Question

Suppose an electric utility is considering whether to install a wind farm with 30 megawatts (mw) of capacity or a natural gas generator that would produce the same amount of annual electricity. An engineering study showed that the site for the wind farm would produce a load factor of 25 percent. (Actual generation would be 25 percent of capacity on average over the course of a year.) The natural gas plant could be operated with a load factor of 50 percent. Capital costs for the wind farm would $1.5 million per megawatt, compared to $1.0 million per megawatt for the natural gas plant. Operating costs for both plants would be $2 million per year excluding fuel costs.

The electric utility is investor-owned and subject to rate of return regulation. The capital costs are allowed in the rate base, but not operating or fuel costs. If the regulatory agency allows the firm to earn a 10 percent return on the rate base, what would be the regulated price of electricity with each type of generation? Which source would the utility prefer? Explain how you derived your answer.

Answer 1