a. s. azzouni energy consultants, nera, saudi electricity company 1 major electricity customers...

A. S. Azzouni Energy Consultants, NERA, Saudi Electricity Company 1

Major Electricity Customers Pricing Options

Presented byAnees S. Azzouni, President

A.S. Azzouni Energy Consultants,Hethie Parmesano, Senior Vice President,National Economic Research Associates,

Saud A. Al-Rashed, Executive Director Commercial Business, TransmissionSaudi Electricity Company

Presented at

Seminar on Electricity Tariffs

Riyadh, Saudi Arabia

January 15 – 16, 2008

A. S. Azzouni Energy Consultants, NERA, Saudi Electricity Company2

Contents of this presentation

Introduction

Electricity sector restructuring and market reform

Major customer electricity procurement economics

Objectives and concerns of key stakeholders

Key pricing issues

Alternative cost bases for pricing

Recommended alternatives

Conclusions


Electricity pricing policies toward major customers need to:

be compatible with the electricity sector’s changing structure

and the business environment of major customers;

lead to economically-efficient behavior; and

be compatible with stakeholders objectives.


Major customer pricing can impact

development of wholesale electricity market

development of cogeneration and distributed generation

effectiveness of load management and energy efficiency

programs

pace of required capacity additions

electricity prices to smaller customers


We will in this presentation provide

brief description of the electricity sector restructuring efforts in Saudi Arabia.

concerns of major Saudi Arabian electricity sector stakeholders

with regard to rates.

major alternative cost bases for pricing of power supplies,

standby power, buy-back, and other supplemental services.

recommended pricing alternatives that are compatible with

electricity sector restructuring.



Introduction




Key pricing issues



Conclusions


Enabling legislation was passed in the last ten years

Key developments include: removal of barriers to private investment entry into generation passage of the electricity law, the grid code, and implementing

regulations the future creation of an independent transmission company the future introduction of open and non-discriminatory access by

major electricity customers to the grid the future implementation of a wheeling tariff the invitation to qualified major electricity customers to establish

their electricity rates outside the regulated industrial rate through direct negotiations with SEC


Proposed electricity industry restructuring plan

Stage one: 2008 the establishment of a single buyer model to accompany

the unbundling of SEC the creation of an independent transmission company the introduction of open access to the grid by major

customers the implementation of a wheeling tariff set by ECRA

Stage two: 2008 – 2015 the creation of parallel wholesale markets where major

customers can have direct supply agreements with SEC and/ or IWPPs and IPPs

Stage three: 2015 full market competition


Questions yet to be answered by present sector reform efforts

the development of competitive wholesale electricity market and the setting of goals for wholesale market institutions

creation of independent transmission system operator(s), creation of large regional transmission networks with

common transmission access and pricing rules, and creation of a set of basic wholesale market institutions

which include: Standard Market Design (SMD) rules, locational marginal pricing and congestion management,

regional transmission planning, market power mitigation mechanisms.

the creation of a legal framework for access to the network. clarification of ECRA’s regulatory oversight over negotiations

between major customers and SEC.



Introduction




Key pricing issues



Conclusions


Major Customer On-Site Generation Economics

Major industrial facilities requiring both heat and power can build cogeneration facilities with thermal efficiency of 90% at cost for electricity competitive with local utilities.

The optimization and sizing of a cogeneration scheme can result in more electricity produced than can be utilized within the plant.

On-Site generation economics are governed by

availability and cost of fuel

market price for electricity

cost and availability of stand-by power

wheeling and

market and price of excess power


Energy profile of industrial facilities

Basically, all industrial facilities reflect in their design:

low price for natural gas, electricity, and water

heavy reliance on SEC for power supply,

low level of plant heat integration,

use of simple cycle technology for on-site generation,

high energy intensive technologies.


Energy profile of industrial facilities

Major customers exhibit varying sensitivity to electricity cost.

basic metals in excess of 30% of variable costs

construction materials and cement in second place

chemical industries, plastic products, and oil and gas 7% or below of

variable costs.

Major electricity customers have the capability for load shifting, the potential to

improve load management, and interfuel substitution.

Major customers hold a large reserve of DSM resources whose cost is

competitive with the cost of new generating capacity.

Captive power generation is a feasible option for petrochemical, gas, and oil refining facilities and is a feasible capacity resource to the utilities as well.



Introduction




Key pricing issues



Conclusions


Objectives and Concerns of Key Stakeholders

The five primary stakeholders of wholesale electricity are:

major customers

the Ministry of Water and Electricity

ECRA

SEC

IPPs and IWPPs


Major customers share the following primary concerns:

adequacy of power supply to meet future power requirements,

the effect of potentially rising and volatile electricity prices on

competitiveness with industry peers, and

cost-effectiveness of captive power generation investment

decisions as a result of uncertainty over

wheeling charges,

price for sale of excess power, and

standby power rates.


