1. Seminar on Electricity Tariffs
Major Electricity Customers Pricing Options Presented by Anees S. Azzouni, President A.S. Azzouni Energy Consultants, Hethie Parmesano, Senior Vice President, National Economic Research Associates, Saud A. Al-Rashed, Executive Director Commercial Business, Transmission Saudi Electricity Company
Presented at
Seminar on Electricity Tariffs
Riyadh, Saudi Arabia
January 15 – 16, 2008
A. S. Azzouni Energy Consultants, NERA, Saudi Electricity Company

2. Contents of this presentation
Introduction
Electricity sector restructuring and market reform
Major customer electricity procurement economics
Objectives and concerns of key stakeholders
Key pricing issues
Alternative cost bases for pricing
Recommended alternatives
Conclusions
A. S. Azzouni Energy Consultants, NERA, Saudi Electricity Company

3. Electricity pricing policies toward major customers need to:
be compatible with the electricity sector’s changing structure and the business environment of major customers;
lead to economically-efficient behavior; and
be compatible with stakeholders objectives.
A. S. Azzouni Energy Consultants, NERA, Saudi Electricity Company

4. Major customer pricing can impact
development of wholesale electricity market
development of cogeneration and distributed generation
effectiveness of load management and energy efficiency programs
pace of required capacity additions
electricity prices to smaller customers
A. S. Azzouni Energy Consultants, NERA, Saudi Electricity Company

5. We will in this presentation provide
brief description of the electricity sector restructuring efforts in Saudi Arabia.
concerns of major Saudi Arabian electricity sector stakeholders with regard to rates.
major alternative cost bases for pricing of power supplies, standby power, buy-back, and other supplemental services.
recommended pricing alternatives that are compatible with electricity sector restructuring.
A. S. Azzouni Energy Consultants, NERA, Saudi Electricity Company

6. Contents of this presentation
Introduction
Electricity sector restructuring and market reform
Major customer electricity procurement economics
Objectives and concerns of key stakeholders
Key pricing issues
Alternative cost bases for pricing
Recommended alternatives
Conclusions
A. S. Azzouni Energy Consultants, NERA, Saudi Electricity Company

7. Enabling legislation was passed in the last ten years
Key developments include:
removal of barriers to private investment entry into generation
passage of the electricity law, the grid code, and implementing regulations
the future creation of an independent transmission company
the future introduction of open and non-discriminatory access by major electricity customers to the grid
the future implementation of a wheeling tariff
the invitation to qualified major electricity customers to establish their electricity rates outside the regulated industrial rate through direct negotiations with SEC
A. S. Azzouni Energy Consultants, NERA, Saudi Electricity Company

8. Proposed electricity industry restructuring plan
Stage one: 2008
the establishment of a single buyer model to accompany the unbundling of SEC
the creation of an independent transmission company
the introduction of open access to the grid by major customers
the implementation of a wheeling tariff set by ECRA
Stage two: 2008 – 2015
the creation of parallel wholesale markets where major customers can have direct supply agreements with SEC and/ or IWPPs and IPPs
Stage three: 2015
full market competition
A. S. Azzouni Energy Consultants, NERA, Saudi Electricity Company

9. Questions yet to be answered by present sector reform efforts
the development of competitive wholesale electricity market and the setting of goals for wholesale market institutions
creation of independent transmission system operator(s),
creation of large regional transmission networks with common transmission access and pricing rules, and
creation of a set of basic wholesale market institutions which include:
Standard Market Design (SMD) rules,
locational marginal pricing and congestion management, regional transmission planning,
market power mitigation mechanisms.
the creation of a legal framework for access to the network.
clarification of ECRA’s regulatory oversight over negotiations between major customers and SEC.
A. S. Azzouni Energy Consultants, NERA, Saudi Electricity Company

