CHAPTER ONE

INTRODUCTION

1.1 Background Information

The Electric Supply Industry as it is known today did not come by chance, but as a
result of deliberate attempts made by innovative minds to explore and build on
inventions before them. From Faraday discovering the basic principles of electricity
generation from the works of Benjamin Franklin and others to Edison’s invention of
the incandescent light bulb and his partner Samuel Insull who made it into a business,
there have been regular attempts to improve on Electricity supply and delivery (IER,
2014).

Due to limited and expensive storage mechanisms, electricity largely must be

consumed at about the instance of its production; hence it is different from other
commodities and so requires a different business model. From the earliest time to few
decades ago, it was therefore treated as a welfare commodity, wherein Governments
of different countries saw it as a basic need of the citizenry and a must provide. In this
approach, the business was owned and operated solely by state firms.

With advancements in technology and a larger consumption of electricity, its supply

as welfare commodity became costly thereby making its provision by the Government
very difficult in the midst of other seriously competing needs. This led many
developed countries in early 1990s to deregulate and privatize most components of
the electricity industry. Today, many developing nations have joined in taking it away
from their budget as a social cum welfare goods. The generation, distribution and
ancillary services are now privatized and commercialized bringing in competition
among the numerous players in the industry.

The essence now is profit making which has pushed the price so high above the reach
of most citizens, despite its seemingly more availability. The question therefore, is
how to determine appropriate pricing mechanism, which will aid in developing a
general more acceptable tariff structure.

1.1.1 Regulation of the Power Industry

Utilities were regulated in the first place due to the inherent risk that one player
may monopolize supply thereby overcharging consumers due to low competition
and enormous demand. Here, prices are set on the basis of production costs solely
(Warwick, 2002).

The pioneers of the electricity industry faced two populist threats from local
government. Rate ordinances that could arbitrarily require rate roll-back or
impose rate ceiling, thus ruining profitability and Municipalization whereby
private investment in electricity infrastructure would be taken over by city or
county government (Geddes,1992). With these threats, the private enterprises were
forced to accept rate regulation in exchange for franchises to run their generators
in specific geographical locations. This led to industry regulation resulting in the
regulated power industry framework, which were vertically integrated whereby a
single entity took charge of generation, transmission and distribution.

The regulated framework was characterized by so many drawbacks which

includes inefficiencies as power companies had monopolistic advantages, utilities
were being obligated to run on the terms of the government, which was not
necessarily profit oriented but under the compulsion to serve, customers need was
constantly unmet.

1.1.2 Deregulation of the Power Industry

Around the world, electric industries are undergoing extensive restructuring. The
trend started in the 1980’s in Chile and UK and spread through Asia, Europe,
Latin America and Africa. The motivation for restructuring differs .Although the
major objectives of electric utility restructuring is to increase competition,
decrease regulation, and in the long run lower consumer prices (Glover, Sarma and
Overbye , 2011).
However, for some other systems, so long as consumers were concerned, they
were not satisfied with the rising costs of electricity. For some other systems,
utility management found that running the system was not viable due to low tariff.
In some systems, pressure from smaller players to open up the business for
competition played a major role. By and large, deregulation took place in
developed countries by pressure to reduce costs while simultaneously increasing
competitiveness in the market.(NPTEL,2015)

The privatization of the power sector has been made possible after recognition that
the sector could be separated into generation, transmission and distribution sectors
and even these sectors could be broken into several companies, without
compromising the economic advantages of a vertically integrated government
monopoly, which earlier existed in most countries (Srivastava, 2002).

A more acceptable definition to deregulation with regards to the power industry is

the restructuring of the rules and economic incentives that government set up to
control and drive the electric power industry.(Abhyankar and Khaparde,2002)

Some of the problems of deregulation are

(i) Utilization of the Product: Electricity is produced and consumed almost at the
same instant making for rapid fluctuation of its marginal cost of production as well
as delivery cost.

