Thursday, October 21, 2010

Case for a socially sensitive merit dispatch order for power plants

The Wasteful gas operated power plants:

Case for a social dispatch order in running power plants.

By Akhtar Ali

Too technical? Let me explain. Utilities or Electric System Operators have a merit list of power plants .The cheapest source/power plant is put at number one and the most expensive at the very last. As power demand increases, plants are ordered to send/dispatch electricity; the cheapest one comes on line first, and then the next cheapest, and so on and the most expensive one in the very end. The rationale is obvious; to buy minimum from the most expensive source and the maximum from the cheapest. There are two variants of this system, depending on whether it is a competitive market environment where market price is determined through demand and supply as determined in a real-time auction in electricity exchanges which these days operate in most developed economies. In these systems, total unit price of electricity (fuel +capital cost + O&M+ profit), is used as a criterion to decide as to which source is expensive or which one is cheaper. In cost-plus or regulated environments, long term pricing is agreed to according to a certain formula. Essentially, an electricity vendor or generator is paid for all his costs plus an agreed rate of return on his equity .Payments are made in two streams; one is the fixed annual costs paid usually in monthly installments. This stream of payments is to be made by the purchaser or the distribution companies or their agent, irrespective of whether , the purchaser orders electricity or not. It is a fixed liability on the buyer to be discharged as per agreed schedule. The buyer therefore treats these costs as sunk costs. Variable component of the price is to be paid at actual according to an agreed rate determined by a formula that includes fuel costs and O&M costs. Meters are installed , which record electricity units(kWh) received , and payments are made by the distribution companies to electricity vendor or generating companies , as an ordinary consumer pays for the electricity. This is the cost-plus system that operates in Pakistan, as it does in other developing countries, where electricity markets do not exist.

Coming back to the merit dispatch order, in cost- plus environments like ours, merit dispatch criterion is set at the unit variable cost. Purchaser would only compare his variable costs, (which for major part is actually fuel cost) for every incremental unit it buys, as his fixed costs are sunk costs.

There is another peculiarity in our energy and electricity systems .All fuels are not priced at their true worth and in this case their energy content, technically termed as Calorific Value. Oil may be inordinately expensive as it is mostly imported, while gas may be cheaper because it is locally produced. Reverse may be the case in most oil producing countries in the developing world, where often petrol prices are cheaper than crude oil.. to the extent of being literally free ,as is the case in Venezuela. False economies and comparative trade advantages and industrial base is established in such pricing regimes. On the other hand there are social constraints. Energy is an essential commodity and is required by the rich and poor alike, directly or indirectly. Usually some kind of trade offs is made. Normally, international financing agencies are opposed to these trades-offs and pressurize the policy makers to reduce or eliminate cheaper rates of energy than these are worth essentially, they argue for a uniform pricing. It is not the time and place here to examine the merits and demerits of uniform or optimal pricing in general and philosophical terms. We will examine here the implications of energy pricing policies on merit order dispatching, especially in Pakistan perspective.

What is happening in Pakistan is as following. In Pakistan, generally, gas is priced at half the rate of oil in terms of Rupees per unit of energy content, technically called Btu. There are a number of plants which are thermally very inefficient and consume a lot of gas , yet these plants are most frequently employed because the commercial cost is low due to cheap gas. Had gas been priced higher as per its energy content, these inefficient plants would only be used scarcely for peak requirements. Currently these double up as intermediary base load plants. Technically speaking, these come up higher in merit order.

Then what should be done. A simple and straight forward solution as would be practiced in rich countries would be to retire these inefficient gas guzzlers. We probably cannot do that , as we are already suffering from load shedding. But the irony is that due to pricing anomalies , even in the periods when there was no load-shedding , these inefficient plants were utilized much more ,and the most efficient and new and costly power plant like HUBCO remained under-utilized . It is now that there is a shortfall of 4000 MW that HUBCO is being utilized as per its availability and capacity. This is another matter that now there is funds issue and the circular debt that may prevent its fuller utilization. NEPRA has recently taken KESC to task for not utilizing its available capacity, which perhaps was for similar reasons.

Coming back, what to do then? Increase gas prices and thus hike electricity tariff, which the public is already crying horse against. More of tariff increase is in pipeline for other reasons, most important of which has been the recent Rupee devaluation. Our textile industry and exports are weaned on cheap gas prices and are quite used to wasting gas as well. Wasting habits go away gradually, but tariff increases may make the exports suffer causing unemployment and balance of payment difficulties.

Theoretically, price increase would discourage waste and bring about what the economists call optimal resource allocation, a Utopia indeed. Energy consumption is already quite low, and people are close to being pushed out of the energy market altogether. There are larger questions, but we would restrict ourselves to the problem of inefficient power plants wasting gas unnecessarily. We can’t throw these away and nor increase the gas prices to be brought in line with those of expensive oil. What to do ? Let us examine the following proposition.

The proposition is simple. Bring these plants out of the merit list and operate these for peak requirements and in emergencies as back up power. I wrote a long preface for this simple solution, but the effort perhaps would be well spent, if it makes our power sector operators respond to it positively.

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