Energy Pricing

(Energy Planning and Management)

Rabin Shrestha
Visiting Faculty
Pulchowk Campus, 2010

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Price Depends on Market Structure

• Perfectly Competitive Market

• Oligopoly
• Monopoly
• Monopsony
• Bi-lateral Monopoly
• Regulated Monopoly

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 Objectives of Energy Pricing
• National resource must be allocated efficiently i.e.,
price reflects true economic costs (marginal cost)
• Fairness and equity
– according to the burden they impose on system
– avoiding large fluctuations from year to year
– basic need
• Raise sufficient revenue for utility, if supplied by utility
• Pricing structure should be simple
• Other economic and political requirement should be
considered

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MC Pricing Rational

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 Marginal Cost
• Change in total cost for a change in
output.
• It is defined broadly as the
incremental cost of all adjustments in
the system capacity expansion and
operations attributable to an
incremental increase in demand that
is sustained into the future.
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 Short-run Marginal Cost

SRMC refers to marginal cost

estimated under the assumption that
any increase in output would be met
solely through increase in the rate of
utilization of the existing plant and
equipments

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 Long-run Marginal Cost

LRMC refers to marginal cost estimated

under the assumption that the increase
in the rate of output would be met by an
appropriate increase and adaptation of
plant capacity

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 Long and Short Run

Time Cost Technology

Very short run All costs are fixed Fixed
Short run Some costs are fixed Fixed
Long run No costs are fixed Fixed
Very long run No costs are fixed Not fixed

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Relationship between LRMC and SRMC

• LRMC = SRMC (system in equilibrium)

• LRMC > SRMC (system is over-equipped)
• LRMC < SRMC (system is under-equipped)

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 MC Categories
• capacity costs: (Generation, transmission, and
distribution) capacity costs

• energy costs: fuel + O&M cost in thermal generation

O&M + storage investment cost in
hydro generation

• consumer costs: hook-up, metering & billing.

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Structure of MC for Electricity

• Time of Day
• Voltage level
• Geographic area
• Seasonal

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Marginal Capacity Cost of Electricity
LRMC of capacity may be determined by asking: What is
the change in system capacity costs C associated with
a sustained increment D in long-run peak demand?

limC
LRMC of capacity 
D  0 D

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Marginal Energy Costs of Electricity

LRMC of energy during the peak will be the

running cost of the marginal unit (according to
the merit order) to meet the incremental peak
kWh corresponding to D.

If GT is the marginal unit in the peak then

LRMCenergy,G = fuel + operating cost of GT.

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LRMC of Generation at Different Level

Generation level = 6.57 cent/kWh

HV level (6.57 / 0.97) = 6.77 cent/kWh
MV level (6.77/ 0.93) = 7.28 cent/kWh
LV level (7.24 / 0.91) = 8.00 cent/kWh

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 Deviation from Strict LRMC

• Social (Life line rates)

• Financial (Financial viability of utility)
• Political

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 Life Line Rates

I a v e ra g e

P e

M C
based
t a r if f

F B
P s

I
S o c ia l ta r if f lo w i n c o m e

0 Q 1
Q m in Q 2

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 Second Best Pricing
• If MC pricing lead to financial loss and utility
is required to break even without receiving
subsidies.
• Second best pricing or “Ramsey Pricing”
• Utility maximizes social welfare (sum of
consumers’ surplus and producers’ surplus)
subject to break-even constraint
• Break-even means meet the costs

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 Second Best Pricing…
 pi  MCi   1
 
 Pi  1   i
• Inverse elasticity rule
• Relative mark-up of price over MC
• (p-MC) is mark-up is inversely proportional to price
elasticity of demand
• Price elasticity of demand = εi
• Ramsey number = α/(1+ α)
• Ramsey pricing discriminates across outputs i
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 Financial Viability of Utility

• Rate of Return on Assets

• Self financing ratio

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 Self Financing Requirements
NEA set tariffs at levels which will provide funds to
cover:
(i) cash operating expenses (fuel, power purchase,
salaries, O&M and administration);
(ii) debt service (principal and interest);
(iii) additional working capital other than cash; and
(iv) self-finance a percentage of total capital
investment (including IDC) averaged over the
past, the current and the next year. NEA is
expected to finance at least 23% of the total
capital investment.

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 Rate of Return on Assets

Under the rate of return covenant, NEA is to

earn rate of return on average net re-valued
fixed assets of not less than 6%.

Income before interest after tax

= 6% of Average Net Fixed Assets

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Political and Other Economic Considerations

• Industrial development objective

• Promotion of cottage industries
• Agricultural development
• Regional development
• ---
• ---

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Comparison of Electricity Tariff with LRMC
Demand Energy Average
Load Charge Charge Tariff LRMC Tariff/
Consumer Category Factor Rs/kVA/Month Rs/kWh Rs/kWh Rs/kWh LRMC
A. High Voltage (66 kV & above)
A.1 Industrial 60% 95 4.35 4.62 6.06 76%
B. Medium Voltage (11 & 33 kV)
B.1 Industrial 45% 105 5.50 5.90 7.32 81%
B.2 Commercial 40% 120 7.10 7.61 7.32 104%
B.3 Non-commercial 40% 98 7.40 7.82 7.32 107%
B.4 Irrigation 15% 26 3.25 3.55 7.32 48%
B.5 Drinking Water 35% 83 3.80 4.20 7.32 57%
B.6 Transport 40% 98 4.00 4.42 7.32 60%
C. Low Voltage ( 400 & 230 volts)
C.1 Domestic
1. upto 20 units 3.90 3.90 8.32 47%
2. 21 - 250 units 6.50 6.50 8.32 78%
3. above 250 units 9.25 9.25 8.32 111%
C.2 Industrial
1. Cottage 30% 25 5.00 5.14 8.32 62%
2. Small 30% 50 6.10 6.38 8.32 77%
C.3 Commercial 40% 125 7.25 7.78 8.32 94%
C.4 Non-commercial 40% 88 7.50 7.88 8.32 95%
C.5 Irrigation 11% 3.25 3.25 8.32 39%
C.6 Drinking Water 35% 78 3.90 4.28 8.32 51%
C.7 Street Light 4.65 4.65 8.32 56%
C.8 Temple 4.65 4.65 8.32 56%
C.9 Temporary 12.00 12.00 8.32 144%
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 References
• M Munasinghe and G Schramm, Energy Economics,
Demand Management and Conservation Policy, Van
Nostrand Reinhold Company, 1983.
• M Munasinghe and J. Warford, Electricity Pricing, 1977.
• Marginal Cost Analysis and Pricing of Water and Electric
Power, Y. Albouy, 1983

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