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Pricing Off the Tariff: How to Figure the Maximum Supportable Electric Rate Discount

Fortnightly Magazine - May 15 1997

of the values in the preceding two rows. The final row shows the expected CPVGM, which is the sum of the Prob. Wtd present values. The resulting value, $78,496, denotes the present value gross margin the utility can expect in the absence of a discount from tariff rates in exchange for a fixed commitment from the customer to take service over the five-year period. It is this value of expected gross margin that is used to determine the MSD from existing tariffs that provides for the same cumulative present value gross margin.

Fixing the Discount

To determine the maximum supportable discount, the first variable to solve is price, which, when reduced by marginal cost, multiplied by the annual sales volume and discounted over the five-year period, will provide for the same level of CPVGM ($78,496) as calculated in Table 2, where it was assumed that no discount or contract extension was in place.

(1) CPVGM ($78,496) =

(Pi - MCi) ' Si /(1+d)I

Where:

P = leveled discounted price

MC = marginal production cost

d = discount rate

I = year

S = sales

Recognizing that P is assumed to be constant throughout the entire period and rearranging terms we find that:

(2) CPVGM =

PSi/(1+d)I - (Mci ' Si)/(1+d)I

(3) P = [CPVGM +

CPVMC] / CPVS

In this example, P is equal to 4.07¢/kWh. Given this value, the MSD is an 18.59-percent reduction from the tariff rate of 5.0¢/kWh. Equation (3) shows that it is calculated as the sum of the CPVGM and the cumulative present value marginal cost (CPVMC) divided by the cumulative present value sales volume (CPVS). Table 2 verifies that this is the correct value.

As can be seen from Table 2, the cumulative present value margin ($78,496) is equal to the expected cumulative present value margin derived in Table 1 where it was assumed that no discount and contract extension was in place. Thus, a discounted fixed price of 4.07¢/kWh produces the same CPVGM the utility can expect to receive by maintaining its current tariff at 5¢/kWh given the assumed probabilities that direct access will occur over the forecast period. %n2%n

Fixing the Discount

The appropriate discount is a function of the anticipated path of competition, and the spread between tariff rates and market prices. %n3%n The MSD (18.59 percent) derived above, assumes there is a 50-percent cumulative probability of customer departure and a 3¢/kWh spread between tariff and market price. Varying these assumptions produces significantly different results. This effect is illustrated in Table 3.

The columns labeled 25 percent, 50 percent, and 75 percent refer to different assumed values for the cumulative probability of retail access (and customer departure) over the analysis period. The rows containing the values 3.5¢/kWh, 3¢/kWh, and 2.5¢/kWh reflect alternate values for the difference between the tariff rate (5¢/kWh) and market price. Given each cumulative probability value, we derive the corresponding probability of retail access for each year assuming, consistent with the original example, that there is an equal chance that direct access will occur in any particular year.

The data