The article
and the slides on “Cross Subsidizing in
______________________________________________________________________________________________
“THE USE OF BOILER HOUSES IS RUSSIA’S NATIONAL
DISASTER” part 8
Cross
Subsidizing in Russia’s Power Industry
Omsk Electricity-generating Company
Perspective Development Department Head Deputy.
Heat Power Industry Analyst.
Where is the root of all evil? Why
are the methods that in terms of technological and business indicators ensure
benefit of up to 40% of fuel NOT used in
The main source of all these
troubles in the Heat Power Industry of Russia is the lack of marketing aimed at
the promotion of energy goods and services which, in its turn, leads to cross
subsidizing in the Power-generating Industry. While there is some minor
progress in the Electricity-generating Industry, for instance, the creation of
The New Wholesale Market of Critical Power and Energy (NWMCPE), the marketing
of heat energy and power, to say nothing of combined-cycle energy, sees neither
attempts to understand the current situation nor even interest to make such
attempts.
Taking into account the lack of
market experience for the Heat Power Industry and the lack of special knowledge
concerning combined-cycle energy generation cost estimation when it is required
to ensure various types of power margin, experts of
Extracts from classical
works
Extracts from the article “he Deregulation of the
Electricity Industry. A Primer.” by Peter M. VanDoren[1]
Cross Subsidies
*Very few residential customers of electric utilities currently face
real-time marginal-cost prices. Instead they face average costs that vary at most twice a year between
winter and summer. In a completely deregulated market, consumers would
presumably face lower off-peak prices and higher peak prices. That, in turn, might create political pressure to protect
residential consumers from "too high" peak prices. States facing such
pressure might mandate that residential customers be offered an average-pricing
plan. Public utilities' costs do not differ substantially from those of private
utilities, but they price their output differently. As one would expect of a
firm driven by electoral concerns,
publicly owned utilities have lower
residential and higher industrial electric prices than do investor-owned
utilities. The possibility of policy change always results in opposition
from those who
perceive that they will lose market privileges that they currently
posses as well as from those who do not think that their share of future
benefits will be appropriate. Electricity is no exception to that rule. Those
who are subsidized in the current regime worry about the loss of subsidies if
deregulation occurs.
Cross subsidies exist if some
customers are charged prices that are above marginal cost in order to allow
other customers to be charged less
than marginal cost. Cross subsidies are possible under monopoly because the
"taxed" consumers may not choose an alternative supplier who charges
them less. Cross
subsidies are not sustainable in competitive markets because the
"taxed" customers may choose an alternative supplier who does not
"tax" them. The good news is that cross subsidies are not
viable in deregulated markets. Cross subsidies distort prices and serve equity
goals very imperfectly.
Means-tested vouchers for
individuals can serve equity goals better with fewer price distortions.
Subsidies in the form of vouchers are more compatible with market innovations.
If conventional electric service to rural areas was expensive when correctly
priced and the political system responded with means-tested rural-electric
vouchers, recipients might buy microturbines with their subsidy to save some of the money
they spend on correctly priced, expensive, conventional electric service.
Vouchers would be subject to much more public scrutiny. By contrast, cross subsidies are embedded invisibly
within existing rates in ways that voters do not perceive. Under closer
public scrutiny, many cross subsidies would not survive. Annual,
transparent, sliding-scale voucher subsidies are more compatible with markets
than are cross subsidies. To be sure, the rationales for these subsidies (with
perhaps the exception of the low-income program) will not survive close public scrutiny, but if they do, explicit
congressional or state appropriations are more efficient than invisible cross
subsidies that alter the price of electricity at the margin. Rather than use
brute force to separate generation from transmission and distribution and
regulate the grid as a common carrier, why
not just eliminate federal and state regulation of the existing vertically integrated
utilities and let market forces discover the "best" economic
arrangements?
(The full text of the article in the Russian
language is presented at: www.libertarium.ru/
libertarium/der_energy05)
“...Unfortunately RAO UES of
10 Types of Cross Subsidizing in the Region’s
Economy
As a result of the lack of efficient
heat and electricity Power, Capacity and Margin marketing, to say nothing of
the combined cycle energy and power, Russia’s current tariff policy has led to
launch a very deep-set invisible (technology-based) and visible (social) cross
subsidizing in the Power-generating Industry. The Regulatory Bodies – Federal
Tariffs Service and Regional Energy Committee – have come to firmly believe
that it is not economically beneficial to use condensing cycle with
cogeneration plants. On the other hand the cost analysis carried out based upon
the demand for fuel required to generate and transport electricity and heat
power shows a different situation. Figure 1 shows energy loss streams as fuel
loss that takes place in the course of electricity generation and transportation
from cogeneration plants and electricity-generating stations. It is plainly
visible that economic indicators for both electricity-generating and
cogeneration plants’ condensing-cycle electricity production and shipment are
equal. Taking into account the fuel loss that takes place during electricity
transportation to the end user the fuel loss is as follows: а) for electricity delivered from a
distant electricity-generating station: at least 62÷64%, b) for
condensing cycle electricity produced at a cogeneration plant close to the
consumer: at least 64÷65%.
