Electric Energy Efficiency

Energy Economics and Markets

Dr. Mohammad Al-Muhaini

 References

[1] Association of Energy Engineering (AEE).

[2] Slides of Dr. Mohammed Muaafa, Senior Energy Researcher at KAPSARC USGBC Faculty.
[3] Dr. Fahd AlIsmail Lecture Notes, EE459
Energy Economics - Basics
 Energy Economics and Markets

What is Economic Analysis?

Economic analysis forms the core methodology of making
decisions about:

– Whether or not a project is cost-effective, or

– Which one of several projects is most cost-effective.

These decisions require the knowledge of project costs

and project benefits (often called “cash flows”) as well as
a knowledge of interest rates and the time value of
money.
 Energy Economics and Markets

Time Value of Money

Important Rule
(A dollar today is worth more than a
dollar in the future)
Because money has earning power. In other words, if today you put a
dollar in a bank where it earns interest, it is worth more than a dollar
tomorrow. This change in value over time is called the time value of
money. Some have called this the most important concept in economic
analysis.

As an example, think of the price of a car. In 1980, a car would have

cost about $20,000. Today, a car is about $30,000. So in about 30
years, your initial $20k would only pay 2/3 of the current cost of a car.
Thus, the value of a dollar falls as time moves on.
 Energy Economics and Markets

Financial Terms
Life Cycle Cost (LCC)
Life cycle cost (LCC) is an approach that assesses the
total cost of an asset over its life cycle including initial
capital costs, maintenance costs, operating costs and the
asset's residual value at the end of its life.
Energy Economics and Markets
 Energy Economics and Markets

Net Present Value (NPV)

For a simple project, NPV is the difference between

the present value of the project’s savings (future
cash flows) and the project’s initial cost. Can also be
called Net Present Worth.
Energy Economics and Markets
 Energy Economics and Markets

Interest Rate (I or i)

This term can be used different ways

– If borrowing money, the “finance rate” is the rate you are

charged
– Conversely, if you are investing money in an account, the
“interest rate” dictates how fast the money will grow over time
– Similarly, when we are moving money backwards through time,
we use the “discount rate” to determine the PV of a cash flow
 Energy Economics and Markets

Salvage Value

The value of the equipment at the end of the

project life.

▪ Sometimes salvage value is positive (sell it)

and sometimes it is negative (disposal cost).
 Energy Economics and Markets

Simple Payback (SP)

Amount of time (in years) for a project to “pay back” the

upfront investment, without considering the time value
of money.

– Simple Payback = (Investment) / (Annual Savings)

– Example: A project’s upfront cost is $100,000. Savings are
$20,000 per year. The Simple Payback period would be:
= ($100,000) / ($20,000 per year)
= 5 years
Electricity Markets - Basics
 Energy Economics and Markets

Traditional Electric Utility Model

• Monopoly
Generation
– Only one supplier of electricity in a
given region (“service territory”)
– Consumer does not have a choice Transmission
of supplier

• Vertically integrated Distribution

– A single organization performs all

the technical and business
Retail
functions

Remember the STC-only era?!

14 Consumer
 Energy Economics and Markets

Why Monopolies?
• Building a power system is expensive

• Building competing transmission and distribution

networks does not make sense

• Until recently having several companies “share”

a power system was too complicated

• Monopoly can be:

– Private
– Public
© 2012 D. Kirschen & University of Washington
 Energy Economics and Markets

Regulation

• A private monopoly could abuse its position

– It must be regulated by the government

• Government-owned utilities operate for the

public good
– No need for outside regulation
 Energy Economics and Markets

Problems with Private Monopolies

• Monopolies are inefficient

– No competition
– No need to be efficient to survive
– No incentive to be efficient:
• Utility earns more if it invests more
• High costs passed on to consumers as high prices of
electricity

• Rates are “higher than they should be”

 Energy Economics and Markets

The “NEW” Electricity Supply Model

• Privatization of public utilities

• “Unbundling”
– Separate the different functions of the utility

• Introduce competition:
▪ Treat electrical energy (MWh) as a commodity
▪ Create markets for trading this commodity

© 2012 D. Kirschen & University of Washington

 Energy Economics and Markets

Unbundling

• Separation between the parts where competition is

possible and those where a monopoly is needed:
– Competition between generators
– Monopoly for transmission and distribution

• Essential to create a fair market:

– An independent system operator (ISO) will not favor one
generator over another

© 2012 D. Kirschen & University of Washington

 Energy Economics and Markets

What is Electricity Market?

Electricity market is a general term that is generally

comprised of the energy market, capacity market,
ancillary service market, and other types of markets.

Distributed Generation Systems, 2017

PJM learning center
 Energy Economics and Markets

Is an Electricity Market like a Grocery Store?

Ron Coutu, Strategic Market Advisor, ISO New England

 Energy Economics and Markets

Differences Between Electricity and Other Commodities

• Electricity is linked with a physical delivery system

– Generation and load must be balanced at all times
– Failure to balance leads to collapse of system
– Physical balance cannot be left to a “free” market
– A breakdown of the system affects everybody
– Traditionally, Electricity cannot be stored in large quantities

• Electricity produced by different generators is pooled

– Generator cannot direct its production to some consumers
– Consumer cannot choose which generator produces its load.
– Pooling is economically desirable

• Production facilities must be able to meet peak demand

© 2011 D. Kirschen and the University of Washington

 Energy Economics and Markets

Electricity Auctions

• Daily auctions for electric power

• Determine wholesale electricity prices

• Buyers and sellers are:

– Large energy users (buyers)
– Load Aggregators (buyers)
(serving homes & businesses)
– Power plant owners (sellers)
– Financial traders (buy and sell)

Ron Coutu, Strategic Market Advisor, ISO New England

Energy Economics and Markets

Monopoly

Generation

Transmission

Distribution

Retail

Consumer
 Energy Economics and Markets

Purchasing Agent

IPP Own Generators IPP

IPP: Independent
Power Producer

Distribution

Customer

© 2012 D. Kirschen & University of Washington

 Energy Economics and Markets

Wholesale Market
Genco Genco Genco Genco Genco

Wholesale Market and Transmission Wires

Disco Disco Disco Disco

Customer Customer Customer Customer

© 2012 D. Kirschen & University of Washington

 Energy Economics and Markets

Retail Competition
Genco Genco Genco Genco Genco

Wholesale Market and Transmission Wires

Retailer Retailer Retailer

Retail Market and Distribution Wires

Customer Customer Customer Customer

© 2012 D. Kirschen & University of Washington