Energy Solutions for the 21st Century
CIGMOD, the Competitive Industry Gaming Model, represents almost ten years of research on the dynamics of "deregulating" the electric utility industry. In its simplest formulation CIGMOD functions as a gaming model reflecting the "day after" the break-up of the utilities into component companies, such as generation and distribution companies. Utility personnel, regulators, and energy planners can use the computer simulation to role-play the staff of the newly formed companies by making contracts, playing the spot-market, building new capacity, meeting customer demands, and performing all the other responsibilities of the respective companies. With enhancements, CIGMOD can become a detailed, multi-region version of ENERGY 2020, simulating the strategies an actual company should undertake given the surrounding competitive environment and providing information concerning the market and financial consequences of these strategies.
The entry level version of CIGMOD focuses on the primary determinates of competitive success (or failure). It acts to educate utility staff, regulators, and energy planners and heighten the awareness of competitive issues. More advanced versions delineate the regional transmission network and the dramatic effect transmission regulation (particularly pricing) has on the required strategy for competitive survival. Energy service companies and other business entities can be added to the model as desired. The corporate planning version can simulate the financials, costs, and strategies of competitors in interaction with those of your business and regulators.
An advanced uncertainty analysis package determines what strategies provide the best opportunity for success with minimal risk. This uncertainty analysis explicitly determines, among other things, the impact of uncertain consumer response to retail wheeling and the impacts of the myriad of alternative "deregulation/re-regulation" schemes regulators could impose on distribution and transmission companies, and energy brokers. It further recognizes the full spectrum of pricing/contract/build strategies that competitors could pursue in light of pricing rules that may restrict transmission, generation, and distribution company options.
Although several advanced versions of CIGMOD are available, the following discussion is limited to the entry level gaming model to illustrate how CIGMOD works.
The "simple" CIGMOD simulates the behavior of electric utility companies under the assumption that the generation sector of the utilities is deregulated. The original electric utility companies are split into distribution companies and generation companies. (Adequate transmission and average cost pricing of transmission is assumed). The distribution companies must satisfy all of the demand they receive from their service territory, but they are free to buy power from any of the generation companies and free to seek business in other service areas (retail wheeling). When retail wheeling is limited, distribution system costs (prices) are regulated. When full retail wheeling is allowed, distribution companies act as though they are deregulated. The generation companies are free to sell power to any of the distribution companies. The players actively negotiate capacity contracts in an attempt to maximize the profits of their company. The terms of these contracts, including the length of the contract, are determined through negotiation. The generation companies must decide if and when to build new capacity. Each company sets its own financing and dividend policies. The last player represents the state regulatory commission and sets the prices charged by the distribution companies. There can be as many generation and distribution companies as desired. One independent power producer is assumed as well as a "global" utility that surrounds the region representing utilities of the game. The computer can play (aggressively or passively) for any missing human players.
For each year the game is played, the players input their policy decisions, including the terms of the capacity contracts into a computer. The computer processes these decisions and produces reports, including an income statement and a balance sheet for each company. Based on the results of the previous year, the players revise their decisions and negotiate new contracts.
The game is designed to study the dynamics of a restructured electricity market. The players learn which factors and conditions lead to an orderly or a chaotic or a monopolistic market for power. The players can test different theories about the behavior of a competitive market.
The Players
The players include the existing electric utility companies which are split into distribution companies and generation companies, independent power producers, and the regulatory commission.
The Distribution Companies
In the absence of retail wheeling, the distribution companies buy electricity from generation companies and sell electricity to the residential, commercial, and industrial customers within their service territory. The distribution companies negotiate contracts with generation companies to buy electricity and obtain any remaining electricity on the spot market. The regulatory commission sets the prices (with generation/transmission cost-pass-thru provisions) charged by the distribution companies. The decisions which the players make include:
1) entering contracts to buy power;
2) canceling contracts to buy power;
3) paying common stock dividends;
4) selling debt to meet financial requirements; and
5) filing for bankruptcy.
