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Using Hourly System Lambda to Gauge Bulk-power Prices

Fortnightly Magazine - May 1 1995

meet expected peak demand with a reserve margin. In contrast, economy or nonfirm power transactions do not count toward the utility's reserve requirement and are provided on an "as available basis."

In the economy markets, a high system lambda should encourage a power plant owner to buy bulk power from utilities with lower marginal costs. In the firm market, system lambda also plays a large role. The typical sale is by an investor-owned utility to a municipal or cooperative on a full-requirements basis, with the seller bundling all services together: energy, backup capacity, and transmission services. However, by unbundling the price component by component, it can be seen that the firm wholesale supply price actually reflects three factors (em average system lambda, capacity, and transmission.

Thus, the seller could choose to obtain the required electrical energy from the grid at a competitive price equal on average to the average annual system lambda. As for capacity, the seller could obtain firm backup by purchasing combustion turbine capacity (combustion turbines set a ceiling on capacity prices since they represent the newest plants with the lowest capacity cost). This capacity would hardly ever be used, but would provide necessary reliability. The costs of this capacity are shown to be spread over the kilowatt-hours of energy. Lastly, the seller would need to reserve firm transmission capacity.

In many cases, current firm prices based on regulated rates that reflect average historical ("embedded") costs are higher than competitive market prices. For example, 1993 firm wholesale contracts in PJM averaged 46 mills per Kwh (source: FERC Form 1). In contrast, the competitive price was about 33 to 35 mills/Kwh. This price reflects: 1) energy prices (lambda) in 1993 averaged 22 mills/Kwh; 2) capacity obtained at the annualized cost of a combustion turbine plant at 9 mills/ Kwh;3 and 3) 3-5 mills/Kwh for transmission.

And what's good for sellers is good for buyers. Retail customers (such as large industrials, public intervenors) will use the same information to ensure that their utilities are aggressively pursuing market offers. Power marketers will also use this information to identify possible sales opportunities based on purchases currently above market.

Resource Planning,

Plant Valuation

In the past, when precious little wholesale bulk-power price information was available, plants were valued by their ability to decrease system cost. This theoretical approach led to correct assessments. Comparing costs or revenue requirement offered a screening method for evaluating new capacity (see Figure 4).

The process will change in the future, however, with the framework recast not only in terms of prices (system lambda), but also energy value and capacity value.

Electrical energy value is measured as the difference between variable operating cost and system lambda (the marginal decrease in electrical energy costs). In Figure 5, the cost of a new generating unit (its variable operating cost) is compared to the system lambda over the course of a year. When the lambdas are high, savings are high (shaded area), and the plant or resource has high energy value. This energy value can be estimated over the useful life of the resource