KATHOLIEKE UNIVERSITEIT LEUVEN ENERGY INSTITUTE Pricing and Liberalisation Pricing in a Liberalised Energy Market Guido Pepermans Economics Department

KATHOLIEKEUNIVERSITEIT

LEUVENENERGYINSTITUTE

Pricing and Liberalisation

Pricing in a Liberalised Energy Market

Guido Pepermans

Economics Department and Energy Institute K.U.Leuven



Structure of the Talk

The liberalisation process

The general principles of pricing

Stranded costs

Cross-subsidies

Transmission pricing



The Liberalisation Idea

Generation

Transmission

Distribution

Customer

One vertically integratedcompany

BEFORE LIBERALISATION AFTER LIBERALISATION

GenCo GenCo GenCo GenCo

TransmissionGrid Company

DistributionCompany

DistributionCompany

DistributionCompany

Regu

latedR

egulated



Before the Liberalisation - Belgium

Electrabel92%

SPE4%

Autoproducers4%

Generation

Transmission

Distribution

CPTE

Mixed Intermunicipalities

80%

Pure Intermunicipalities

20%

Customer

Direct Customers

33%

SMEIndustry

47%

Households20%

Regulator

CCEG



After the Liberalisation - Belgium

Electrabel SPE Autoproducers Generation

Transmission

Distribution

CPTE (ELIA)

Mixed Intermunicipalities

80%

Pure Intermunicipalities

20%

Customer

Direct Customers

33%

SMEIndustry

47%

Households20%

Regulators

CCEGfor the Captive

customers(SME,

Industry, Households)

CREGfor the Eligible

customers (Direct

customers)

Competitors



General Principles of Pricing - 1

Desirable criteria for a pricing rule Provide incentives for efficiency (p = MC) Allow suppliers to cover their costs (p > AC) Non-discriminating Transparent

PROBLEM: Natural monopoly match efficiency and cost recovery

Solutions Ramsey pricing Two-part tariffs Peak-load pricing




quantity

price

pR

O

C

Market Demand

O

Market Supply

quantity

price

O

B

Market Demand

O




Average cost

quantity

price

pR

O

C

Market Demand

O

Marginal cost

quantity

price

O

B

Market Demand

OMarginal revenue

pM

D

E

FGH



Stranded Costs - 1

Problem What to do with past investments?

Were ‘guaranteed’ to be recoverable through price increases In an open market, this ‘guarantee’ falls away

Problem mainly for private monopolists

Definition is important As recovery of stranded costs is foreseen in the

European Directive



Stranded Costs - 2

FIXED OR SUNK COSTS IMPOSEDBY THE REGULATOR?

Yes

Strandable

No

Not strandable

Full recovery Not stranded Not stranded

RECOVERABLEVIA THE MARKET Partial recovery

Non-recoverablepart is stranded

Not stranded

No stranded Not stranded

Table 1 : The definition of strandable and stranded costs.

Fixed or sunk costs that were imposed ( approved) by the regulator and that cannot be recovered via the market if the market is opened up for competition



Stranded Costs - 3

MCE

ACI

AVCI

pR

B

A

MCI

ACI

AVCI

OI OE=qD

MCI

E1

E2

E3

MCE

q*

pC



Stranded Costs - 4

Price covers the average costs

Average variable cost

Average fixed non-strandable cost

Average fixed strandable cost

Price of electricity

generation

= Average cost

= Average economic profit



Stranded Costs - 5

Price covers average variable costs and average fixed non-strandable costs



Average fixed strandable cost = Average cost

= Average economic profit (= loss)Price of

electricity generation



Stranded Costs - 6

Price covers average variable costs but not average fixed non-strandable costs



Average fixed strandable cost = Average cost

= Average economic profit (= loss)

Price of electricity

generation



Stranded Costs - 7

Conclusion From the point of view of efficiency

Stranded cost recovery is not necessary

If recovery is allowed It should be competitively neutral An upper limit on allowable recovery

Size of the strandable cost



Cross-subsidies - 1

General pricing principles Should reflect marginal costs Should allow to recover total costs

Misunderstandings Uniform pricing may imply cross-subsidies Price differentiation does not necessarily indicate

cross-subsidies



Cross-subsidies - 2

Definition of cross-subsidy-free prices For all customers

Price is below the average stand-alone cost The cost of self-providing the good or the service An upper bound on cross-subsidy free prices

Price not lower than the average incremental cost A lower bound on cross-subsidy-free prices