10. Contents of this presentation
Introduction
Electricity sector restructuring and market reform
Major customer electricity procurement economics
Objectives and concerns of key stakeholders
Key pricing issues
Alternative cost bases for pricing
Recommended alternatives
Conclusions
A. S. Azzouni Energy Consultants, NERA, Saudi Electricity Company

11. Major Customer On-Site Generation Economics
Major industrial facilities requiring both heat and power can build cogeneration facilities with thermal efficiency of 90% at cost for electricity competitive with local utilities.
The optimization and sizing of a cogeneration scheme can result in more electricity produced than can be utilized within the plant.
On-Site generation economics are governed by
availability and cost of fuel
market price for electricity
cost and availability of stand-by power
wheeling and
market and price of excess power
A. S. Azzouni Energy Consultants, NERA, Saudi Electricity Company

12. Energy profile of industrial facilities
Basically, all industrial facilities reflect in their design:
low price for natural gas, electricity, and water
heavy reliance on SEC for power supply,
low level of plant heat integration,
use of simple cycle technology for on-site generation,
high energy intensive technologies.
A. S. Azzouni Energy Consultants, NERA, Saudi Electricity Company

13. Energy profile of industrial facilities
Major customers exhibit varying sensitivity to electricity cost.
basic metals in excess of 30% of variable costs
construction materials and cement in second place
chemical industries, plastic products, and oil and gas 7% or below of variable costs.
Major electricity customers have the capability for load shifting, the potential to improve load management, and interfuel substitution.
Major customers hold a large reserve of DSM resources whose cost is competitive with the cost of new generating capacity.
Captive power generation is a feasible option for petrochemical, gas, and oil refining facilities and is a feasible capacity resource to the utilities as well.
A. S. Azzouni Energy Consultants, NERA, Saudi Electricity Company

14. Contents of this presentation
Introduction
Electricity sector restructuring and market reform
Major customer electricity procurement economics
Objectives and concerns of key stakeholders
Key pricing issues
Alternative cost bases for pricing
Recommended alternatives
Conclusions
A. S. Azzouni Energy Consultants, NERA, Saudi Electricity Company

15. Objectives and Concerns of Key Stakeholders
The five primary stakeholders of wholesale electricity are:
major customers
the Ministry of Water and Electricity
ECRA
SEC
IPPs and IWPPs
A. S. Azzouni Energy Consultants, NERA, Saudi Electricity Company

16. Major customers share the following primary concerns:
adequacy of power supply to meet future power requirements,
the effect of potentially rising and volatile electricity prices on competitiveness with industry peers, and
cost-effectiveness of captive power generation investment decisions as a result of uncertainty over
wheeling charges,
price for sale of excess power, and
standby power rates.
A. S. Azzouni Energy Consultants, NERA, Saudi Electricity Company

17. Key major customers’ policy concerns include:
Energy and industrialization policies impact on energy intensity, fuel availability and pricing, and technology choice.
Policies which impact the position of incumbent electric utilities’: market power, concentration, and market share.
Rules governing the treatment of cross subsidies.
Provisions for ancillary services: buy-back, stand-by, wheeling, frequency imbalance, and voltage support and control.
Policies, standards, and licensing with regard to: on-site generation, distributed generation, interconnection standards, and dispatch rules of qualified independent generators.
Rules on who is entitled to have access to the network.
A. S. Azzouni Energy Consultants, NERA, Saudi Electricity Company

18. Key Ministry of Water and Electricity and ECRA Concerns
The impact of policy legislation and long range electricity planning on cogeneration legislative options, power system optimization, energy efficiency and subsequently pricing.
The impact regulating the electricity market and restructuring of the electricity sector have on major customers’ decisions regarding energy use, energy procurement, and the efficiency and competitiveness of the market.
A. S. Azzouni Energy Consultants, NERA, Saudi Electricity Company

