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

Fortnightly Magazine - May 15 1997

show MSDs under varying assumptions regarding spreads and the probability of retail competition. These results indicate that the MSD can vary significantly as the assumptions change, with the highest MSD (35.43 percent) occurring where the spread is highest (3.5¢/kWh) and the cumulative probability is highest (75 percent). The lowest MSD (7.32 percent) is obtained where the spread between tariff and market price is lowest (2.5¢/kWh) and the cumulative probability is lowest.

It is interesting to note that the MSD varies more widely across cumulative probability values than it does across changes in the spread between tariff and market prices. This can be seen by noting that the MSD varies from 7.32 percent to 25.31 percent given a spread of 2.5¢/kWh. At a spread of 3.5¢/kWh, the MSD varies from a low of 10.25 percent to a high of 35.43 percent. Conversely, the MSD varies much less with changes in spread for each given cumulative probability value. At 25 percent, the MSD goes from a low of 7.32 percent to a high of 10.25 percent. With a cumulative probability of 75 percent, the MSD varies from a low of 25.31 percent to a high of 35.43 percent. Clearly, the MSD is highly dependent on the assumptions one uses. These results suggest that errors in anticipating the likelihood of regulatory changes that allow for direct access may be more costly than errors in accurately forecasting market prices over time. t

James C. Cater is director of strategic analysis at Central Vermont Public Service Corp. Cater is a Chartered Financial Analyst and holds a BA and MA in economics.

Table 1. Cumulative Present Value of Margin vs. Year of Bypass

Year Margin Margin Margin Margin Margin Margin

Stay Leave Yr. 1 Leave Yr. 2 Leave Yr. 3 Leave Yr. 4 Leave Yr. 5

(1) (2) (3) (4) (5) (6) (7)

1 $30,000 $0 $30,000 $30,000 $30,000 $30,000

2 $30,000 $0 $0 $30,000 $30,000 $30,000

3 $30,000 $0 $0 $0 $30,000 $30,000

4 $30,000 $0 $0 $0 $0 $30,000

5 $30,000 $0 $0 $0 $0 $0

Cum PV $113,724 $0 $27,273 $52,066 $74,606 $95,096

Prob. 50.0 percent 12.9 percent 11.3 percent 9.8 percent 8.5 percent 7.4 percent

Prob Wtd. $56,878 $0 $3,072 $5,107 $6,370 $7,069

Expect Value $78,496

Table 1 depicts all of the possible outcomes that could occur given the assumption that there is a 12.94-percent probability that retail choice (and customer departure) occurs in any single year over the course of five years.

Table 2. Cumulative Present Value

of Margin w/No Discount.

Year Revenues Marginal Costs Margins

1 $40,707 $20,000 $20,707

2 $40,707 $20,000 $20,707

3 $40,707 $20,000 $20,707

4 $40,707 $20,000 $20,707

5 $40,707 $20,000 $20,707

CUM PV $154,312 $75,816 $78,496

Table 2 shows that the cumulative present value margin is equal to the expected cumulative present value margin (derived in Table 1), where it is assumed that no discount and contract extension was in place.

Table 3. Price Spread

(Tariff - Market)

vs. Probability of Bypass.

Probabilities

SPREAD (¢/kWh) 25% 50% 75%

3.5 10.25% 21.68% 35.43%

3.0 8.79% 18.59% 30.38%

2.5 7.32%