Transcript Estimation of Long Run Capacity Costs

Estimation of Long Run Capacity Costs
Gas TCMF
26th April 2006
Aims

To clarify different approaches that can be used for pricing
capacity
Long run marginal costs (LRMCs) and incremental costs (LRICs)
 Why different approaches can be taken and their implications
 Supply and demand assumptions


To explain current approaches for entry/exit capacity pricing

To set out potential options for consideration
2
Estimation of Long Run Marginal Costs (LRMCs)
Cost
gradient at Q ~ y/x = marginal cost
change in Cost
y
x
Small change in Quantity =
marginal increment
Quantity (Capacity)
Q



For a small (marginal) change in capacity, the marginal cost at Q approximates the
gradient of the cost curve at Q
The price of capacity at the level Q is based on the marginal cost at Q
Long run costs assume that investment can be made to accommodate a change in
capacity (c.f. short run costs = no investment made)
3
Estimation of Unit Incremental Costs (LRICs)
Cost
y/x = incremental cost
change in Cost
y
x
Large change in Quantity
Quantity (Capacity)
Q




In general, y/x no longer approximates the gradient of the cost curve at Q
The interpretation given to y/x is a unit incremental cost of moving from the capacity
level Q to the new capacity level
The LRIC does not represent the price at the new capacity level
LRIC based prices will signal costs of providing additional capacity
4
LRMCs at Different Capacity Levels
Cost
change in Cost
marginal increment
marginal increment
Large change in Quantity
Q1




Q2
Quantity (Capacity)
LRMCs at Q1 and Q2 are used to set prices for capacity levels of Q1 and Q2 respectively
The same marginal increment is used in calculating each LRMC
Prices generated will signal costs of maintaining a higher capacity level = forecast future LRMCs
The change in total cost can be also be estimated
5
Marginal Costs and Unit Incremental Costs
Why are they applied?
Marginal Costs (LRMCs)
Unit Incremental Costs (LRICs)

Generates the route costs of
capacity

Generates the route costs of
moving to an increased capacity
level

Targets costs of maintaining a
given capacity level at Users
requiring that capacity

Targets investment costs at
Users, but not necessarily only
those requesting additional
capacity

Represents the price for a given
capacity level

Represents the average price
over the increment in capacity
6
Marginal Costs and Unit Incremental Costs
Implications
Marginal Costs (LRMCs)
Unit Incremental Costs (LRICs)

Easier to understand?

More difficult to understand how
price schedules calculated

Can be modelled using a single
Pricing model

Requires more sophisticated
modelling for larger increments

Implicit assumption that
investment has been made to
generate the required capacity
level

Implicit assumption that
investment needs to be made to
generate the required capacity
level

Costs can be targeted at Users
by ensuring commitment
model/economic test recovers
appropriate revenues

Post-investment marginal costs
may reduce significantly due to
economies of scale
7
Marginal Costs and Unit Incremental Costs
Supply and Demand Assumptions
Marginal Costs (LRMCs)

Unit Incremental Costs (LRICs)
Currently only applied for
administered exit capacity
charges

Single “central” supply/demand
case used with small increment
to generate entry-exit route costs

An option could be to define
supply substitution/load
absorption rules to generate
realistic multiple base cases to
reflect large changes in capacity
level
8

Currently provides basis for entry
UCAs and entry capacity reserve
prices

Single “central” supply/demand
case used with varying
increments to generate entry-exit
route costs