Why is there a problem? Wrong incentives

Distributive considerations



Cross-subsidies - 3

Assume a given revenue requirement : 190 Bln = (25.000+50.000) x 2 BEF + 40 Bln BEF

Variable costs

2 BEF/kWh

Variable costs

2 BEF/kWh

Liberalised market(25.000 GWh)

Regulated market(50.000 GWh)

Joint costs

40 Bln

A B C

A : Joint costs fully allocated to the regulated market pL=2 BEF pR=2,8 BEF

B : Joint costs evenly allocated to both markets pL=2,8 BEF pR=2,4 BEF

C : Joint costs fully allocated to liberalised market pL=3,6 BEF pR=2 BEF



Cross-subsidies - 4

Where can they occur?

Large Industrial Small Industrial Households

Market share : 35% (H.T.) Market share : 30%(H.T. and L.T.) Market share : 35% (L.T.)

Generation

Belgian generation companies :Electrabel ( 92% market share)SPE ( 8% market share)

Transmission

Grid operator : CPTE

Distribution

Pure and Mixed intermunicipalities Regulated at the Regional level. Cross-subsidies in distrisbution activities arenot considered in this study

Table 1 : the structure of the electricity market and the potential cross-subsidy flows.



Cross-subsidies - 5

Cross-subsidies in a partially liberalised belgian electricity market Intentional misallocation of joint costs in generation Transmission tariffs

Why do they occur? Historical reasons Unintentional misallocation of joint costs Stranded costs Predatory pricing Intentional misallocation of joint costs



Cross-subsidies - 6

How to reduce the potential for unwanted cross-subsidies

Price cap regulation or yardstick competition

Speed up the liberalisation process

Better control of cost allocation exercise



Transmission Pricing - 1

What makes transmission pricing of electricity difficult? Fixed transmission capacity Cost recovery Some physical laws apply to electricity transport

Law of least resistance

Belgium is part of a European network in which it cannot control flows

Dutch import from France via Belgium or via Germany?

Transmission costs and capacity limits will play an important role in the competitive process




Alternative pricing systems for transmission Cost coverage Incentives for optimal siting of generation and consumption Incentives for efficient operation, investment and cost

minimisation by the transmission company

Postage stamp Fixed fee per MWh

Simple cost recovery No incentives for correct siting of generation and consumption No incentives for cost minimisation of system operator




Distance related tariff Fee proportional to distance

Cost recovery easy No perfect incentive for siting generation and consumption No incentives for cost minimisation of system operator

Marginal cost pricing Cost recovery not guaranteed Good siting incentives if also future tariffs are announced Better incentives for cost minimisation




A proposal for Belgium (Energy Institute) Mixture postage stamp and marginal cost pricing

Postage stamp Individualised costs Non-individualised costs

Costs not directly linked to actions of generators and consumers

Congestion correction for some sites (discount or extra margin)

Incentive for overall cost efficiency based on yardstick competition




The fixed component Covers

Individualised costs Reactive power for outlyers, connection costs, metering and

billing

Non-individualised costs Allocation based on last year’s

Peak demand: grid maintenance,black start capacity, personnel and operating costs and return on investment

Energy use: reserve capacity, reactive power and voltage control and grid losses

Avoid cross-subsidies




FunctionNon-individualised cost component

allocated on the basis ofIndividualisedcost component Peak-Demand Energy use

Maintenance cost X

Reserve capacity X

‘Normal’ Reactive power and voltage control X

Connection costs for new customers X

Reactive power for outlyers X

Black start capacity X

Grid losses X

Metering and billing X

Labour and operational costs X

Return on assets X

Table 1: Summarising table.




Incentives for optimal grid use and siting A grid quality charge (GQC)

Based on typical and critical load flows of previous year Nodes are evaluated w.r.t. Congestion, loss, stability and

reliability problems Nodes causing extra problems get a surplus charge Nodes relieving problems get a negative charge

Overall the net revenue from the GQC for the system operator is zero

Avoid incentives to create congestion




Incentives for efficient grid operation and investment SO is rewarded or penalised for delivering good or bad

quality (measured by overall system reliability) Benchmarking

Compare with neighbouring countries

Investing improves quality of the service Avoid over-investment Make the SO the residual claimant for a share of grid investment

Documents

KATHOLIEKE UNIVERSITEIT LEUVEN ENERGY INSTITUTE Pricing and Liberalisation Pricing in a Liberalised Energy Market Guido Pepermans Economics Department