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Incremental-Cost Pricing: What Efficiency Requires

Fortnightly Magazine - January 1 1996

incremental real and reactive losses (em and ancillary services would be measured and priced separately.

Line loadings also provide a good measure of value added, because the most heavily loaded lines are those that connect areas with low generating costs to areas with higher costs. The greater the difference in regional generating costs, the more valuable the use of the transmission system and the greater the loadings on the connecting lines.

When lines are fully loaded, Impacted Megawatt-Mile pricing provides for opportunity bidding by users and generators able to free up capacity for a new transaction. Through this mechanism, fully loaded transmission capacity can always be used for the most valuable transactions.

Prices That Make Sense

Incremental pricing makes basic economic sense. Incremental cost pricing under the Impacted Megawatt-Mile proposal creates strong incentives for efficient use of the existing transmission system and efficient additions to transmission capacity.

In addition, transmission prices that reflect incremental trans-mission costs promote efficient

decisions on the location of new generating capacity. Unless independent generators consider the incremental costs of transmission, they will be unable (em as vertically integrated utilities managed (em to minimize total generation and transmission costs in choosing new generation sites.

By contrast, prices based on embedded costs would improperly reflect past costs. Moreover, they would vary capriciously. In a flow-based system with embedded-cost pricing, the cost of using an identical transmission line providing identical service would change, perhaps drastically, depending on the embedded costs of the system it belongs to.

Besides its important features encouraging efficiency, Impacted Megawatt-Mile pricing offers other advantages for both users and owners.

Because pricing is based on a formula and considers the same flows in pricing that are examined in reliability (i.e., availability) evaluations, Impacted Megawatt-Mile pricing allows almost instantaneous determinations of availability and price in real-time information networks (RINs). Impacted Megawatt-Mile pricing provides a transparent and predictable pricing system that would apply equally to all competitive users, including transmission owners.3 Users would pay only for the lines their transactions actually used, not for slices of entire systems. They would pay based on distance, but not be subject to pancaked prices.

For owners, Impacted Megawatt-Mile pricing provides proper payment for the services each owner's system actually provides, eliminating uncompensated loop flows. Native customers would be protected, and owners would have incentives to add needed new transmission capacity. Impacted Megawatt-Mile pricing is also well suited to provide regional transmission service without the need to alter existing transmission ownership.

Impacted Megawatt-Mile pricing can be applied to bilateral transactions, in pools or in a mixed setting. It applies to firm and nonfirm service as well as point-to-point and network service.

Objections are Invalid

The objections often raised against incremental-cost pricing are not valid in the case of the Impacted Megawatt-Mile proposal.

First, Impacted Megawatt-Mile pricing does not lead to a substantial increase in average transmission prices. The prices for specific transactions would differ sharply from traditional pricing (em as they must to give efficient price signals. But the variations above and below traditional prices would tend to balance out, with no sharp