The information which is available includes:
1) an income statement;
2) a balance sheet;
3) a statement of financial requirements;
4) a forecast of future electricity demands and capacity needs for the service area;
5) a list of their existing contracts; and
6) the cost of spot market power;
With retail wheeling, distribution prices have reduced regulatory restrictions and the CIGMOD model provides additional forecasts of the loads the distribution company can expect from all the service areas in which it is selling. (The magnitude, timing and acceptance of retail wheeling is set at the beginning of a CIGMOD game.)
The Generation Companies
CIGMOD recognizes three types of generation companies: the generation companies which result from splitting the current utility companies, the independent power producers (IPPs) , and the "boundary" electric utility companies which may service distribution companies in the region. Each type of generation company is modeled in the same manner, the only difference being the financial assets and the existing capacity of each company. The model can be set up to handle an arbitrary number of generation companies; the current model has one independent power producer and one out-of-region "boundary" generation company in addition to the original regional companies.
The generation companies, which represent each of the existing electric utility companies, were constructed by removing the distribution and transmission portion of the assets and liabilities. All of the capacity of the original company, including capacity under construction, are retained by the generation company.
The independent power producer starts the game with no assets, liabilities or capacity (unless IPPs exist at the beginning of the initial gaming period). The IPP does have the ability to raise money for the construction of generating capacity by issuing common stock and selling bonds.
The out-of-region company may represent a specific company or may be constructed from aggregating the financial strength and capacity of neighboring utilities.
The generation companies earn money by generating and selling electricity. They enter into contracts with distribution companies and construct new plants to fulfill these contracts. They are required to meet their financial requirements by either selling bonds or common stock. The decisions which the players make include:
1) beginning construction of new plants;
2) canceling a plant under construction;
3) suspending construction for one year;
4) entering contracts to sell power;
5) canceling contracts to sell power;
6) buying generating capacity from another generation company;
7) selling generating capacity to another generation company;
8) paying common stock dividends;
9) selling debt to meet financial requirements; and
10) filing for bankruptcy.
The information which is available includes:
1) an income statement;
2) a balance sheet;
3) a statement of financial requirements;
4) a forecast of future electricity demands and capacity needs;
5) a list of plants under construction;
6) a list of their existing contracts; and
7) the cost of spot market power.
The Regulatory Commission
In the absence of retail wheeling, the regulatory commission has the responsibility of setting the pricing rules that the distribution companies will follow to charge the residential, commercial, and industrial customers. It also determines the pricing and access rules for the transmission companies and/or the operation rules of energy brokers and operating companies. Regulated prices are based on the expenses, the rate base, and the cost of capital of the regulated companies. The decisions which the regulation commission player makes include:
1) allowed return on equity;
2) allowed rate base;
3) allowed expenses;
4) revenue adjustment and
5) class price differentials.
The information which is available for each distribution company includes:
1) an income statement;
2) a balance sheet;
3) the cost of capital;
4) the return on common equity; and
5) the current year's prices.
The Role of the Computer Program
The CIGMOD game is hosted by a computer program written in a language called PROMULA. The computer program has five basic functions: control, input, output, accounting, and simulation. The computer controls the flow of the game by executing the segments of the program in the required order and incrementing the time variable after each year is simulated. The user friendly input segments of the program interactively prompt the users to enter information for the game. The output segments provide reports which summarize the status of each segment of the game in either printed or video format. Although the major policy decisions in the game are all decided by the players, the computer program is used to perform accounting functions and to simulate parts of the utility system which are within the policy making domain of the players. It can also act on behalf of absent players.
Simulation Functions
The computer program simulates parts of CIGMOD which are not within the policy making domain of the players or which are not considered relevant to the central purpose of the game. This section briefly describes these simulation functions.
