JPS can lighten burden
Evan Duggan, GUEST COLUMNIST
Productivity improvements could lower electricity costs
A study by the Jamaica Productivity Centre (JPC) offers evidence of the performance gap between Jamaica Public Service (JPS) power generation and other domestic power producers; ranks the JPS distribution operations among the least efficient in the region for total distribution losses, non-technical losses and reliability; and places JPS in the group with the highest electricity prices.
At issue is whether modifications to the current operations of JPS and changes to the orientation of regulation could deliver significant short-term benefits by way of lower electricity prices.
The rising cost of electricity is inimical to the interest of consumers and to national growth and development. Hence the generation and distribution of electricity in Jamaica continues to be the focus of intense debate.
While much of this debate has been centred on whether coal or liquefied natural gas should be the fuel choice in the expansion of the generation system programmed for 2014, this is undoubtedly a long-term solution.
In a 2011 study by the JPC, it is argued that modifications to the current operations of JPS, and changes to the orientation of regulation, could deliver short-term benefits by way of lower electricity prices to consumers. It is, therefore, in this context that we considered it worthwhile to examine the issues raised in the study and their short-term implications for reducing electricity prices.
The JPC study, which benchmarks the performance of Jamaica's electricity sector against that of 25 Latin American and Caribbean countries, indicates that in 2009 the average system losses for the group were 16 per cent, compared to 23.9 per cent registered by JPS in the same year. The study estimates that significant savings can be achieved, at least J$7.43 billion annually, if JPS reduces its system losses to the 16 per cent average.
JPS has argued that the estimated savings identified in the study are an overstatement. Further, it has pointed out that the study fails to recognise that the tariff places an upper limit on the amount of system losses that can be passed on to electricity customers. Currently, this limit is 17.5 per cent.
However, while there is merit in JPS's argument, our calculations at the Mona School of Business (MSB) show that customers would see a reduction of about two per cent in the average electricity price even if only a quarter of the savings estimated in the JPC study can be realised.
Credit ought to be given to JPS for its aggressive drive over the last two years to reduce losses by bringing technology and capital to bear on the problem. The company's annual report indicates that loss fell from 24 per cent to 23 per cent between 2009 and 2010. In addition, JPS estimates that it can reduce system losses by one per cent per year over the next four years.
However, what is clear is the need for alertness on the part of the regulator. JPS has acknowledged that it possesses the capability to reduce losses, something we all knew. The Office of Utilities Regulation (OUR) should lower the upper limit on losses by at least one per cent over the next four years. This would force JPS to maintain and expand its effort and, more important, all other things remaining equal, lower electricity bills.
The heat rate is a measure of the efficiency with which fuel is converted into electrical energy. A lower heat rate indicates greater conversion efficiency. Not surprisingly, the study found the heat-rate performance of the independent power producers (IPPs) to be better than JPS's. After all, most of JPS's generating plants are more than 30 years old, more than twice the age of the average IPP plant. The IPP's heat rate hovered around 8,000 kilojoules per kilowatt-hour, whereas JPS's hovered above 10,000 kilojoules per kilowatt-hour.
JPS has pointed out that it has improved the heat rate from using 12,000 kilojoules per kilowatt-hour to the present level of 10,000. This is no trivial achievement. The JPC's call for further reductions in the fuel efficiency conversion gap between JPS and the IPP is valid, but it is certainly not feasible in the short term. Any further significant lowering of the heat rate will have to await the introduction of newer, more efficient plants.
Currently, JPS operates with a heat-rate target of 10,470 kilojoules per kilowatt-hour. This means that if the company converts fuel at a higher heat rate, it has to absorb the additional fuel cost for doing so. On the other hand, if it converts fuel at a heat rate below 10,470 kilojoules per kilowatt-hour, it reaps the reward of higher revenues. Mona School of Business (MSB) recognises the importance of regulatory incentives, and JPS's efforts at reducing the heat rate over the last decade ought to be compensated.
However, we believe the gap between JPS's actual heat rate of 10,000 kilojoules per kilowatt-hour and the target rate of 10,470 kilojoules per kilowatt-hour is overly generous. This is something that could impact electricity prices favourably for consumers and it should be looked into.
THE PRODUCTIVITY IMPROVEMENT FACTOR
JPS operates under what is called a price cap. This type of tariff regime sets the average real price of electricity every five years. The present regime took effect in 2009 and will end in 2014. A price cap is a well-established approach to incentive regulation. Over the period of the price cap, JPS can make greater profit if it can lower its operating and maintenance cost. But, if its operating and maintenance costs increase, they cannot be passed on to its customers.
There are two components of the price-cap formula which the JPC argues represent sources of savings to electricity users. The first, is a productivity improvement component often referred to as the X-factor. It is intended to be a reasonable measure of total productivity growth in the industry. The X-factor, therefore, is used as a target in the price cap and reflects the expected percentage by which the utility should lower non-fuel costs. If the X-factor is greater than zero, in real terms, over time, JPS's average price ought to decline annually. Since June 2011, the X-factor has been 2.72 per cent. Consequently, electricity consumers will see modest reduction in the non-fuel portion in real terms over the next two years.
The JPC contends that the productivity improvement factor of 2.72 per cent is too low and takes issue with the regulator for setting it at zero in 2010. However, the JPC has not stated what the X-factor should be, nor has it provided any compelling argument as to why it should be different. On this matter, MSB has no basis for challenging the regulator. Indeed, we would be happy if JPS's actual productivity exceeds this rate, as it would mean that these benefits could redound to consumers during the next price-cap regime.
The second element of the price cap that the JPC has identified as a potential channel for lowering electricity price is the quality of service, or Q-factor. Simply put, Q represents an annual penalty or reward that would flow to JPS depending on the frequency and duration of outages during that year. If JPS outperforms the stipulated Q-factor, the price of electricity would increase. And underperformance would see the price falling.
JPC's contention in the study is that the OUR has been complacent in determining the value of Q and has simply set it at zero since 2004. The JPC study estimates that savings of $440m would have accrued to customers between 2005 and 2009 if international benchmarks were used to set Q. In the scheme of things, $440m over four years would have a negligible effect on the tariff. MSB supports the JPC position on the OUR's lack of rigour in dealing with this matter.
However, we at MSB are of the view that the JPC's certainty concerning the impact of a Q-factor on electricity price is misplaced. It should be recognised that Q is fundamentally a quality-of-service parameter, and it serves the purpose of pushing the utility to improve the standard of service. It, therefore, follows that the application of greater regulatory rigour in setting Q might have resulted in an improvement in the quality of service and not necessarily lower tariffs.
At a time when the Jamaican economy is emerging from a long period of decline, the JPC study on the electricity sector is timely. Indeed, lower electricity prices would have a positive multiplicative effect on the economy. Our analysis indicates that in real terms, average electricity prices should decline because of the productivity improvement factor in JPS's tariff.
While regulatory diligence in establishing a non-zero Q-factor should positively impact the quality of service, it is doubtful that this will have any meaningful effect on electricity prices. It is clear to us that the channels through which the greatest reduction in prices may flow are the proper setting of the system losses and heat-rate targets. However, this will demand alertness and decisiveness on the part of the OUR. Needless to say, the time to act is now.
Evan Duggan is professor of Management Information Systems and executive director, MSB. William Lawrence is director, Professional Services Unit, MSB. Reprinted from the MSB Review. Email feedback to email@example.com and firstname.lastname@example.org.