(ii) The lack of metering and real-time billing: This causes a lack of demand
responsiveness to price or technically, a lack of demand elasticity.
(iii) The lack of real-time control of power flow to specific customers: This
prevents physical enforcement of bilateral contracts and results in the system
operator being the default supplier in real time.

Unfortunately, the system operator, as default supplier, is forced to set the price, at
least when supply fails to intersect demand. It can also improve the market by
setting price under slightly less dire circumstances. Presently, all power markets
operate like this and will continue to do so until very short-run demand elasticity is
significantly improved.

1.1.3 Components of a Restructured Electricity Environment

With the advent of deregulation came the restructuring of the electricity
environment, with each component performing different functions. According to
(Abhyankar and Khaparde, 2002), the following players or entities have evolved
(i) GenCos (Generating Companies)
These companies generate, bids and sells energy in the competitive market place.
(ii) TransCo (Transmission Company)
This company conveys the bulk of generated power from where it is produced to
where it is meant to be delivered. It is also saddled with the responsibility of
maintaining the transmission facilities.
(iii) DisCos (Distribution Companies)
The distribution company owns the system that delivers power to individual
industries, businesses, commercial, as well as, residential areas.
(iv)RESCo(Retail Energy Service Company)
The RESCo is the retailer of power. In some forms of deregulation, no new
company is actually created and tagged “RESCo”. In such cases, the retail
department of the former vertically integrated system carries out the function of
the RESCo.
 (v)ISO (Independent System Operator)
This is the unit responsible for the consistency, dependability and security of the
entire system. It observes the electricity market trades.
(vi) Customers
The customers are the consumers of electricity. Deregulation has given the
customers several options from which to purchase electricity.

1.2 Problem Statement

During the regulated era, electricity was treated as a welfare package, but with the
recent trend of restructuring in the power sector there is need for effective pricing of
the various players involved in power delivery. The transmission which is still largely
in the hands of the government proves problematic in its pricing, but since it is an
interconnecting link between the generating firms and the distribution sectors, its
pricing is of importance. The generators can account for the cost of production of
power since they know their fuel and maintenance costs but without the transmission
cost appropriately determined it would not be easy to cost appropriately the
transmission component of power. In the course of operating the system, reactive
power is absorbed and introduced from point to point in the system, which could lead
to instability in the power system. With some existing transmission pricing methods
been cumbersome and not including reactive power in its computation, a simpler and
fairer method, which incorporates reactive power in its pricing, is necessary, as this
would lead to proper accounting of the reactive power introduced or absorbed in the
system, leading to a system with higher stability. Therefore, this work seeks to find a
solution to the problem of appropriately pricing the transmission which has a
significant deficiency in its pricing due to the non-inclusion of the reactive power
component, which is seriously needed to ensure system stability.
1.3 Objectives

The main objective of this work is the development of an improved postage stamp
transmission tariff model for the deregulated electricity market.

While specific objectives include:

i. Compare transmission cost allocation methods

ii. Develop an improved transmission tariff model
a) Mathematical model
b) Algorithm
c) Flowchart
iii. Implement recommended tariff model in test systems using Matrix Laboratory
(MATLAB) and Microsoft Excel.

1.4 Justification of Study

With the restructuring of the power industry across the globe, definitely, investors
would want to maximize profit and this can be done effectively by minimizing cost.
Customers on their own part would want to be treated fairly as they would want to
participate in the gains deregulation brings. It has been observed in some quarters that
customers deliberately or sometimes unknowingly introduce or absorb reactive power
into or from the system with its attendant consequences on the grid. It is argued in this
work that if such customers are made to pay for such actions or rewarded in the way
of lower bills for improvements made to the system, it would lead to an efficient grid
in the long run.

1.5 Scope of Study

This report would cover the context of tariff structures in generation, transmission and
distribution. It would focus on deregulated electricity markets in the USA, South
Africa and Nigeria. Comparisons would be made on the different cost allocation
methods of pricing used across the transmission sector. Analysis would be carried out
to demonstrate the effectiveness of the proposed approach in determining a simpler,
fairer and more effective tariff structure to be used in deregulated electricity markets.