
- References 105
Chapter 3: State Regulations, Policies, and Updates on States With Retail Choice 109
- 3.1. A History of Regulation in the U.S. Electric Utility Industry 109
  - The Rise of Regulation 109
  - The Public Utility Holding Company Act (1935) 111
  - ASIDE 113
  - The Era After PUHCA 113
  - Focus on Reliability: The North America Reliability Council 114
  - NERC Reliability Assessment Areas Names 115
  - The 1970s-A Time of Change 117
    - The Federal Energy Regulatory Commission (FERC) 118
    - The Public Utility Regulatory Policies Act (PURPA) of 1978 119
    - The National Energy Conservation Policy Act of 1978 119
  - Industry Restructuring in the 1980s and 1990s 123
    - Natural Gas Utilization Act of 1987 125
  - The 1990s-The Pace of Industry Restructuring Accelerates 125
    - The Energy Policy Act of 1992 (EPACT) 126
    - FERC Orders 888 and 889 (1996) 129
    - FERC Order 2000 and Grid Regionalization 133
    - The Energy Policy Act of 2005 138
    - The Energy Independence and Security Act of 2007 139
    - FERC Order 719 140
    - FERC Order 890 141
    - The American Recovery and Reinvestment Act of 2009 141
    - The Consolidated Appropriations Act of 2008 141
    - The American Energy and Security Act of 2009 142
    - The American Clean Energy Leadership Act of 2009 143
  - FERC Order 1000 146
- 3.2. Conclusion 147
- 3.3. Regulation at the State and Local Levels 147
- 3.4. Retail Choice Participation 150
  - Some Details 152
  - Some History About Illinois 153
  - A Little More History on Texas 158
- 3.5. Electricity Deregulation 158
- 3.6. Summary: Deregulation of the Electricity Industry-A Failed Experiment 165
- 3.7. Rate Making and Incentivizing Electricity Suppliers to Invest in Demand-Side Management and Energy Efficiency Programs 166
  - Demand Reduction: Key to Lowering Costs and Emissions 166
  - Traditional Rate Making in the United States 167
- 3.8. The Current Environment 171
- 3.9. Energy Efficiency Resource Standards 172
- 3.10. A Brief History of Energy Efficiency Resource Standards 173
  - EERS Achievements Over Time 174
  - Other Benefits 175
- 3.11. The Future of the Electric Industry 176
- 3.12. Summary 180
- Appendix 180
  - Case Study: The California Debacle (or, What Not to Do) 180
  - Introduction 180
  - The Electricity Crisis: Summer 2000 181
    - Factors Precipitating the Crisis 181
  - Chronology of the California Electricity Crisis: Lessons Learned (or, What Not to Do) 182
  - Mistakes 185
    - Mistake #3 185
    - Mistake #1 185
    - Mistake #4 185
      - The Ability to Game the System 185
    - Mistake #2 185
    - Conclusion 189
  - References 189
- Chapter 4: The Economics (and Econometrics) of Cost Modeling 193
  - 4.1. The General Cost Model 193
    - Cobb-Douglas Cost Function 194
    - Translogarithmic Cost Function 195
  - 4.2. The Econometrics of Cost Modeling: An Overview 196
    - Ordinary Least Squares Estimation 196
    - Regression Analysis and Cost Modeling 197
    - Examples: Examining Data-An Illustration of Salient Points 197
    - Estimation Results: Basic Cost Model 200
      - ASIDE: The Consequences of Heteroscedasticity 201
      - Impure Heteroscedasticity 202
      - Estimation Results-Quadratic Cost Model 204
    - 4.3. A Brief History of Cost Models and Applications to the Electric Industry 204
      - The Cobb-Douglas Functional Form 204
        
        Returns to Scale 205
        
        Nerlove's Cobb-Douglas Function 205
        
        Economies of Scale 207
        
        Minimum Efficient Scale 207
        
        A Priori Expectations 208
        
        Nerlove's Results 208
        
        Elasticities 210
      - The Constant Elasticity of Substitution Functional Form 211
      - The Generalized Leontief Cost Function 212
        
        ASIDE: Leontief Production Technology 212
        
        The Leontief Cost Function 213
      - Hicks-Allen Partial Elasticities of Substitution 214
      - The Translogarithmic Cost Function 215
        
        Digression: Use of Zellner's Method (Seemingly Unrelated Regressions Method) 217
      - Quadratic Cost Models 218
        
        Digression: Why the Quadratic Is the ``Best´´ Suited for Modeling Industry Structure 219
        
        Multiple-Output Quadratic Cost Function 219
        
        The Degree of Scale Economies 219
        
        Ray Average Cost 220
        
        Product-Specific Returns to Scale 221
        
        Economies of Scope 221
        
        Cubic Cost Models 223
      - 4.4. Appendix 224
        
        Proof That Eq. (4.86) Allows for Concavity in Input Prices: Nonpositive Own-Price Effects 224
      - 4.5. Exercises 225
      - References 227
    - Chapter 5: Case Study: Breaking Up Bells 229
      - 5.1. Introduction 229
      - 5.2. The Natural Monopoly Conundrum 229
        
        Defining Natural Monopoly 230
        
        Economies of Scope and Subadditivity 231
        
        Subadditivity of the Cost Function 231
        
        Economies of Scope 231
        
        5.3. Breaking Up Bell: The Case of AT&T 232
        
        The Evans and Heckman Methodology 234
        
        Discussion of Results 234
        
        Discussion of Results 236
        
        ASIDE: Quadratic Cost Model 237
        
        Discussion of Table 5.3. Bell Data Estimated via Greer's Quadratic Cost Model 237
        
        Literature Review: Other Studies on the Subadditivity of the Bell System 238
        
        5.4. Economies of Vertical Integration: An Argument for Natural Monopoly? 242
        
        Discussion: Economies of Vertical Integration-An Argument for Natural Monopoly? 242
        
