Incremental Pricing - Fixed and Variable O&M
A key question all utilities are now facing is
that of pricing incremental O&M costs for use in determining
prices for off-system sales. Previous methodologies, which
addressed energy versus capacity pricing, do not meet
todays needs of defining variable costs.
One of the key components in determining
incremental costs of power production is variable O&M. The
issues surrounding variable O&M have become very important in
the utility industry as competition increases and more and more
utilities try to improve their earnings or margins through
increased off-system sales. Historically, fixed and variable
O&M calculations were established primarily to determine
demand and energy charges for long-term sales. Under these
circumstances, the concern was proper cost accounting and
allocations between the two types of rate charges. Today, as
margins for off-system sales become smaller and competition
becomes greater, it is important for a utility to know, as
closely as possible, its incremental costs of producing
electricity so that it can be assured that sales are being made
which cover production costs.
At many utilities, a "fixed percent"
method , i.e. 70% fixed/30% variable has been used for a number
of years. This method was developed in the early 1980s and
was based on estimates of the appropriate variable and fixed
costs needed to operate a power plant. Other methods that have
been accepted include the Federal Energy Regulatory Commission
(FERC) procedure, which classifies expenses as pro-rated to
demand or energy related; the National Association of Regulated
Utility Commissions (NARUC) method, which uses a similar
classification of demand in energy related expenses; and the EPRI
method of classification.
The evaluation of production O&M expenses
is generally the responsibility of the Rates Department for most
utilities, in conjunction with Power Production, Engineering, and
System Operation Department to provide input and utilize the
O&M expense information for off-system sales.
The impact of decisions regarding variable cost
on fuel procurement are somewhat indirect, but extremely
important. The pricing structure that is utilized by system
operations for off-system sales will dictate the level of system
sales and the result in fuel consumption. Some utilities use spot
coal in its pricing for off-system sales. By using the spot price
of coal for the production of off-system sales, the short-term
procurement policies must be capable of changing very quickly, as
sales opportunities rise or diminish.
Our consultants will work directly with power
supply, rates, cost accounting, engineering and system operations
management to determine both the corporate philosophy and
specific costs needed for the evaluation. The typical steps would
· Determine if management has developed
specific objectives regarding off-system sales and
develop if necessary.
· Review the current methodology for
determining fixed/variable mix.
· Establish a proposed sales strategy for
each unit in the system.
· Establish a work team for each station/unit
to identify specific activities.
· Review and allocate all cost elements into
· Develop algorithms for converting current
cost accounting information to incremental pricing
· Prepare pricing policy for dispatch and
The benefits of a system that provides accurate
and current information regarding incremental costs provide an
array of benefits:
· At any time, power sales personnel will
know, with some assurance, the actual incremental
cost of power production. This will help in
maximizing profits and avoiding sales at below cost.
· An increase in sales is also likely as a
result of better definition of mission and clearer
cost estimates. For example, a 500 MW coal fired unit
with a capacity factor of 60% might see an increase
in capacity factor of 1% to 3%. With a 5 mill margin
between incremental cost and sales level, the annual
net revenue would be approximately $219,000 for each
1% increase in capacity factor.