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UNITED STATES OF MtERICANUCLEAR REGULATORY CCMMISSION

BEFORE THE AT0f1IC SAFETY AND LICENSING BOARD

In the Matter of )}

METROPOLITAN EDISON CCMPANY, )JERSEY CEiiTRAL PCWER AND LIGHT ) Docket No. 50-320CCMPANY & PENilSYLVANIA ELECTRIC )COMPANY )

)(Three Mile Island Nuclear )Station, Unit 2) )

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TESTII CNY OF G. THCMAS SAV CNPETITICfl AS CITED IN PARAGRAPH NUMBER 5

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Contention 5

"T5e Petitioners contend that the rate structure of the Applicant is aprctotional rate structure designed to increase tne consum; tion ofelectricity by effering declining rates for increased consumotion. Sucna rate structure minimizes the possibility and practicality of worth-while energy conservation efforts. Petitioners contend that a flat ratestructure - one price for all levels of consumption and for all customers -or a declining block rate structure would make conservation a viable andpractical alternative to Three Mile Island, Unit II."

Recent empirical evidence indicates that the price of electricity is animportant deteminant of the amount of electricity de anded per unit oftime. 1/ Historically, U.S. electric utilities have charged a price perunit of electricity tnat has exnibited both intra-consumer and inter-consumer differentials. Intra-censumer price dif ferentials exist withrespect to the amount of electricity consumed per customer during thebilling period. As successively larger amounts of electricity are con-sumed, the price per unit of electricity decreases in a series of steos -such a price scnedule is usually referred to as a declining block rateInter-consumer price differentials exist as a result of distinguishingamong different classifications of customers for pricing purpcses; e.g.,residential, ccmmercial, and industrial custcmer classifications arethree major classifications generally used. For eacn customer class-ification there is generally a different price or rate senedule whichhas historically been of a declining block nature. Thus, tne price ofelectricity depends, inter alia, en (1) how mucn is consumed and (2) bywhcm it is consumed.

In the wake of an increasing awareness for the need to efficiently utilizecur scarce resources, the pricing practices of the electric power industryhave been subject to much criticism. One of tne major criticisms putforth has been directed toward the declining block rates within custcmerclasses. Critics maintain that ceclining bicck rates encourage tneconsumption of more electricity by offering lower per unit prices asquantity consumed increases. As a means for enccuraging conservationin electricity usage critics have proposed a restructuring of thedeclining block rates. Ccmonly mentioned alternatives include increasingblock rates and flat rates. Under increasing block rates (wnich accuntsto inverting the declining block rate scaedule) the per unit crice ofelectricity increases in a series of steps as cuantity consumed increasesduring the billing pericd. Under a flat or unifem rate scnedule the priceper unit of electricity is invariant witn respect to quantity consumed.

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One of the most widely accepted principles of reasonable public utilityrates and rate relationships is cost of service. 2/ Rates snculd be setin such a way that tney are cost justified, i.e. , rates shculd. reflect thefull cost associated with supplying electricity to customers at any giventime. Using this principle of rate setting, the argument that costs ofproducing electricity decline as volume produced increases has long beena justification for declining block rates. Ecwever, proponents of increasingblock and flat rates have argued that wnile electric utilities haveexperienced declining costs in the past, the recent trend has been forcosts per KWh to increase with increasing cutput. If this hypothesis werecorrect, then increasing bicck rates would be cost justified. Similarly,

if costs per KWh were constant with respect to electricity produced, tnena flat rate would be cost justified.

A simple graphical analysis in which electric production expenses expressedin mills per KWh are plotted against time would accear to suggest thatsince abcut 1965 the per KWh production costs of electricity have changedfrom a dcwnward to upward sloping relationship. However, more sophisticatedempirical studies have concluded tnat these recent upturns overtime areactually the result.of dynamic upward shifts in declining cost curves. 3/Moreover, statistical evidence shows that, even for these later years,the cost per KWh said is inversely related to both average residentialelectricity consumpticn and average nonresidential censumotion. Inaddition, econcmies of scale are realized frcm increases in consumpticnper customer. Thus, the evidence substantiates the rationale underlyingdeclining bicck rates.

