Methods for assessing the value of unsupplied electricity

Several approaches to estimating shortage costs have been pointed out in the literature on the subject, including the following three:

1. on thebasis of the observed or estimated willingness to pay for planned production of electricity(Brown and Johnson [1969]: Crew and Klein-dorfer [1976 and 1978]);

2. on the basis of losses in production value for the various goods and services affected (Munasinghe and Gellerson [1979]; Munasinghe [1979,1981a and 1981b]; FFE [1980];

3. on the basis of the opportunity cost of back-up power (Sangh vi [1982];

Bental and Ravid [1982].

In this section we will analyze these different approaches.

Munasinghe and Gellerson criticize the first assessment basis and prescribe the second instead:

The consumer's surplus approach is questioned since outages may disrupt other activities complementary to electricity consumption. Thus actual short-term outage costs may greatly exceed those estimated on the basis of willingness-to-pay for planned consumption ([1979], p. 254).

Munasinghe and Gellerson point out that load shedding does not neces-sarily take place according to the ranking of willingness to pay and therefore 'underlines the fact that the kilowatt hours lost owing to a random outage are not always marginal' (p. 356). Munasinghe and Gellerson claim that:

"the outage cost reflects not just the small wedge shaped area of consumers' surplus lying between the downward sloping demand curve and the horizontal price line owing to kWhs lost at the margin but rather a much larger amount of consumers' surplus forgone corresponding to inframarginal kWh lost." (p. 356).

Also, even if this is the case, Munasinghe and Gellerson claim that the losses can be significantly larger, 'because such an outage is unplanned and this leads to the forced idleness of complementary productive factors' (p. 56). Munasinghe repeats these arguments ([1981b], p. 150).

Let us analyze these statements. It is, of course, clear that the actual outage costs may be considerably greater than 'observed (long-run) willingness to pay" ([1981a], p. 150). The value of the elasticity of demand is (in absolute terms) lower in the very short run than in the long run and in this context, it is the very short run that is relevant.

In a comment to Brown's and Johnson's classical 1969 article, Visscher points out that load shedding does not take place according to the ranking of willingness to pay. However, this is hardly a decisive objection to continued use of the concept of willingness to pay as a point of departure for estimating outage costs that Munasinghe and Gellerson seem to believe. Naturally, the marginal willingness to pay is not an adequate measure in such cases. Instead, it is the average willingness to pay that is relevant, as was pointed out in the previous section. This is the case mainly when we are dealing with capacity shortages. The marginal willingness to pay is relevant when the advance warning of a shortage is sufficiently long and when dealing with risks for energy shortages.

Munasinghe and Gellerson's argument that the evaluation of outage costs on the basis of production losses is a better measure than on the basis of willingness to pay is not tenable. The demand function is derived from an evaluation of the production losses. Thus, an evaluation of outage costs on the basis of the one or the other, if properly carried out, should lead to the same result. Therefore, the method furthered by Munasinghe and Gellerson has no advantages in principle, though, of course, it may have some advantages in practice.

Munasinghe and Gellerson propose 'unsupplied electricity' for households according to the 'opportunity cost for leisure' and set this cost equal to net income per unit of time. However, it is hardly the case that the household's leisure time is lost. Rather, the content of the leisure time must be reconsidered. Therefore, it may be that the method proposed by Munasinghe and Gellerson leads to an overestimation of the true value. The method they propose for estimating the value of unsup-plied electricity to industry by estimating the value of production losses is of considerable interest providing that studies are made when inter-ruptions have actually occurred, and not only in connection with hypothetical questionnaires.

B en tal and Ravid [1982] suggest that the value of un supplied electricity for industrial purposes be measured by the costs of maintaining back-up supplies. The theory behind this method is that for a profit maximizing firm 'the expected gain from the marginal self-generated kWh is also the expected loss from the marginal kWh which is not supplied by the utility'.

Using this equilibrium condition 'the marginal cost of generating its own power may serve as an estimate or the marginal outage cost' (p. 250).

The authors are careful to point out that it is meaningful to talk about the cost of outages only given a certain level of supply reliability (p. 251).

We have interpreted this concept as the ex ante opportunity cost for unsupplied electricity. Thus it represents the maximum limit to the firm's willingness to pay. The basis for this interpretation is that the profit maximizing firms with a willingness to pay that is greater than the cost of back-up power will supply themselves with back-up power, while those with a lower willingness to pay will not.

This approach, based on revealed preferences rather than on the usual questionnaire concerning hypothetical situations, seems to us to be valid and promising. Therefore, we used this concept of a maximum limit to the willingness to pay in a study of the optimal reserve margins for electrical energy of the Swedish power industry; see the next chapter.