United States
Environmental Protection
Agency
Industrial Environmental Research
Laboratory
Research Triangle Park NC 27711
Research and Development
EPA-600/S7-81-157 Oct. 1981
Project Summary
Electric Rates and
Boiler Fuel Choice
K. T. Sherrill and J. L. Weatherby, Jr.
In a quick-look fashion, the economic
tradeoffs of using purchased utility
electricity as an alternative to on-site
combustion of fossil fuels for industrial
steam generation were examined in
this study. Specifically, the impacts of
marginal or incremental cost pricing
of electricity and increasingly stringent
industrial boiler emission controls
were examined for a 44 MW, (150 x
10» Btu/hr heat input) industrial
boiler. Data were compared to deter-
mine if electricity, despite its lower
overall thermal efficiency, could be
economically competitive with direct
firing of fossil fuels in this size boiler.
Marginal (incremental) costs are
designed to reflect the full social costs
of resources needed to deliver addi-
tional (incremental) electricity. In this
study, the marginal cost pricing
concept is extended to industrial
steam generation.
This study is neither a definitive
analysis of marginal cost pricing
techniques nor a comprehensive
overview of the impacts of marginal
cost pricing on industrial energy
sources. Only a few of the many
pertinent variables were considered in
estimating marginal industrial steam
costs, and a number of simplifying
assumptions were made because of
resource limitations. Several simplifi-
cations tended to reduce the hypo-
thetical marginal cost of electricity
while increasing the estimated margi-
nal cost of on-site fossil fuel combus-
tion. Nevertheless, the study results
show that (for the two cases evaluated)
electricity would not be competitive
with direct firing of fossil fuels as an
industrial boiler energy source if both
electricity and fossil fuels were priced
at marginal cost. These results are not
applicable to all situations where
selection of an industrial boiler energy
source has to be made, but only for the
cases described and for the assump-
tions made.
This Project Summary was devel-
oped by EPA's Industrial Environmen-
tal Research Laboratory, Research
Triangle Park, NC, to announce key
findings of the research project that is
fully documented in a separate report
of the same title (see Project Report
ordering information at back).
Introduction
In the industrial sector, steam is
generated primarily by the combustion
of fossil fuels. The objective of this study
was to examine the economic tradeoffs
associated with industrial fossil-fuel
combustion and the use of electricity for
steam generation given existing (1980)
electricity rates, hypothetical rates
reflecting marginal costs, unregulated
1980 market prices of four fossil fuels,
and several levels of emission controls
for the fossil-fuel-fired boilers. The
basic issue addressed was the economic
tradeoffs associated with selecting an
industrial boiler energy source if all
energy sources (oil, gas, coal, and
purchased utility electricity) were priced
at hypothetical levels reflecting their
marginal costs.
A number of variables influence the
selection of boiler energy sources. Two
factors which were considered in this
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study are: 1) the impact of electricity
rate structures which more closely
reflect marginal costs and which, as a
result are higher than existing regulated
rates; and 2) increased costs resulting
from application of emission controls to
fossil-fuel-fired boilers to meet environ-
mental regulations. While use of
electricity eliminates costs associated
with emission controls for industrial
boilers, the much higher electricity
costs (compared with fossil fuels on a
dollar per million Btu basis) significantly
limit the viability of this alternative.
Theoretically, marginal or incremental
cost pricing is defined as pricing all units
of output at a level equal to the marginal
cost of the last unit of output produced.1
The economic justification for marginal
COST pricing is the efficient use of
society's scarce resources. Prices set on
the basis of marginal costs reflect the
full costs to society of the resources
used to produce the goods or services. If
prices are less than marginal costs,
resources are used inefficiently and
society has to bear the cost of inefficient
rates of resource utilization. To the
extent that electric rates reflect marginal
costs, rates provide signals to customers
concerning the amount of consumption
that is consistent with the regulatory
obje'ctive of economically efficient use
of resources, especially those that are
energy-related.2 Marginal cost pricing
of electricity was first used in the design
of pVomotional rates in the 1920's.
Promotional rates, designed to capture
specific markets, were justified by the
industry as capitalizing on the economies
of scale in electricity generation and
producing lower costs to all customers.3
The gradual downward trend in electric-
ity rates was ended in the late 1960's
and early 1970's by rapidly increasing
fuel costs and capital costs. The current
problems of utility revenue erosion have
generated considerable interest in
developing rate structures that could
curb uneconomic growth of the peak.
During the last 10 years, a version of
'The issues surrounding marginal cost pricing of
electricity are not addressed in this study because
they are beyond the scope of this work.
2Electric Utility Rate Design Study. Rate Design and
Load Control: Issues and Directions. Electric Power
Research Institute, Palo Alto, CA, November 1977.