The Demand Model
The demand model of CIGMOD produces a sales and peak forecast by revenue class for each service area. In the entry level model, the forecast is econometric. The independent variables for the forecast include the price of electricity, the price of gas, and the contribution to gross state product by economic sector. The parameters for the forecast include own price and cross price elasticity, income demand elasticity, cogeneration market share multiplier, cogeneration demand elasticity and a saturation trend. Changes in the demand forecast are smoothed over a four year period. Load shape factors for each revenue class convert the sales forecast into a forecast of the load duration curve.
Based on extensive analysis by the Stanford Research Institute, University of Southern California, Los Alamos National Laboratory, and Policy Assessment Corporation, CIGMOD approximates the load duration curve using three points over five seasons: the seasonal peak load, the average day load, and the minimum load. (In the more advanced versions, complete hourly, typical days/weeks are used).
The Demand Forecast
The demand forecast simulates the internal forecasting procedure of the distribution and generation companies. (In the advanced version it also includes forecasts for the transmission companies.) A forecast of the load duration curve is produced for each company by extrapolating internally generated growth trends. This reflects the commonly used approach that past history is still the best guide to future developments. Average growth rates are calculated for the peak, average and minimum points on the load duration curve. These growth rates are used to extrapolate the load duration curve five, ten, and fifteen years into the future. The forecasts for each distribution company are summed to produce a region-wide demand forecast.
A capacity requirements forecast is calculated for each distribution company, for each generation company and for the region. The distribution company forecast is based on its demand forecast and its existing capacity contracts. The generation company forecast is based on its existing capacity contracts, its existing capacity, and its capacity under construction. The region-wide forecast is calculated by comparing the demands of all the distribution companies with the existing capacity and capacity under construction of all the generation companies. These forecasts are calculated for base load and peak load requirements.
Production Costing
Production costing is a two step procedure. The distribution companies’ demands are met first by "dispatching" the contracts the distribution companies have with the generation companies. The "loading order" of the contracts (the order in which the distribution companies actually buy power) is determined by the variable costs of the contracts. After all the existing contracts have been dispatched, the distribution companies must buy power from the spot market.
The peak load and energy demands which the generation companies must satisfy are determined by the contracts which are "dispatched" by the distribution companies. An advanced-rotated derating method is used for the production costing of the generation companies. Extensive research at Southern California Edison, the University of Virginia, the University of Washington, and at the Policy Assessment Corporation has shown this fast approximation, when properly parameterized, to be as accurate as the cumulant method. The loading order is based on the "bid-cost" of each plant type. After all generating capacity has been dispatched, the generation company must buy from the spot market.
Spot Market Power
An unlimited amount of generating capacity is assumed to be available on the spot market. The price of this power is determined by the supply/demand balance within the region. The spot market power is priced at the "transmission-bid" price of the marginal plant. The same price is used for distribution and generation companies.
Construction
CIGMOD simulates the construction of new capacity within the model. After the generation companies initiate the construction of a new plant, the program determines the construction expenditures for each year of the construction time. The generation companies must finance these expenditure as they occur. The generation companies also have the option to cancel or suspend construction. When canceling construction, the generation companies lose all the money invested in the plant, plus pay a cancellation penalty. Suspending construction causes the plant to be delayed one year with no explicit penalties. The final cost of the plant will be higher, if suspended, because of inflation and financing costs. All financing costs, however, are included in the financial segment.
Assets
Assets are calculated in essentially the same manner for all companies. For example, the assets of the distribution companies are composed of investments in distribution equipment and investments in capacity contracts; the assets of the generation companies are composed of investments in generating capacity (net of any construction losses) and investments in capacity contracts.
Settlements
Settlements are one time payments from one party to another party when a capacity contract is signed. The distribution company may be paying the generation company, or the generation company may be paying the distribution company. The program allows money to flow in either direction when a contract is signed. The company making the payment is investing in a capacity contract. This investment in a capacity contract is treated as an asset and is expensed through amortization over the life of the contract. For the company receiving the payment, the settlement is revenue. This revenue is classified as other income on the income statement of the program.
