Skip to main content
Log in

Pricing the use of capital-intensive infrastructure over time and efficient capacity expansion: illustrations for electric transmission investment

Journal of Regulatory Economics Aims and scope Submit manuscript

Abstract

Traditional economic theory provides a conundrum for pricing large, lumpy infrastructure investments: very different short- and long-run pricing prescriptions. Unless the facility is congested, efficient short run prices should only cover operating costs (short-run marginal cost, SMC); any higher price designed to also recover capital costs would risk inefficient under-utilization. However, if the facility becomes crowded, capital costs should be included in the calculation of user-fees since that burgeoning demand is likely to cause the construction of more capacity, and users should be confronted with the cost-consequences of their decisions. Once additional capacity is completed, however, and if because of the large size of the addition the facility is no longer congested, then price should once again fall to SMC. The resulting jagged pattern of prices offers little assurance to investors of capital cost-recovery without a government guarantee, and it may lead to schizophrenic behavior by both customers and potential suppliers. Just because the physical investment is lumpy, should the price pattern also be dichotomous or can a smoother transition be employed? By integrating the use of congestion fees that are based upon the external costs imposed by one user on all others prior to the construction of added capacity, and then by using the same congestion charge to gauge the “willingness-to-pay” for new capacity and to set an “opportunity-cost”-based benchmark for capital cost recovery afterward, a smoother sequence of prices can evolve. The capital cost recovery portion of these prices, whose magnitude is based upon the congestion eliminated, is premised on a long-run, dynamic view of markets and the transitions they can facilitate, and these cost-recovery adders can be combined with “peak-load-pricing” and the “inverse-elasticity” rule, for example, to improve efficiency and fairness over both space and time. The resulting price patterns can provide compatible incentives for all parties, and they complement several existing electricity system planning processes in those regions where congestion rents are already assessed for the use of transmission. The net effect could be similar to a sequential “real-options” analysis of efficient capacity expansion.

This is a preview of subscription content, log in via an institution to check access.

Access this article

Price excludes VAT (USA)
Tax calculation will be finalised during checkout.

Instant access to the full article PDF.

Institutional subscriptions

References

  • Baumol W. J., Bradford D. F. (1970) Optimal departure from marginal cost. American Economic Review 60: 265–283

    Google Scholar 

  • Blumsack, S., Illic’, M., & Lave, L. B. (2007). Separability and independence of congestion and reliability: Theory and simulations. In Proceedings IEEE power engineering systems conference.

  • Bower R. S. (1985) The capital recovery question: An overview. Resources and Energy 7(1): 7–42

    Article  Google Scholar 

  • Chang N. B., Schuler R. E., Shoemaker C. A. (1993) Environmental and economic optimization of an integrated solid waste management system. Journal of Resource Management and Technology 21: 87–100

    Google Scholar 

  • Chao H.-P. (1983) Peak load pricing and capacity planning with demand and supply uncertainty. The Bell Journal of Economics 14: 179–190

    Article  Google Scholar 

  • Crew M. A., Fernando C. S., Kleindorfer P. R. (1995) The theory of peak-load pricing: A survey. Journal of Regulatory Economics 8: 215–248

    Article  Google Scholar 

  • Manne, A. S. (eds) (1967) Investments for capacity expansion. MIT Press, Cambridge, MA

    Google Scholar 

  • Mount, T. D., Maneevitjit, S., & Lamadrid, A. (2010). How integrating wind power into an electric grid affects the economic value of transmission lines. Presented at Rutgers advanced workshop in regulation and competition, 29th eastern conference.

  • Mount, T. D., Schuler, R. E., & Schulze, W. D. (2003). Markets for reliability and financial options in electricity: Theory to support the practice. In: Proceedings of Hawaii international conference on systems science (Vol. 36).

  • Oren S., Smith S., Wilson R. (1985) Capacity pricing. Econometrica 53: 545–566

    Article  Google Scholar 

  • Ramsey F. P. (1927) A contribution to the theory of taxation. Economic Journal 37: 47–61

    Article  Google Scholar 

  • Schuler R. E. (1985) Alternative electric power plant financing and cost recovery methods: Introduction. Resources and Energy 7(1): 1–6

    Article  Google Scholar 

  • Schuler, R. E., Schulze, W. D., Mount, T. D., & Alvarado, F. (2009). Summary of the executive forum on planning, markets and investment in the electric supply industry. Power Systems Engineering Research Center Report 09-01.

  • Vickrey W. (1963) Pricing of urban and suburban transport. American Economic Review Proceedings 53: 452–465

    Google Scholar 

  • Walters A. A. (1961) The theory and measurement of private and social costs of highway congestion. Econometrica 29: 691

    Article  Google Scholar 

  • Williamson O. E. (1966) Peak load pricing and optimal capacity under constraints. American Economic Review 56: 810–827

    Google Scholar 

Download references

Author information

Authors and Affiliations

Authors

Corresponding author

Correspondence to Richard E. Schuler.

Additional information

An early version of this paper was presented at the Hawaii International Conference on Systems Science, 44, Kauai, Hawaii, Jan. 6, 2011.

Rights and permissions

Reprints and permissions

About this article

Cite this article

Schuler, R.E. Pricing the use of capital-intensive infrastructure over time and efficient capacity expansion: illustrations for electric transmission investment. J Regul Econ 41, 80–99 (2012). https://doi.org/10.1007/s11149-011-9176-x

Download citation

  • Published:

  • Issue Date:

  • DOI: https://doi.org/10.1007/s11149-011-9176-x

Keywords

JEL Classification

Navigation