Key major customers’ policy concerns include:

Energy and industrialization policies impact on energy intensity, fuel availability and pricing, and technology choice.

Policies which impact the position of incumbent electric utilities’: market power, concentration, and market share.

Rules governing the treatment of cross subsidies.

Provisions for ancillary services: buy-back, stand-by, wheeling, frequency imbalance, and voltage support and control.

Policies, standards, and licensing with regard to: on-site generation, distributed generation, interconnection standards, and dispatch rules of qualified independent generators.

Rules on who is entitled to have access to the network.


Key Ministry of Water and Electricity and ECRA Concerns

The impact of policy legislation and long range electricity planning on cogeneration legislative options, power system optimization, energy efficiency and subsequently pricing.

The impact regulating the electricity market and restructuring of the electricity sector have on major customers’ decisions regarding energy use, energy procurement, and the efficiency and competitiveness of the market.


SEC Concerns

The retention of major customers is a key objective of SEC. Major customers represent a significant portion of SEC revenues with prices that fully cover the cost of service.

A critical challenge faced by SEC over the period 2008 – 2015 concerns balancing major customer pricing and wholesale electricity pricing and the balance of SEC sales governed by regulated rates.

On-site generation makes it more difficult for SEC to forecast load and plan the system, and increases uncertainty of revenue recovery.

Non-utility generation will increase uncertainty for the system operators as SEC becomes the residual demand supplier and provider of stand-by power.


IPP/IWPPs Concerns

Under the restructuring plan, IPPs and IWPPs will eventually be

allowed to sell power directly to major customers

They will be competing directly with SEC for major customers

and thus have concerns with SEC’s industrial tariffs.

IPPs and IWPPs are concerned about SEC pricing policies that

affect the feasibility of captive power generation—their potential

competitors.

IPPs and IWPPs have interest in the level and structure of

wheeling charges they or their customers will pay to use the

transmission grid.



Introduction




Key pricing issues



Conclusions


Design of appropriate prices for major customers raises key interrelated issues

economic efficiency

transition to competitive electricity market

cross-subsidies

system reliability

risk allocation


Economic Efficiency means

Efficient investment by consumers, utilities, other market

participants

Efficient use of existing infrastructure

Avoidance of uneconomic bypass

Use of marginal cost as the basis for electricity pricing promotes

economic efficiency and enhances welfare.


Transition to Competition is enhanced by major customer pricing that:

mimics the structure of likely competitive offerings and avoids

long-term agreements that preclude full participation in the

market;

promotes new entry by basing prices on economic (marginal)

costs;

encourages effective demand response through use of

innovative rate structures;

provides transparent price signals, with key elements unbundled

to permit comparison with alternatives;


Cross-subsidies

distort customers’ decision about consumption and investment

decisions;

are difficult to sustain if customers have supply choices (via self-

generation or purchase from a competitive supplier);

can be defined as the difference between amount charged and

marginal cost (adjusted efficiently to match the regulated

revenue requirement).


Preservation or enhancement of system reliability

Tariffs for all users should reflect marginal costs so that only

capacity that customers are willing to pay for is built.

Prices paid for power produced by major customers’ generators

should provide incentives to supply that power when it is most

useful to the system.

Prices charged for standby power required by non-utility

generators should provide incentives for them to manage their

outages in a way that minimizes the effect on system reliability.


Risk Allocation implicit in pricing to major customers should:

allocate cost, price and operational risks to the parties best able

to bear them;

consider pros and cons of short- and long-term agreements in

terms of risk allocation;

consider the effect of higher risk on cost of capital.



Introduction




Key pricing issues



Conclusions


Alternative Cost Bases for Major Customer Pricing Policies

Allocated embedded (historical accounting) cost Backward looking Sensitive to the classification and allocation methods used Does not provide detailed information needed for time-of-day pricing

Long-Run marginal cost Assumes hypothetically optimal system Does not reflect actual conditions of the system

Incremental cost Change in cost given a specific assumed change in expansion plan or load Does not provide detailed information needed for time-of-day and other

innovative rate structures Short-run marginal cost

Includes both utility variable costs and costs of changes in reliability (shortage costs to consumers)

Can be computed over several years to show trend Mimics market prices Provides all the details needed for efficient pricing


Two Other Cost Alternatives

Net Metering (for pricing excess energy generated by a customer) Customers’ meter is allowed to run backward when generation

exceeds generating customer’s own load. Rather than based on cost, the “price” paid for excess energy is the

full retail rate. Depending on retail rate design, this can be an efficient or inefficient

approach. Pricing customer-generated power based on the customer’s generation

costs Reduces risk for the customer-generator Provides little or no incentive to operate efficiently from total system

point of view (e.g. rates are not time-differentiated). This can also be used for standby rates (i.e., price at the customer’s

cost of providing its own standby power)