Buying and Selling Generating Capacity
Generation companies are able to buy and sell capacity from each other. For the company buying the capacity the price paid is added to their assets. For the company selling the capacity the price paid is treated as a capital gain (selling price minus book value of the capacity). Their assets are reduced by the book value of the capacity.
The book value of the capacity is not calculated by the program; the players must input an approximate value when buying and selling capacity. The book value of the capacity being sold primarily affects the timing of earnings and taxes and has only a minor impact on cash flow or long term earnings.
Finance
The finance segment simulates the financial activity of the distribution and generation companies. The user can select debt or equity financing (or a mixture) to meet the financial requirements of the company. Financing requirements before common stock dividends are a function of operations, debt repayments, construction expenditures and other financial transactions. The players specify the fraction of the financial requirements to be met by issuing new long term debt. The remaining financial requirements are met by selling common stock. Excess funds are used to pay off long term debt until debt is zero. After debt is zero, excess funds are invested in short term bonds.
Contracts
A key element of CIGMOD is the negotiation of capacity contracts between the distribution companies and the generation companies. These negotiations can take place outside or inside of the program. When contacts are "externally" transacted, the agreed upon contracts are input to the program. The contracts have the following components: the distribution company, the generation company, the fuel type, the capacity in megawatts, the time period in years, the energy cost in mills per kilowatt-hour, the fuel cost pass-thru fraction, the capacity cost in dollars per kilowatt, and the settlement in millions of dollars.
When a new contract between the same companies and for the same fuel type overlaps an existing contract, the components of both contracts are combined. The energy cost, capacity cost, and the fuel costs pass-thru are averaged using the capacity as a weighting factor. The capacity of the new contract is added to the capacity of the existing contract. The settlement is a one time payment, so the settlement in the existing contract is not affected. When a contract is canceled or the capacity of a contract reduced, the unit costs of the contract are unchanged.
CIGMOD allows users to test alternative theories on how the electric market will function. The users can test strategies for both the generation companies and the distribution companies. These strategies range from aggressive price cutting to insisting on recovering full costs for all energy sold. Assumptions regarding how the market will function include a sellers market (like the airlines) or a more balanced market (like the natural gas market). These market strategies and assumptions can be tested in CIGMOD.
As an example, let’s assume a market similar to that of the airlines. Based on expected prices, distribution companies determine what share of needed load should come from bilateral contractual agreements. (The fastest way to lose at CIGMOD is to misjudge how much to utilize the spot market.) These contracts are further divided by length; a ten year contract should have lower cost but more "demand" risk than a one year contract. A random selection scheme is used to closely approximate market transactions. Generators place prices on the market in blocks of fixed nominal size. The distribution companies accept these bids in order of cost (and length) based on their (partially random) ability to obtain the contract -- since all distribution companies would like all the low cost power, the random sequencing typifies the actual ability to gain access to the contracts. The probabilistic nature of the contract market is further modified to capture "long-term relationships" whereby some distribution companies may have "preferred" access to specific generators. Depending on their "market" success, generators adjust their bid prices up or down in the next period.
Financial Reorganization - Bankruptcy
CIGMOD allows the players to determine when a company needs to submit to financial reorganization, merger, or bankruptcy. The players negotiate the details of the financial reorganization outside the program. After an agreement has been reached, the agreement is input to the program. The financial reorganization procedure allows changes to be made to any of the companies, not just the one leaving the market.
Advanced Play
The computer can be set to play selected strategies against a particular company. The human player can then determine what information determines the strategy of a competitor and the potential outcome. The player can then develop the appropriate counter-strategy. However it must be noted that the efficacy of the strategy will change with even minor variations in the "game rules" determined by the regulator. In some ways the game approximates a game of chess, but because the market-place prevents any player from acting entirely unilaterally, there exist heuristic rules that can defend against a wide range of strategies. Further, letting regulatory options vary from game to game exposes regulatory schemes that superficially appear acceptable but produce unacceptable consequences under real-world (non-idealized) conditions as portrayed in CIGMOD.