There are additional econcmic consequences which must be considered inevaluating the effects of rate restructuring. Econcaic theory suggeststhat consumers of electricity base their incremental consw ption decisions(i.e., whether or not to consume more or less electricity) on the marginalprice of electricity (i.e. , en the price of one more or one less unit ofel ectricity) . Under a declining block rate, tne average price of elec-tricity to tne consumer is higher than tne marginal price. An increasingblock or flat rate scnedule whicn increases the marginal price even thcughthe average price remains uncnanged cculd have the effect of reducingcensumption of an indivicual customer. This, however, does not imply thata particular group of custcrers (e.g., residential) will reduce theirccabined cr overali consumption of electricity. In fact, overall con-sumption could increase, since small quantity users may pay a lowerm ginal price than before tne restructuring - even thcugn large quantityusers pay a higher marginal price. In total, increased censumction ofsmall quantity users within a particular group may more tnc.) offset thedecreased consumption of large quantity users. The net result being anincrease in the overall censucction of electricity.

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Research conducted at Cornell University has attempted to estimate theimpact of such rate restructuring an the consumption of electricity. J/The research methodology used a model for forecasting electricity consum;tien.The model included explanatory variables whicn represented botn tne leveland steepness of the rate schedule. The study leads to the conclusion thatthere is no evidence to support the contention that restructuring of therate schedule will lead to significant recuctions in the consumption ofelectricity. Moreover, there mignt be a slign expansion in consumptionas a result of increased ceisumotion by small quantity users offsettingthe reduced consumpticn by large users.

Yet another study has investigated the effects of eliminating scme of theinter-consumer price differentials for electricity. 5/ The results indicatethat an elimination of the price differentials between residential, ccm-mercial, and incustrial consumers wculd lower industrial consumptionand increase both residential and ccmmercial consumation. In scmeinstances, the aggregate growth rate of electricity consumption remainedunchanged. In otner instances, rate equalization resulted in an increasedaggregate growth.

State public utility ccamissions are delegated with the authority of reg-ulating electric power companies and have the responsibility of approving

. rates and rate designs. The FEA recently recuested that the fiaticnalAssociation of Regulatory Utility Commissioners submit a cuestionnaire to statecommissioners concerning, among other things, electric utility ratestructures. 6/ The responses indicated a general disagreement abcut thepotential effect of increasing block rates. Financial effects, it wasthougnt, cannot be predicted with certainty since the response of differentgroups of consumers to a rate change is highly speculative in the absenceof any definative elasticity of demand studies. As to whether or not rateinversion would be beneficial to consumers, it was mentioned that icwusage custcmers would face icwer rates but any additional costs incurredby industry would precably be passed on to the consomer in the fcnn ofhigher product costs. It was also felt that where rates were increasedmore than is cost justified, incustry would be driven out of tne stateand that higner rates would affect plant location decisions.

In sum, these renarks suggest that the level of the rate schedule is a moreimportant determinant of electricity consumption than is the shace of therate schedule. Althougn increasing bicck rates or flat rates are notexpected to lead to substantial reducticns of overall electricity demand,this does not imply that they are ineffective as a conservation measure.Declining bicck rates tend to stimulate the demand for electricity in suchuses as air conditioning and space heating. Albeit inverted or flat rates

may discourage electricity use for such activities, the expected net effectis one of increasing overall useage.