Introduction




Key pricing issues



Conclusions


Key prices or tariffs applicable to major customers must cover/include

standard tariffs for purchases by major customers without generation; interruptible tariffs under which customers without generation curtail

load in system emergencies; tariffs for the utility’s purchase of a generating customer’s energy

production made available by curtailment of a customer’s load or additional energy production in critical periods;

tariffs for supplemental purchases by major customers whose generators do not serve their entire load on regular basis;

tariffs for backup energy and capacity, for use when a customer’s generation is down for planned or unplanned maintenance;

tariffs for sale of excess production of a customer’s generation to utilities;

tariffs for wheeling of excess production of a customer’s generation to the customer’s other sites or to third parties


Tentative Recommendation: Standard Tariffs for Major Customers

Two primary goals: efficiency and transition to competitive market Short-run marginal cost is the cost basis most likely to achieve the

primary goals Major customer tariffs should

be differentiated by time of day and season to reflect time patterns of electricity production and as a prelude to market prices;

include a fixed charge based on contract capacity to cover the cost of facilities that must be sized based on the customer’s maximum demand;

include time-differentiated demand charges, unless there are sufficient pricing periods that capacity costs can be efficiently recovered in per-kWh charges.

include optional real-time pricing programs.


Tentative Recommendation: Interruptible Tariffs for Major Customers without generation

Major customer interruptible tariffs should

reward participating customers for their willingness to accept

non-firm service in exchange for lower prices

provide a discount from firm tariffs that reflects the marginal

value to the system of the expected load reductions

structure discounts in the form of reduced charges, credits

when curtailments take place, or some combination of the

two.


Tentative Recommendation: Interruptible Tariffs for Major Customers with generation

Major customers with generation may be willing to curtail load or

increase generation in response to a request from the utility.

Such arrangements may require individual analysis for proper

pricing.

An appropriate cost basis for the payments/credits for

interruptibility should reflect the value of the interruptions to the

system if economic efficiency is given a high priority.


Tentative Recommendation: Tariffs for supplemental power required by customers with generation

Unless supplemental service has load characteristics very

different from loads of similarly sized customers without

generation, the standard practice is to charge standard tariffs for

supplemental service.

Thus, tariffs for supplemental service should be time-

differentiated by time of day and season and based on short-run

marginal costs.

This approach provides incentives for economically efficient

design of the generator, and serves as a transition to retail

competition.


Tentative Recommendation: Tariffs for standby power required by customers with generation

For economic efficiency, tariffs for standby service must cover

the utility’s short-run marginal cost of standing by to provide

intermittent power when the customer’s generator is forced out

of service or is taken down for planned maintenance.

Charging less creates a cross-subsidy.

The amount of reserve capacity (distribution, transmission and

generation) required to provide this intermittent service without

reducing service quality to other customers is very situation

specific.

Tariff structure should include reservation charges and time-

differentiated charges for power consumed.


A marginal cost basis for wheeling tariffs promotes economic efficiency.

However, cost shifting to other customers or stranded costs may occur if tariffs formerly paid by the third party did not reflect marginal cost.

The costs (or avoided costs) associated with wheeling may be complicated if the utility must provide standby service to non-utility generator.

These arrangements generally require individual analysis to identify costs, protect other customers, and result in economically efficient outcomes.

Tentative Recommendation: WheelingTariffs



Introduction




Key pricing issues



Conclusions


This paper focused on choice of appropriate cost basis for major customer pricing.

Our tentative recommendations point to short-run marginal cost as the appropriate basis for most tariffs involving major customers.

The short-run marginal costs should mimic the market prices that will emerge as wholesale and eventually retail competition is introduced.

They should be differentiated by time of day and season and be forecast out for the period the tariffs or contract arrangements are likely to be in effect.

Adjustment mechanisms or index provisions can be used to keep the tariff levels tracking current costs within the term of a tariff or contract.


Review of electricity pricing options has led to the following insights regarding Saudi Arabia’s electricity sector restructuring.

The significant volume of transmission sector wholesale business allows the establishment of an electricity market at the transmission level without creating multiple distribution companies or competitive suppliers for lower voltage customers.

Restructuring should encourage customers to invest in on-site generation or negotiate contracts with IPPs.

Restructuring should encourage major customers to take actions that reduce SEC’s cost of maintaining operating reserves, and improve system reliability by raising the installed capacity reserve margin.

Restructuring should encourage the development of market competition as a tool for achieving the least-cost mix of new generating resources with SEC’s tariffs for wheeling and standby fixed and in reflection of economic costs.

a. s. azzouni energy consultants, nera, saudi electricity company 1 major electricity customers...

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