An option could be to remove the
indivisible increment assumption
to generate more appropriate
results i.e. calculate total system
reinforcement costs rather than
route costs
Where are long run costs used (and why)?
Current assumptions
Entry UCAs
Baseline
Entry
Capacity
Reserve
Prices
LTSEC
Reserve
Price
Schedules
Requirement
Costing
approach
Pricing
adopted
9
Exit Capacity Charges
Where are long run costs used (and why)?
Current assumptions
Entry UCAs
Requirement
Revenue
drivers for
incremental
capacity
Costing
approach
Unit
Incremental
Costs
Pricing
adopted
Based on
2001 LRICs
Baseline
Entry
Capacity
Reserve
Prices
LTSEC
Reserve
Price
Schedules
10
Exit Capacity Charges
Where are long run costs used (and why)?
Current assumptions
Entry UCAs
Baseline
Entry
Capacity
Reserve
Prices
Requirement
Revenue
drivers for
incremental
capacity
Efficient
allocation of
baseline
capacity
Costing
approach
Unit
Incremental
Costs
Unit
Incremental
Costs
Pricing
adopted
Based on
2001 LRICs
[Discounted]
price set from
UCAs
LTSEC
Reserve
Price
Schedules
11
Exit Capacity Charges
Where are long run costs used (and why)?
Current assumptions
Entry UCAs
Baseline
Entry
Capacity
Reserve
Prices
LTSEC
Reserve
Price
Schedules
Requirement
Revenue
drivers for
incremental
capacity
Efficient
allocation of
baseline
capacity
Incremental
capacity
investment
signal
Costing
approach
Unit
Incremental
Costs
Unit
Incremental
Costs
Unit
Incremental
Costs
Pricing
adopted
Based on
2001 LRICs
[Discounted]
price set from
UCAs
LRICs
updated
annually
12
Exit Capacity Charges
Where are long run costs used (and why)?
Current assumptions
Entry UCAs
Baseline
Entry
Capacity
Reserve
Prices
LTSEC
Reserve
Price
Schedules
Requirement
Revenue
drivers for
incremental
capacity
Efficient
allocation of
baseline
capacity
Incremental
capacity
investment
signal
Efficient
allocation of
baseline
capacity
Incremental
capacity
investment
signal
Revenue
Recovery
Costing
approach
Unit
Incremental
Costs
Unit
Incremental
Costs
Unit
Incremental
Costs
Marginal
Costs
Marginal
Costs
Adjustment/
Scaling
Pricing
adopted
Based on
2001 LRICs
[Discounted]
price set from
UCAs
LRICs
updated
annually
13
Exit Capacity Charges
Based on 2001 LRMCs with annual scaling
Where are long run costs used (and why)?
Current costing assumptions
Entry UCAs
Baseline
Entry
Capacity
Reserve
Prices
LTSEC
Reserve
Price
Schedules
Requirement
Revenue
drivers for
incremental
capacity
Efficient
allocation of
baseline
capacity
Incremental
capacity
investment
signal
Efficient
allocation of
baseline
capacity
Incremental
capacity
investment
signal
Revenue
Recovery
Costing
approach
Unit
Incremental
Costs
Unit
Incremental
Costs
Unit
Incremental
Costs
Marginal
Costs
Marginal
Costs
Adjustment/
Scaling
Pricing
adopted
Based on
2001 LRICs
[Discounted]
price set from
UCAs
LRICs
updated
annually
14
Exit Capacity Charges
Based on 2001 LRMCs with annual scaling
Gas TCMF - Areas for Review
Entry UCAs
Baseline
Entry
Capacity
Reserve
Prices
LTSEC
Reserve
Price
Schedules
Requirement
Revenue
drivers for
incremental
capacity
Efficient
allocation of
baseline
capacity
Incremental
capacity
investment
signal
Efficient
allocation of
baseline
capacity
Incremental
capacity
investment
signal
Revenue
Recovery
Costing
approach
Unit
Incremental
Costs
Unit
Incremental
Costs
Unit
Incremental
Costs
Marginal
Costs
Marginal
Costs
Adjustment/
Scaling
Pricing
adopted
Based on
2001 LRICs
[Discounted]
price set from
UCAs
LRICs
updated
annually
15
Exit Capacity Charges
Based on 2001 LRMCs, scaled and
rebalanced from previous years
Alternative approach (1): Decoupling UCAs and LRIC
based incremental capacity prices
Baseline
Entry
Capacity
Reserve
Prices
LTSEC
Reserve
Price
Schedules
Requirement
Revenue
drivers for
incremental
capacity
Efficient
allocation of
baseline
capacity
Incremental
capacity
investment
signal
Efficient
allocation of
baseline
capacity
Incremental
capacity
investment
signal
Revenue
Recovery
Costing
approach
Unit
Incremental
Costs
Marginal
Costs
Unit
Incremental
Costs
Marginal
Costs
Unit
Incremental
Costs
Adjustment/
Scaling
Potential
Outcome
“System”
LRICs with
modified S/D
assumptions?
LRMCs
LRICs*
LRMCs
LRICs*
Entry UCAs
* Could be based on price schedules or a single price
16
Exit Capacity Charges/Reserve Prices
Alternative approach (2): Decoupling UCAs and
System LRIC for Entry incremental prices
Baseline
Entry
Capacity
Reserve
Prices
LTSEC
Reserve
Price
Schedules
Requirement
Revenue
drivers for
incremental
capacity
Efficient
allocation of
baseline
capacity
Incremental
capacity
investment
signal
Efficient
allocation of
baseline
capacity
Incremental
capacity
investment
signal
Revenue
Recovery
Costing
approach
Unit
Incremental
Costs
Marginal
Costs
Unit
Incremental
Costs
Marginal
Costs
Unit
Incremental
Costs
Adjustment/
Scaling
Potential
Outcome
“System”
LRICs with
modified S/D
assumptions?
LRMCs
“System”
LRICs with
S/D balancing
rules
LRMCs
LRICs
Entry UCAs
17
Exit Capacity Charges
Alternative approach (3): Decoupling UCAs and
LRMC based incremental capacity prices
Entry UCAs
Baseline
Entry
Capacity
Reserve
Prices
LTSEC
Reserve
Price
Schedules
Requirement
Revenue
drivers for
incremental
capacity
Efficient
allocation of
baseline
capacity
Incremental
capacity
investment
signal
Costing
approach
Unit
Incremental
Costs
Marginal Costs*
Potential
Outcome
“System”
LRICs with
modified S/D
assumptions?
LRMCs with S/D balancing rules
Exit Capacity Charges
Efficient
allocation of
baseline
capacity
Incremental
capacity
investment
signal
* Assumes investment has been made, could be based on price schedules or a single price
18
Revenue
Recovery
Adjustment/
Scaling