P. 5
National Economic Research Associates. An
Overview of Regulated Katemaking in the United
States: Topic 1.1. Report prepared for the Electric
Utility Rate Design Study. National Economic
Research Associates, New York, NY, February 2,
1977. p. viii.
marginal cost based on long-run incre-
mental cost has been introduced into
various rate proceedings for the purpose
of providing economic insight into
efficient rate design.4
This study is neither a definitive
analysis of marginal cost pricing nor a
comprehensive overview of the impacts
of marginal cost pricing on industrial
energy source selection. It is a modest
attempt to deal with some of the issues
involved in marginal cost pricing of
electricity, fossil fuels, and industrial
process steam. As described here, a
number of simplifying assumptions
were made to carry out the comparisons,
and not all variables involved in estima-
ting marginal industrial steam costs
were considered.
Actual 1980 data from public utility
files were collected for two utilities to
estimate the hypothetical marginal
costs of electricity. The selection of the
two utilities was based on: 1) a signifi-
cant amount of industrial electricity use;
2) location in regulatory jurisdictions
that use both original (embedded) and
current (replacement) cost in rate
proceedings; 3) diversity in terms of
geographic locations; and 4) availability
of necessary data on a ti.nely basis. The
hypothetical marginal costs of electricity
for the two utilities were estimated from
existing electric rates and the ratio of
current (replacement) cost to historical
(embedded) cost. The basic procedure
employed was to duplicate the existing
rate-setting process but to use current
(replacement) cost.6 Four factors were
adjusted: return-on-capital, deprecia-
tion, fuel costs6, and income taxes.
To define the marginal costs of
producing industrial steam, it was
assumed that a hypothetical industrial
steam user could choose from four
alternative energy sources for the
production of process steam: oil, natural
gas, coal (either high-sulfur Eastern or
low-sulfur Western subbituminous),
and purchased electricity. The marginal
costs of fossil fuels were defined as
their unregulated market prices (1980)7.
A new 44 MW, (150 x 10" Btu/hr heat
'National Economic Research Associates, op.cn., p.
ii.
This procedure will likely result in electricity costs
which are different than the cost of electricity that
would be generated from a newly installed power
plant meeting current environmental regulations.
'Fuel costs were not available for one utility and
could not be escalated.
'Because of limitations of the study, location-
specific fossil fuel prices were not compiled.
input) industrial boiler was assumed foi
the purposes of estimating the margina
cost per million Btu of process steam
Current annualized costs of controllinf
emissions generated by industria
fossil-fuel combustion were includec
with the uncontrolled boiler and fue
costs. Defining marginal costs 01
industrial steam in this manner is ar
attempt to estimate the social value ol
scarce energy resources and clean air.
The economic feasibility of each ol
these industrial boiler energy sources
(oil, natural gas, coal, and electricity]
was examined under the following
conditions:
• Existing 1980 electricity prices of
two utility companies to industrial
consumers, a new 44 MWt indus-
trial boiler, and three levels of
emission controls for the fossil-
fuel-fired boilers.
• Hypothetical industrial electricity
prices for two utility companies
that reflect marginal cost pricing, a
new 44 MWt industrial boiler, and
three levels of emission controls
for the fossil-fuel-fired boilers.
Conclusions
For marginal cost pricing of all energy
sources, it was found that electricity,
would not be competitive with fossil
fuels as an industrial boiler energy
source at any level of emission control
for the fossil-fuel boilers. This is
expected since the overall efficiency of
using electricity as an industrial boiler
energy source is less than half that
obtained by directly firing industrial
boilers with fossil fuels. It was found
that use of electricity may be economi-
cally feasible for a hypothetical industri-
al user of electricity, given actual 1980
electricity rates of one utility, fossil fuel
alternatives limited to imported oil or
coal, and intermediate or stringent
emission controls. Given the actual
1980 rates of the second utility,
however, electricity was not found to be
competitive with any fossil-fuel alterna-
tive under any level of emission control.
I
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K. T.Sherrillis with Radian Corporation, Austin, TX 78766 and J. L Weatherby,
Jr., is with Southwest Econometrics. Inc., Austin, TX 73731.
Arthur R. Eckels is the EPA Project Officer (see below).
The complete report, entitled "Electric Rates and Boiler Fuel Choice," {Order No.
PB 82-107 541; Cost: $8.00, subject to change) will be available only from:
National Technical Information Service
5285 Port Royal Road
Springfield. VA 22161
Telephone: 703-487-4650
The EPA Project Officer can be contacted at:
Industrial Environmental Research Laboratory
U.S. Environmental Protection Agency
Research Triangle Park, NC 27711
• U S GOVERNMENT PRINTING OFFICE; 1981 — 559-017/7391
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United States
Environmental Protection
Agency
Center for Environmental Research
Information
Cincinnati OH 45268
Postage and
Fees Paid
Environmental
Protection
Agency
EPA 335
Official Business
Penalty for Private Use $300
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