19. A. S. Azzouni Energy Consultants, NERA, Saudi Electricity Company
SEC Concerns
The retention of major customers is a key objective of SEC. Major customers represent a significant portion of SEC revenues with prices that fully cover the cost of service.
A critical challenge faced by SEC over the period 2008 – 2015 concerns balancing major customer pricing and wholesale electricity pricing and the balance of SEC sales governed by regulated rates.
On-site generation makes it more difficult for SEC to forecast load and plan the system, and increases uncertainty of revenue recovery.
Non-utility generation will increase uncertainty for the system operators as SEC becomes the residual demand supplier and provider of stand-by power.
A. S. Azzouni Energy Consultants, NERA, Saudi Electricity Company

20. A. S. Azzouni Energy Consultants, NERA, Saudi Electricity Company
IPP/IWPPs Concerns
Under the restructuring plan, IPPs and IWPPs will eventually be allowed to sell power directly to major customers
They will be competing directly with SEC for major customers and thus have concerns with SEC’s industrial tariffs.
IPPs and IWPPs are concerned about SEC pricing policies that affect the feasibility of captive power generation—their potential competitors.
IPPs and IWPPs have interest in the level and structure of wheeling charges they or their customers will pay to use the transmission grid.
A. S. Azzouni Energy Consultants, NERA, Saudi Electricity Company

21. Contents of this presentation
Introduction
Electricity sector restructuring and market reform
Major customer electricity procurement economics
Objectives and concerns of key stakeholders
Key pricing issues
Alternative cost bases for pricing
Recommended alternatives
Conclusions
A. S. Azzouni Energy Consultants, NERA, Saudi Electricity Company

22. A. S. Azzouni Energy Consultants, NERA, Saudi Electricity Company
Design of appropriate prices for major customers raises key interrelated issues
economic efficiency
transition to competitive electricity market
cross-subsidies
system reliability
risk allocation
A. S. Azzouni Energy Consultants, NERA, Saudi Electricity Company

23. Economic Efficiency means
Efficient investment by consumers, utilities, other market participants
Efficient use of existing infrastructure
Avoidance of uneconomic bypass
Use of marginal cost as the basis for electricity pricing promotes economic efficiency and enhances welfare.
A. S. Azzouni Energy Consultants, NERA, Saudi Electricity Company

24. Transition to Competition is enhanced by major customer pricing that:
mimics the structure of likely competitive offerings and avoids long-term agreements that preclude full participation in the market;
promotes new entry by basing prices on economic (marginal) costs;
encourages effective demand response through use of innovative rate structures;
provides transparent price signals, with key elements unbundled to permit comparison with alternatives;
A. S. Azzouni Energy Consultants, NERA, Saudi Electricity Company

25. A. S. Azzouni Energy Consultants, NERA, Saudi Electricity Company
Cross-subsidies
distort customers’ decision about consumption and investment decisions;
are difficult to sustain if customers have supply choices (via self-generation or purchase from a competitive supplier);
can be defined as the difference between amount charged and marginal cost (adjusted efficiently to match the regulated revenue requirement).
A. S. Azzouni Energy Consultants, NERA, Saudi Electricity Company

26. Preservation or enhancement of system reliability
Tariffs for all users should reflect marginal costs so that only capacity that customers are willing to pay for is built.
Prices paid for power produced by major customers’ generators should provide incentives to supply that power when it is most useful to the system.
Prices charged for standby power required by non-utility generators should provide incentives for them to manage their outages in a way that minimizes the effect on system reliability.
A. S. Azzouni Energy Consultants, NERA, Saudi Electricity Company

27. Risk Allocation implicit in pricing to major customers should:
allocate cost, price and operational risks to the parties best able to bear them;
consider pros and cons of short- and long-term agreements in terms of risk allocation;
consider the effect of higher risk on cost of capital.
A. S. Azzouni Energy Consultants, NERA, Saudi Electricity Company

28. Contents of this presentation
Introduction
Electricity sector restructuring and market reform
Major customer electricity procurement economics
Objectives and concerns of key stakeholders
Key pricing issues
Alternative cost bases for pricing
Recommended alternatives
Conclusions
A. S. Azzouni Energy Consultants, NERA, Saudi Electricity Company