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Declining block rates have more recently been criticized not because oftheir intra- or inter-consumer price differentials, but rather the absenceof differential rates / tween ceak and off-peak consumotion. The demandfor electricity is not .tiform over time. It varies uitn the time of day

and according to the season of tne year. Historically declining blockrates have not incorporated a time differential ccmconent. As a resulteratic load patterns nave been maintained and characterized by (1) ceakperiods witn demand pressing against available generating capacity and(2) off-peak periods with demand insufficient to utilize available capacity.However, because electric utilities are required to provide a level ofcapacity sufficient to meet demands in peak periods, tney are left withsubstantial amounts of idle capacity in off-peak periods. Peak loadpricing has been proposed by many critics of electricity pricing as asolution for moving away from this inefficient utili:ation of resources.

Peak load pricing involves a pricing schedule in which price varies arcord-ing to the level of kilowatt demand on the system over a daily and seasonalcycl e. In the peak period prices would be set relatively hign, therebydi;couraging use, whereas in the off-peak period comparatively low priceswould be in effect, tnececy encouraging demand. This type of pricing scnemeis alleged to smooth out the pattern of demand; i.e. , remove the peaks andhollows f rca the demand pattern. Depending on the own price and cross priceelasticities of the demand for electricity, peak load pricing would have theffect of decreasing quantity demanded at the peak and increasing the quantity

demanded at the off-peak. As a result, (1) the amount of unused gen-erating capacity is reduced due to a smoother demand pattern and (2) thetotal generating capacity requirements are reduced due to both a more stabledemand pattern and a decrease of quantity demanded at the peak. 7]

The arunt of total capacity needed by an electric utility is determinedby the level of peak demand. Obviously, if peak load pricing reduced peakdemand, then total capacity recuirements would be reduced (unless own priceand cross price elasticity of demand for peak power is zero). But con-sideration as to the ultimate effects of ;eak load pricing must go beyondthe total capacity requirements. Soecifically, consideration must be givento the effects en the optimal mix of generating capacities.

For any given pattern of electricity demand there is a least cost (hencecptimal) mix of gererating capacities for supplying this demand. The

optimal mix, being determined by the pattern of demand, varies as thepattern changes. The flatter is the load duration curve, the more baseload capacity (low ocerating cost) it is optimal to include in the gen-erating mix. Steeper load duration curves imoly the inclusion of moreceicing capacity (high operating cost) in the optimal mix. Comoared topresent rate structures, peak load pricing wcula have the effect of flatteningthe load duration curve; i .e. , decrease *ne cuantity demanded at the peakand increase the quantity demanded at the off peak. S/ Consecuently, peak

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load pricing would likely alter the least cost mix of generating capacities,viz., decrease peak Icad capacity requirements and increase base loadcapacity requirements.

A study recently conducted at the Massachusetts Institute of Technologyexamined the impact of peak load pricing on the U.S. Nuclear Energy Industry. 9]The study concludes that peak load pricing wculd increase the demand fornuclear base lead facilities. Additional literature addressing the subjectof peak load pricing indicates a general consensus that this type of pricingscheme will lead to additional base load capacity requirements whilereducing the need for peaking capacity.

Peak load pricing of electricity in the United States has just begun togain mcmentum. The Federal Energy Acministration (FEA) is currentlyfunding a series of demand management projects to be undertaken in severalstates - including Ari:cna, Arkansas, California, Connecticut, New Jersey,and Ohio. These projects involve various types of experimental rates(primarily time of day rates) within the residential sector, generally200 to 400 hcuseholds are included in each project. Althcugh any definiteresults are not yet available, preliminary data indicate that houseboldsrespond to time of day rates by shifting tneir consumption away frcm peakperiods toward off peak pericds. The system wide effects, however, willbe determined in the final phases of the projects - when all data havebeen obt'ained.

Jersey Central Power and Light Ccapany is a participant in the FEA demand-management, demonstration project. The experimental tests, however, arejust getting underway and are expected to continue a couple of years intothe future. There is, of ccurse, no data currently available wnich lendsitself to evaluation by the staff.

