Financial and regulatory considerations in capacity expansion planning for the electric utility industry

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Virginia Polytechnic Institute and State University

Due to large amounts of capital involved, the financial considerations gain paramount importance in the capacity planning decision of an electric utility. Three important financial issues are choice of appropriate capital and fuel costs, effect of regulation and scarcity of capital. The first section of the dissertation is devoted to an overview of the electric utility industry and literature review.

In the second section, we address the issue of selection of appropriate capital and fuel costs. When a time-stepped approach is used for electric utility capacity planning, an important question is what fuel and capital costs should be used in a single period model to replicate the first period part of the multiperiod optimal solution. We address this question and show that a generalization of Baughman-Joskow surrogate fuel price is optimal for the case of a linear load duration curve. Similarly, a generalization of Soyster- Murphy annualization process is obtained for the selection of appropriate surrogate capital costs.

In the third section, capacity planning for a regulated utility is analyzed when the objective of the utility is value maximization. the resulting mathematical program is shown to have the same algebraic form as the cost minimization capacity planning model. The optimal solution under the value maximizing assumption is consistent with several important results of regulated economics. The value maximizing approach is extended to include certain inperfections like lead times and finite equipment lifetimes.

In the final section, a single period capacity expansion model is developed for a utility faced with a rising supply curve of capital. The properties of the optimal solution to this model are analyzed. It is shown that if one uses a constant cost of capital model for a utility faced with a rising cost of capital, one produces an overly capital intensive solution. A graphical procedure for solving the rising cost of capital, single period model is developed and presented. A technique for estimating the capital supply curve for the electric utility industry is developed. The sensitivity of the capital supply curve to various regulatory parameters is analyzed and the capital supply curve is found to be very sensitive to regulatory parameters.