It is clearly seen that even with
this fuel loss the electricity produced according to the cogen
cycle costs the society 4 times less than the electricity produced according to
the condensing cycle (15% vs 64%)!
Type 1
Subsidizing of electricity generation
at the expense of heat power produced at the cogeneration plant
Electricity subsidizing at the
expense of heat power. This is the most widespread type of subsidizing used at cogeneration
plants and debated about since 1952. The subsidizing of electricity generation
at the expense of heat power reaches up to 30 % of fuel and related overheads
distributed in proportion to the fuel that is presumably required for the
generating of electricity. This type of subsidizing is discussed in detail in
my articles published in previous issues of the journals (“The Use of Boiler
House …” parts 2-3). This type of subsidizing also includes some cost transfer
methods, such as manufacturer’s cross subsidizing between basic, semi-basic and
on-peak heat power and electricity.
Type 2
Subsidizing of electricity consumers
at the expense of cogeneration plant’s heat power consumers
Subsidizing of electricity consumers
at the expense of the consumers receiving heat power from the cogeneration
plant. This method of cross subsidizing is invisible and absolutely hidden from
ordinary consumers. In order to understand this method one must clearly
understand cost-generating mechanisms connected with the consumption of
combined energy received from the cogeneration plant. From the times of the
Type 3
Subsidizing of electricity supply
Capacity (reliability) at the expense of energy fees
Subsidizing of electricity
generating capacity maintenance costs at the expense electricity costs. This is
the most widespread type of cross-subsidizing used at the stage of electricity
shipment. It is used in the estimation of services of electric network
companies, system operator, sales network operator. Fees for the margin, for
the required reliability and failure-free supply of electricity – are
hard-to-measure categories which require a detailed analysis. Real costs
required to ensure capacity Margin may amount to at least 50-300% of the costs
required to ensure on-balance capacity. Nevertheless, due to the lack of
methodology for estimating Margin, System Reliability and Failure-free Operation
related costs they are not specified as a separate service but are included in
the Power and Capacity fees as an extra fee in the form of cross subsidizing
for the purpose of calculation simplification.
At the stage of electricity shipment
and distribution energy-related variable costs that are determined based upon
electricity loss resulting from idle running and warming-up (reflected as
primary fuel loss) are not the key costs and amount to no more than 20% of
energy producer’s costs. The key costs for a shipment company are the capacity
maintenance costs classified based upon the process characteristic: on-balance
electricity power; off-balance “stand-by capacity”, off-balance “seasonal”
power capacity; off-peak on-balance capacity required to attract off-peak
summer consumers; “proclaimed perspective” capacity of the coming years,
“long-term ownerless” power capacity not declared by the consumer etc. (Classification
of types of energy services is presented in my article “The Use of Boiler Houses…”,
part 4). A special type of cross
subsidizing in the Electricity-generating Industry used to be a user’s fee
intended to cover system reliability assurance and federal network construction
costs.
Transfer from invisible to visible
subsidizing will enable one to determine the cost of such types of energy
services: fee for short-term and long-term electric power capacity, fee for
non-justified “ownerless” capacity, fee for energy-saving category – 1, 2, 3
etc. The current consumer will either be willing to pay the costs related to
the aforementioned items or the electricity network owner will have to cover
the costs. The desire to assign capacity and electrical power maintenance costs
to the energy price leads to hiding these expenses and as well as to the lack
of incentives to identify, norm-set and gradually decrease them.
