Efficiency rents of storage plants in peak-load pricing, ii: hydroelectricity

Duality methods of linear and convex programming are applied to impute definite marginal values to the fixed inputs of a hydroelectric plant from the operating profit. Our earlier analysis of pumped storage (of energy and other cyclically priced goods) is thus extended to valuation of an external inflow to the reservoir. Given a continuous time-of-use price for electricity, the profit-imputed hydro values are uniquely determined - unlike the corresponding values imputed from fuel savings for a mixed hydro-thermal system. In particular the water inflow is assigned a unique, time-dependent shadow price. The short-run profit is then differentiable in all the fixed inputs, so that unique and separate marginal values can be imputed to the reservoir and the turbine capacities (despite their perfect complementarity). The two rents can be expressed in terms of the shadow price for water (which determines the optimal storage policy). In particular, the unit reservoir rent equals the total positive variation of the shadow price over the cycle. Evaluation of profit-imputed rents is shown to be useful not only to a profit-maximising industry but also to a public utility aiming to price its outputs at long-run marginal cost and to optimise its capital stock on the basis of purely short-run calculations. In addition we verify the production set properties that are needed to incorporate such a storage problem into a continuous-time model of general competitive equilibrium with the space of bounded functions of time as the commodity space.

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http://eprints.lse.ac.uk/19342/1/Efficiency_Rents_of_Storage_Plants_in_Peak-Load_Pricing%2C_II_Hydroelectricity.pdf