29. Alternative Cost Bases for Major Customer Pricing Policies
Allocated embedded (historical accounting) cost
Backward looking
Sensitive to the classification and allocation methods used
Does not provide detailed information needed for time-of-day pricing
Long-Run marginal cost
Assumes hypothetically optimal system
Does not reflect actual conditions of the system
Incremental cost
Change in cost given a specific assumed change in expansion plan or load
Does not provide detailed information needed for time-of-day and other innovative rate structures
Short-run marginal cost
Includes both utility variable costs and costs of changes in reliability (shortage costs to consumers)
Can be computed over several years to show trend
Mimics market prices
Provides all the details needed for efficient pricing
A. S. Azzouni Energy Consultants, NERA, Saudi Electricity Company

30. Two Other Cost Alternatives
Net Metering (for pricing excess energy generated by a customer)
Customers’ meter is allowed to run backward when generation exceeds generating customer’s own load.
Rather than based on cost, the “price” paid for excess energy is the full retail rate.
Depending on retail rate design, this can be an efficient or inefficient approach.
Pricing customer-generated power based on the customer’s generation costs
Reduces risk for the customer-generator
Provides little or no incentive to operate efficiently from total system point of view (e.g. rates are not time-differentiated).
This can also be used for standby rates (i.e., price at the customer’s cost of providing its own standby power)
A. S. Azzouni Energy Consultants, NERA, Saudi Electricity Company

31. Contents of this presentation
Introduction
Electricity sector restructuring and market reform
Major customer electricity procurement economics
Objectives and concerns of key stakeholders
Key pricing issues
Alternative cost bases for pricing
Recommended alternatives
Conclusions
A. S. Azzouni Energy Consultants, NERA, Saudi Electricity Company

32. Key prices or tariffs applicable to major customers must cover/include
standard tariffs for purchases by major customers without generation;
interruptible tariffs under which customers without generation curtail load in system emergencies;
tariffs for the utility’s purchase of a generating customer’s energy production made available by curtailment of a customer’s load or additional energy production in critical periods;
tariffs for supplemental purchases by major customers whose generators do not serve their entire load on regular basis;
tariffs for backup energy and capacity, for use when a customer’s generation is down for planned or unplanned maintenance;
tariffs for sale of excess production of a customer’s generation to utilities;
tariffs for wheeling of excess production of a customer’s generation to the customer’s other sites or to third parties
A. S. Azzouni Energy Consultants, NERA, Saudi Electricity Company

33. Tentative Recommendation: Standard Tariffs for Major Customers
Two primary goals: efficiency and transition to competitive market
Short-run marginal cost is the cost basis most likely to achieve the primary goals
Major customer tariffs should
be differentiated by time of day and season to reflect time patterns of electricity production and as a prelude to market prices;
include a fixed charge based on contract capacity to cover the cost of facilities that must be sized based on the customer’s maximum demand;
include time-differentiated demand charges, unless there are sufficient pricing periods that capacity costs can be efficiently recovered in per-kWh charges.
include optional real-time pricing programs.
A. S. Azzouni Energy Consultants, NERA, Saudi Electricity Company

34. A. S. Azzouni Energy Consultants, NERA, Saudi Electricity Company
Tentative Recommendation: Interruptible Tariffs for Major Customers without generation
Major customer interruptible tariffs should
reward participating customers for their willingness to accept non-firm service in exchange for lower prices
provide a discount from firm tariffs that reflects the marginal value to the system of the expected load reductions
structure discounts in the form of reduced charges, credits when curtailments take place, or some combination of the two.
A. S. Azzouni Energy Consultants, NERA, Saudi Electricity Company