Type 4
Subsidizing of Capacity, heat supply
Margin Capacity at the expense of Energy fees
Subsidizing of heat-generating
capacities maintenance costs, heat capacity margin costs at the expense of heat
power generation costs. This is also a very widespread type of cross
subsidizing in the Power Industry which is based upon the lack of
methodology-based approach to the estimation of costs required to ensure
reliable and failure-free heat supply. The costs required to ensure reliable
heat supply are one of the highest costs that amount to at least 30-150% of the
power costs; besides these costs are the least studied costs in terms of
norm-setting. One of the reasons that this type of subsidizing exists is that
the system enabling to measure heat power per external air calculated
temperature is still poorly developed. Until now calculations and norm-setting
practice do not account for such notions as network pipe installed capacity, network pipe actual capacity, pipe’s calculated annual throughput, network
pipe’s actual energy and power annual throughput. The existing methodology does
not use such notions as: calculation of costs required to ensure low-potential
(up to 70°С) heat power
and high-potential (above 115°С) heat power. In the Heat Power Industry the situation concerning the
identification of heat generating capacity margin maintenance costs is even
worse than in the Electricity-generating Industry. There is no power cost classification
or norm-setting system: а) based upon the process
characteristic, b) on-balance heat power; с) off-balance “stand-by capacity”; d)
off-balance “seasonal” power capacity; е) off-peak “on-balance” power necessary to
attract off-peak summer consumers; “proclaimed perspective” power capacity of
the coming years; “long-term ownerless” power capacity not specified by the
consumer etc.
The
exclusion of reliability assurance costs or reliability assurance through
non-economic measures – namely, by means of assigning the costs to other
expense items leads to the distortion of heat energy and power real costs.
Types 5 and 6. Subsidizing of social
consumers (electorate). “Everyone at
everyone’s expense”
Social
(visible) subsidizing of various types of consumers in favor of the population.
What is interesting is that the basis of this type of subsidizing is not
process-related but social differences that determine electorate’s behavior.
The population is subsided at the expense of industries and commercial
consumers. This type of subsidizing is used both in the visible form at the
tariffs generating stage and in the invisible or semi-invisible form. A good
example of semi-visible social subsidizing is different natural gas tariffs.
For instance, the population and public utilities services are offered
privileged or so-called limited gas tariffs while industrial consumers are
faced with “above-the-limit” gas tariffs exceeding those for thee population by
30-40%.
Types 7 and 8
Subsidizing of distant consumers at
the expense of close consumers
Subsidizing
of distant consumers at the expense of close consumers is one of the most
widespread and relatively “innocent” types of cross subsidizing used in the
current tariffs regulating practice. For instance, in the
Electricity-generating Industry this method is used to subsidize distant
villages, elite areas and resort territories located at about 15-30 km away
from electricity sources and whose load is around 10÷15 lamps. In the
Heat Power Industry, for instance, this method is used to subsidize detached
houses built away from main heat lines. The most widespread form of cross
subsidizing is artificial unification of various sources into a unified power
center, the joining of inefficient and efficient heat power sources.
Type 9 “Time-based” subsidizing of
new consumers at the expense of old consumers
This is the most widespread, the
most invisible and the least discussed type of cross subsidizing in the Power
Generating Industry. The subsidizing of current time new consumers’ costs at
the expense of old consumers. This type of subsidizing is widely used when new
consumers are connected to the existing electricity or heating systems.
Type 10 Subsidizing of new
technologies, power saving, “green” technologies
Producers of “green” energy and
power using environmental-friendly power-saving technologies: waste
incineration plants, heat pumps, heat batteries etc.
“Inconsistent”
electricity and heat power supply policy in the regions
Inconsistent policy – contradictions
arising between words (proclamations of politicians) and actions (actual measures
implemented)[3]. Cross subsidizing is good for managers of
large electricity-generating companies that use the flaws of regulations and
recommendations in favor of Electricity-generating Industry. The desire of
large energy generating companies to use company-average or holding-average
calculations is quite understandable. When companies on the on hand are presumably
in the market conditions and on the other hand they are still regulated
structures, they can afford not to work on real cost minimization. Cross
subsidizing is good for politicians, town or city mayors, region governors who
are forced to make decisions contradicting their previously declared
obligations to decrease energy tariffs. It is much simpler to work with the
electorate - heat and electricity consumers paying equal prices than explain
why real costs for consumers from a street powered from a cogeneration plant
are 2÷5 times lower than for consumers residing in a street powered from
a residual fuel-operated boiler house.
But neither the Federal Law “On
Electricity-generating Industry”, nor the Draft of the Federal Law “On Heat Supply”
responds to the following questions: what does one do with huge unused capacities
of power generating sources, power transmission lines, main and district heat
lines? Who is going to cover the maintenance cost spent on the equipment with
long-term (over 2 years) power margin of over 4 %? Should it be the consumer
who pays long-term capacity margin costs or should it be the owner who has a
huge power margin and no real perspective of demand growth?
A few more words about cross subsidizing
“..another problem arising as a result of the “average costs plus
profit” pricing model is brought to light by the notion “cross subsidizing”. In itself cross subsidizing is a form of price discrimination, in
other words it enables one to fix such price level that covers average common
costs of the industry. In this case some consumers pay higher prices than the
value of the goods and services they receive while some consumers pay lower
prices[4]”.
