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An application of marginal cost pricing principles to B.C. Hydro

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Title: An application of marginal cost pricing principles to B.C. Hydro
Author: Osler, Sanford Lake
Degree Master of Arts - MA
Program Economics
Copyright Date: 1977
Abstract: The purpose of this paper is to develop and apply a methodology to determine the marginal economic costs of supplying electricity in the predominantly hydro-electric system of the British Columbia Hydro and Power Authority (B.C. Hydro). This information is used to design an economically efficient rate structure in which marginal price is set equal to marginal economic cost. The resulting implications for the growth rate in electrical demand and costs are then calculated. A computer simulation model is built which, once given a demand forecast to 1990, plans and operates the electric system in a cost minimizing fashion subject to technical constraints and the operating policies of B.C. Hydro. The associated annual accounting costs are determined and the rate levels adjusted in accordance with the Authority's financial policies. Marginal economic costs are calculated by introducing various alterations to the demand forecast and examining the implications for the present value of economic costs of such changes. These amounts, when divided by the quantity of electricity involved, give estimates of the unit costs of a change in energy and/or peak demand for various classes of customers. These marginal economic costs are then incorporated in a redesigned rate structure in which marginal prices equal these marginal costs while average prices continue to equal average accounting costs. By applying various estimates of long run own price elasticity of demand, the impact on demand growth caused by marginal price changes can be determined. This new demand forecast will, in turn, affect system design and operation and thus ultimately, costs. The result of this analysis is that the larger users (both within each class and within the system) face substantially higher marginal rates from those now in effect. In particular, the economic analysis attaches far greater weight to the energy component of demand in the energy-critical B.C. Hydro system than does the accounting approach. Under the median elasticity estimates, this rate structure reform reduces the electrical growth rate from 9.0 to 7.0 percent in the 1976-1990 period, reduces average real accounting costs from 18.1 to 16.5 mills per KWH, and reduces the gross debt outstanding in 1990 from 17.1 to 11.2 billion historic dollars. We conclude that there exists substantial gains in social welfare to be obtained from redesigning B.C. Hydro's electrical rate structures.
URI: http://hdl.handle.net/2429/21023
Series/Report no. UBC Retrospective Theses Digitization Project [http://www.library.ubc.ca/archives/retro_theses/]

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