35. A. S. Azzouni Energy Consultants, NERA, Saudi Electricity Company
Tentative Recommendation: Interruptible Tariffs for Major Customers with generation
Major customers with generation may be willing to curtail load or increase generation in response to a request from the utility.
Such arrangements may require individual analysis for proper pricing.
An appropriate cost basis for the payments/credits for interruptibility should reflect the value of the interruptions to the system if economic efficiency is given a high priority.
A. S. Azzouni Energy Consultants, NERA, Saudi Electricity Company

36. A. S. Azzouni Energy Consultants, NERA, Saudi Electricity Company
Tentative Recommendation: Tariffs for supplemental power required by customers with generation
Unless supplemental service has load characteristics very different from loads of similarly sized customers without generation, the standard practice is to charge standard tariffs for supplemental service.
Thus, tariffs for supplemental service should be time-differentiated by time of day and season and based on short-run marginal costs.
This approach provides incentives for economically efficient design of the generator, and serves as a transition to retail competition.
A. S. Azzouni Energy Consultants, NERA, Saudi Electricity Company

37. A. S. Azzouni Energy Consultants, NERA, Saudi Electricity Company
Tentative Recommendation: Tariffs for standby power required by customers with generation
For economic efficiency, tariffs for standby service must cover the utility’s short-run marginal cost of standing by to provide intermittent power when the customer’s generator is forced out of service or is taken down for planned maintenance.
Charging less creates a cross-subsidy.
The amount of reserve capacity (distribution, transmission and generation) required to provide this intermittent service without reducing service quality to other customers is very situation specific.
Tariff structure should include reservation charges and time-differentiated charges for power consumed.
A. S. Azzouni Energy Consultants, NERA, Saudi Electricity Company

38. Tentative Recommendation: WheelingTariffs
A marginal cost basis for wheeling tariffs promotes economic efficiency.
However, cost shifting to other customers or stranded costs may occur if tariffs formerly paid by the third party did not reflect marginal cost.
The costs (or avoided costs) associated with wheeling may be complicated if the utility must provide standby service to non-utility generator.
These arrangements generally require individual analysis to identify costs, protect other customers, and result in economically efficient outcomes.
A. S. Azzouni Energy Consultants, NERA, Saudi Electricity Company

39. Contents of this presentation
Introduction
Electricity sector restructuring and market reform
Major customer electricity procurement economics
Objectives and concerns of key stakeholders
Key pricing issues
Alternative cost bases for pricing
Recommended alternatives
Conclusions
A. S. Azzouni Energy Consultants, NERA, Saudi Electricity Company

40. A. S. Azzouni Energy Consultants, NERA, Saudi Electricity Company
This paper focused on choice of appropriate cost basis for major customer pricing.
Our tentative recommendations point to short-run marginal cost as the appropriate basis for most tariffs involving major customers.
The short-run marginal costs should mimic the market prices that will emerge as wholesale and eventually retail competition is introduced.
They should be differentiated by time of day and season and be forecast out for the period the tariffs or contract arrangements are likely to be in effect.
Adjustment mechanisms or index provisions can be used to keep the tariff levels tracking current costs within the term of a tariff or contract.
A. S. Azzouni Energy Consultants, NERA, Saudi Electricity Company

41. A. S. Azzouni Energy Consultants, NERA, Saudi Electricity Company
Review of electricity pricing options has led to the following insights regarding Saudi Arabia’s electricity sector restructuring.
The significant volume of transmission sector wholesale business allows the establishment of an electricity market at the transmission level without creating multiple distribution companies or competitive suppliers for lower voltage customers.
Restructuring should encourage customers to invest in on-site generation or negotiate contracts with IPPs.
Restructuring should encourage major customers to take actions that reduce SEC’s cost of maintaining operating reserves, and improve system reliability by raising the installed capacity reserve margin.
Restructuring should encourage the development of market competition as a tool for achieving the least-cost mix of new generating resources with SEC’s tariffs for wheeling and standby fixed and in reflection of economic costs.
A. S. Azzouni Energy Consultants, NERA, Saudi Electricity Company