20060308Ben Johnson Analysis for Idaho Farm Energy.pdf

PRINClPAL OFFICES:
2252 KILLEARN CENTER BLVD.
TALLAHASSEE,FLORIDA 32309850-893-8600
FAX [phone]i March 8,2006
ECONOM)C RESEARCH
AND ANALYSIS ASSOCIOtBS,iflC
Brian Jackson
President
idaho Farm Energy Association
515 N.27*St.
Boise,ID 83702
Dear Mr.Jackson:
Your Association has asked me to review the calculations related to thepriceforNon-Conforming Energy in the Schwendiman wind energycontractandtheimplicationsofthemodified90/110 Performance Band
mechanism.The following analysis indicates that the new mechanism is
a maior improvement over the existing mechanism.However
PacifiCorp's method of calculation of the Non-Conforming Energy Price
contains a significant theoretical flaw that needs be corrected before the
mechanism is generally applied in future avoided cost calculations,
Modified 90/110 Performance Band
The Modified Band is superior to the current methodology because it
eliminates market price risk from the contract.The forecast of revenues
for the wind projects will be far less volatile because they are no longerexposedtonaturalgasprices.For the ratepayers,there will now be aneconomicincentiveforaccurateforecastingatalltimes.Under the
current mechanism,there is no forecasting incentive when 85%of the
prices at Mid-C exceed the contract price.This situation has occurred inthepast.
The basis of fixed price contracts is to eliminate market price risks forbothparties.The avoided costs represent a common view as to the longtermcostofproducingelectricity.One problem with the current 90/110mechanismisthatitviolatedthisbasiccompactRatherthanusingthe
agreed upon prices,it uses market prices _only if they are lower.The
one-sided nature of this mechanism is unfairly biased against windprojectsandartificiallyreducessupply.This in turn increases costs to
ratepayers in the long run,since they will then buy more energy from
less economic sources.The Modified Band returns to the common viewofforecastedenergyprices.
6070 HILL ROAD
8015E IDAHO 83703
208-342-1700
FAX [phone] N
VISIT OUR WEBSITES:benjohnsonassociates comutilityregulationcom
ELECTRONIC MAIL:staff@benjohnsonassociates com
Non-Conforming Energy Price
PacifiCorp has used a common approach to dividing the total avoided
cost,calculated with the SAR method,between capacity and energy.Injurisdictionswhichusetimedifferentiatedavoidedcosts,the value ofreliabilityisseparatedfromthevalueofenergy.If the fixed cost of acombinedcycleisusedtopricecapacity,a competitive market could add
an infinite number of simple cycle combustion turbines (SCCT)and the
owners of those turbines would reap above market returns.
Hence,it is generally recognized that the fixed cost of owning the least
cost peaking resource,such as an SCCT,is the appropriate proxy for
pricing capacity,regardless of what type of power plant is used as theSAR.
With this approach all other costs of the SAR,including the balance ofthecapitalcosts,are allocated to energy.Essentially,any additionalfixedcostsoftheSARcomparedtothepeakingresourceisjustified onthebasisofoperatingcostsavings.
If the additional capital costs of the combined cycle SAR are notallocatedtotheenergyprice,then only resources operating at or belowtheheatrateoftheSARwouldbeeconomic.However,there are
obviously times when peaking resources,such as Bennett Mountain,willoperateeventhoughtheiroperatingcostsarehigher.This can occur for
a variety of reasons such as load balancing,mitigating transmission
constraints,replacement of outages of other units,etc..Addingthe extra
capital costs of the SAR to energy has the effect of increasing the
energy price to account for periods when more expensive resources are
operating.
PacifiCorp Methodology Error
There is a theoretical flaw in PacifiCorp's avoided cost calculation
methodology.The Company includes variable O&M in the SCCT's fixed
costs.While this is consistent with the way PacifiCorp calculates
avoided capacity prices in Utah and Oregon,it is simply incorrect.In
economic terms,the task here is to determine the change in cost due to
a change in demand (kW).Operating costs (kWh)are not part of thiscalculation.The change in variable O&M due to a change in kW is zero.
There is no justification for treating variable O&M costs differentlythan
variable fuel costs.
In both Oregon and Utah,the avoided capacity price is simply used to
allocate tg avoided costs between time periods.Therefore,
PacifiCorp's methodology does not reduce total avoided costs.It onlyshiftsaminoramountofavoidedcostsbetweenon-peak and off-peak
periods.In the Schwendiman case,this flawed methodology reduces
the price of Non-Conforming Energy.Therefore,it causes an unfair loss
to the projects that will be subject to this approach.
Applying the Methodology to Idaho Power
The size of the PacifiCorp error is determined by the capacity factor
assumed for the SCCT.PacifiCorp uses an 18%capacity factor based
on their 2004 IRP Update.If this error isn't corrected,it will have a farlargerimpactifthemethodisappliedtoIdahoPower.Idaho Power
assumes an SCCT capacity factor of 59%in their 2004 IRP.For 2006,the PacifiCorp calculation reduces the Non-Conforming Energy Price by1.86 $/MWh.If applied to Idaho Power,the error will equal 2.80 $/MWh.
Attached is a calculation of Non-Conforming Energy Prices for idaho
Power using its 2004 IRP assumptions and eliminating variable O&M
from capacity prices.To adjust for seasonal prices,I assumed that no
avoided capacity costs be allocated to the three off peak months andthattheNon-Conforming Energy Prices be assigned in the other two
seasons.The result is that most of the difference in seasonal prices is
assigned to capacity prices,which is logical.
It should be noted that there is a small rounding error when applying
Idaho Power's normal seasonality factor to the March-Mayperiod.The
actual factor is 73.33%,which has been rounded to 73.5%in the current
SAR model.
Recommendation
The a theoretical flaw in PacifiCorp's avoided cost calculation
methodology needs to be corrected for the reasons stated above.Variable O&M should not be included in fixed costs.In future contracts
PacifiCorp needs to fix this error and the methodology should not be
extended to Idaho Power,or any other utility without correction.
ly,
Don C.Reading,PhD
Consulting Economist,VP
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