In contrast to practice in the United States, several European utilities -e.g. , in Norway, Sweden, Finland, France, and Britain - have insti tutedvarious forms of peak load pricing. Results frcm tne British experienceare readily available and widely published. lof The British experimentwas motivated by an undesiracle increase in tne winter peak load. Theexperiment began in the 1966-67 winter and lasted until the 1971-72winter. It involved nearly 3500 residential households divided intoexperimental and control groups. Experimental housencids were sucjectedto several types of new rate structures, including a seasonal time-of-day(STD) rate. Ccmpared to the ordinary rates, the STD rates had a 300%mark-up during the daily work day peak hours of 8 A.M. to 1 P.M. and4:30 P.|i. to 7:30 P.M. for the winter months of December, January, andFeb rua ry. The results of the experiment indicate that, av:rauec overthe five years, the STD households consumec 1.75 more annual Lh perhcusehold than the control group. Mcwever, the pattern of consumpticn

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among the two groups also varied. Relative to the control households,STD households consumed less electricity during peak hours and moreelectricity during off-peak hours. Although these resuits may not bedirectly transferable to the United States, they do support the generalresults anticipated in the current literature on peak load pricing;viz., that peak load pricing will reduce peak consumption and increaseoff-peak consumption.

In conclusion, the staff does not believe that alternative rate structureswould be a viable alternative to Three Mile Island, Unit II. Recentevidence suggests that inverted or flat rate structures have little, ifany, cost justification and in any event could have the effect ofincreasing the overall consumption of electricity if adopted. European

experience indicates that the implementation of peak load pricing reducesconsumption at the peak period and increases consumption at the off-peakpariod. When a heterogeneous mix of generating capacities are recuired,however, peak load pricing implies an increased demand for base loadcapacity in order to supply electricity at least cost. Thus, raterestructuring would increase the need for Three Mile Island, Unit II.

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REFERENCES

1. L. D. Taylor, "The Demand For Electricity: A Survey," BellJournal of Econccics, Spring 1975, 6, 74-110. Also W. S. Chern,S. B. Caucill, S. D. Holccab and W. W. Lin, " Future Growth OfElectric Power Demand In The Scuth Atlantic Regicn," October1976, research sconsored by the U.S. iiuclear Regulatory Ccm-mission under Union Carbide Corporation's contract with theEnergy Research and Development Administraticn.

2. James C. Benbrignt, Princicles of Public Utility Rates, New York,1961, Chapter IV.

3. John W. Wilson and Robert G. Uhler, " Inverted Electric UtilitiesRate Structures: An Empirical Analysis," Federal Power Commission,March 1974.

4. L. D. Chapman, G.G. Akland, et. al . , " Electricity Demand: ProjectIndependence And The Clean Air Act," Cak Ridge National Laboratory,work supported by the National Science Foundation, November 1975.

5. See Reference 4.

6. National Associatit - of Regulatcry Utility Ccmmissioners,1974Recort of the General Counsel On Economics, Washington, D.C.,October 1974.

7. Elizabeth E. Bailey, " Peak-Load Pricing Under Regulatory Con-straint," in Elizabeth E. Bailey, Economic Theery of ReculatoryConstraint, Bell Telephone Labcratories, W/3,1:::i-Itd

8. John T. Wenders, "The Misapplication of the Theory of Peak-LoadPricing to the Electric Utility Incustry," Public Utilities Fort-nichtly, Cecember 4,1975

9. Paul L. Joskew and Martin L. Saughman, The Future of the U.S.Nuclear Ecercy Incustry, Massachusetts Institute of Tecnnoicgy,April 1975,

10. John T. Wenders and Lester D. Taylor, " Experiments in Seasonal-Time-Of-Cay Pricing of Electricity to Residential Users," BellJournal of Econenics, Autumn 1976, 7, 631-552. Also Bridger M.Mitcnell, "Les1gnis Peak-Load Pricing for Electricity withReference to Eurocean Theory and Practice," pa::er presented at the1976 kmual rsdarenco nf rhn ,Ies te rn Econ mic Association; andreference number 6.

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