        Economies of Vertical Integration 242
        
        5.5. Parallels Between Telephony and Electricity 243
        
        Vertical Integration-The Case of Telephony 243
        
        The 1982 Consent Decree 244
        
        Technological Change 246
        
        The 1996 Telecommunications Deregulation Act (or, the Reintegration of the Industry?) 247
        
        ASIDE: First-Mover Disadvantage 248
        
        Select Provisions From the Telecommunications Deregulation Act 248
        
        Discussion: Economies of Scope vs. Economies of Vertical Integration 243
        
        The Market for Electricity 249
        
        Economies of Scope (Horizontal Production) Applied to Electricity 250
        
        Vertical Stage 1: Generation 250
        
        Other Parallels Between Telephony and Electricity, and Reasons That Both Were Thought to be Subject to Gains from Deregulation 252
        
        Technological Change as a Parallel 252
        
        Parallels Between Individual Components 253
        
        Ownership Parallels-Non-Investor-Owned Entities, or Rural vs. Urban Service Territories 254
        
        5.6. Lessons to be Learned 254
        
        Lesson 1: A Caution to Regulators re: Encouraging Entry 254
        
        A Lesson for Electricity Deregulation 255
        
        Lesson 2: Incentives Matter 256
        
        Other Lessons From the 1982 Consent Decree 256
        
        A Lesson for Electric Utility Deregulation 257
        
        Lessons on the Physical Structure (Bottleneck) 257
        
        5.7. Conclusion 258
        
        References 259
        
        Chapter 6: Cost Modeling: Single- and Multiple-Output Specifications 261
        
        6.1. The Determination of an Appropriate Objective Function: A Brief Overview of the Literature 261
        
        Rural Electric Cooperatives 263
        
        Data 264
        
        Review of the Literature: Cost Function Estimation in the Electric Utility Industry 265
        
        Economies of Scale 265
        
        Nerlove's Cobb-Douglas Cost Model 266
        
        Further Considerations 268
        
        End-of-Section Exercises: Basic vs. Nerlove Cost Model 268
        
        6.2. Flexible Functional Forms 269
        
        Translogarithmic Cost Function 270
        
        Cost-Share Equations 270
        
        A Priori Expectations 272
        
        Discussion of Estimation Results: Single-Output Translog Cost Equation 273
        
        Price Elasticities 274
        
        Substitution Elasticities Among Input Variables: The Hicks-Allen Partial Elasticities of Substitution 274
        
        Homotheticity 275
        
        End-of-Section Exercises: Translogarithmic Cost Function 276
        
        ASIDE: Translogarithmic Cost Model Details: Calculating Average and Marginal Cost 278
        
        Proof 278
        
        6.3. Multiproduct-Cost Models 279
        
        Distributed Electricity as a Multiproduct Industry 279
        
        Multiproduct Translogarithmic Cost Model 281
        
        Multiproduct-Cost Models 281
        
        Multiproduct-Cost Concepts (Revisited) 284
        
        Product-Specific Economies of Scale 284
        
        Ray Average Costs 284
        
        Economies of Scope 285
        
        Quadratic Cost Functions 286
        
        A Properly Specified Quadratic Cost Function 287
        
        ASIDE: Nonlinear Least Squares Estimation 288
        
        Reasons That the Quadratic Form Is the ``Best´´ Suited for Modeling Industry Structure 289
        
        End-of-Section Exercises 292
        
        6.4. Measures of Efficiency for Multiple-Output Models 293
        
        Ray Cost Output Elasticity 293
        
        Product-Specific Economies of Scale 294
        
        Economies of Scope 295
        
        Cost Complementarity 296
        
        6.6. End-of-Section Exercises: Multiple-Output Cost Models 297
        
        6.5. Conclusion 297
        
        Appendix: Proofs 298
        
        The quadratic cost equation of the following form is not linearly homogeneous in input prices. 298
        
        Proof 298
        
        Proofs 299
        
        Labor 300
        
        Purchased Power 300
        
        Capital 300
        
        Aside 301
        
        Proof 301
        
        References 302
        
        Chapter 7: Case Study: Can Rural Electric Cooperatives Survive in a Restructured U.S. Electric Market? An Empirical Analysis 305
        
        7.1. Introduction 305
        
        Reasons That Cooperatively Owned Utilities Are Different 305
        
        Urban vs. Rural Differences 306
        
        Institutional Differences 307
        
        Regulatory Differences 308
        
        Philosophical Differences 308
        
        7.2. Literature Review 309
        
        7.3. Cost Models 310
        
        Flexible Cost Models 310
        
        Translogarithmic Cost Models 310
        
        Quadratic Cost Models 311
        
        Modified Quadratic Cost Function 312
        
        Data and Variables 312
        
        A Properly Specified Multiple-Output Quadratic Cost Equation 313
        
        Estimation Results 313
        
        Cost Concepts Applicable to Multiproduct Cases 314
        
        Ray Average Costs 314
        
        Degree of Scale Economies 314
        
        Interpretation of Results-Economies of Scale 315
        
        Product-Specific Economies of Scale 315
        
        Economies of Scope 318
        
        Interpretation of Results-Economies of Scope 319
        
        Sources of Cost Savings 320
        
        General Implications of Estimation Results 320
        
        7.4. Implications for Public Policy 321
        
        7.5. Conclusion 322
        
        References 324
        
        Chapter 8: Case Study: A Test of Vertical Economies for Nonvertically Integrated Firms: The Case of Rural Electric Cooper ... 327
        
        8.1. Introduction 327
        
        8.2. Background: Rural Electric Cooperatives 327

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Regulations, Technology, and the Role of Renewable Energy

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