(page 394)…….for a number of
reasons the regulation of natural monopolies based upon the profit rate they receive
is not always a success. This good idea is often undermined by such an
unpleasant motif as political rent
seeking. Hypothetically there are two possibilities: merging of
entrepreneurship and supervisory bodies and consequent filling of the positions
with interested persons or bribers and patience of supervisory bodies in
relation to some companies where state
bureaucrats and politicians hope to “seek shelter” after their time in office
is over. There is also another
threat: in some fields supervisory bodies are under very severe pressing from
consumers who are interested to minimize the prices ignoring long-term demands
and needs of businesses and industries.
Another important problem is the lack
of knowledge concerning real profit rates in various industries. Accurate
measurement of a company or a business capital, actual market-based profit rate
and alternative value of invested capital seems to be an overcomplicated task. The more guesswork and “out-of-the blue”
data, the higher the probability of erroneous and careless decisions.
Last but not least. If a company is placed within the framework of the
“costs plus profit” model the regulation of the market process undermines the
basic incentives of market economy. If company’s profit exceeds the costs by a
certain value, it eliminates the necessity to minimize the costs which is
rather complicated to do. Thus, the incentives to minimize the costs are
weakened.
As was mentioned earlier, it is quite probable that natural monopoly
regulation efficiency calculations use increased (or decreased) profit rates
per capital that may not match the alternative value of its use. For instance,
in the 50÷60s the profit rates in the Electricity Supply and Power
Industries were very much increased which easily attracted the capital to the
construction of new power stations (which, by the way, later became part of
industry’s basic estimation calculations). That led to careless and
overabundant investment into the Industry. In the 80s the situation changed –
the profit rates were decreased. It led to the decrease in investment required
for normal operation of the Industry. Moreover, low prices for such services
disguise the acuteness of the problem. In the course of equipment aging and
depreciation the quality of electricity supply services rendered to the
population sharply drops; some experts predict a serious deficit of electricity
in case of using an artificial profit rate suppression mechanism in the
Industry. Thus, profit-rate artificial regulation mechanism gives a two-edged
effect while the efficiency of the market process is caught in the narrow
pathway between two extremes.
(page 395)…It is a priori believed that electricity generation maximum costs are
constant and only slightly different from the common average costs taking into
account the product yield. It is easy to prove that in practice
such view is rather idealistic (for instance, power plant commissioning time
brings about a change of maximum costs for new and outdated power-generating stations).
Thus, Regulatory Bodies have to differentiate their pricing policy within one
Industry which
may result in the prices below the maximum cost level, lack of incentives to
implement modern resource-saving technologies etc.
Measures in tended to
eliminate cross subsidizing in the Heat Generating Industry of
At the Federal Level:
- Stipulate
in the Law the responsibility of the Federal Bodies (Ministry of Economic
Affairs, Ministry of Industry and Power, Ministry of Natural Resources
etc.) concerning efficient use of fuel in
- Develop
the “Power Code of the
- Develop
the National Project: “State-initiated Cogeneration Development in
- Develop
“Recommendations on Identification of Power-saving Effect” and extend
“6tp” statistics with “Fuel Saving Potential through Power Cogeneration”
Section;
- Develop
“Recommendations on Identification of Visible and Invisible Cross
Subsidizing Scope” in the Heat Generating Industry of
At the Regional Level:
- Specify
a Body responsible for the efficient use of fuel in the Region;
- Approve
and implement “Regulations on the Generating of Heat Supply Systems and
Public Utilities Companies’ Integrated Development”;
- Develop
a long-term “Program on Stage-by-stage Transfer from Quality to
Quantity-based Regulation of Heat Delivery to Public Utilities Consumers”;
- Implement
“The Regional Standard of Heat and Cogen Power
Consumption”;
- Develop
and implement “City Complex Heat and Power Facility Operation Quality
Estimation System”.
[5][1] Peter M. VanDoren “The Deregulation of the Electricity
Industry. A Primer.”. Russian edition is available at: www.libertarium.ru/
libertarium/der_energy05)
*
Here and further in the text bold, red, underlined and italicized text is
according to Mr. Bogdanov (translator’s remark)
[6][2] Marketing / U. Rudelius
and others -M: DeNovo,
2001-706 pages, page 342
[7][3] N.Gregory
Mankiw ‘Principles of Macroeconomics’ – quoted by
Russian editions, 2nd edition, PITER 2006, page # 536
[8][4] Edwin J. Dollan;
David E. Lidsney “The Market. Microeconomic Model” -
quoted by Russian editions, translated from the English language by V. Lukashevich and colleagues, edited by B. Lisovik and V. Lukashevich. moscow.1996, 496pages