Effects of Gas Subsidy on the Behavior of Power Stations in Iran: A
new policy for reducing energy intensity in electricity powerhouses
Mohammad Keimanesh, Sharif University of Technology, Unit 4, No.3, Bonbast Yas, Shahid
Soori Ave., Evin, Tehran, Iran, 00989127009232, keimanesh@ce.sharif.edu
Amin Yazdani Salekdeh, Sharif University of Technology, Unit 1, No. 60, Bonbaste Dovvome
Sharghi, Amrollahi Ave., Bayandoriha Ave., Shahid Azizi Blvd., Shahid Salehi Blvd.,
Mohammad Ali Jenah Blvd., Tehran, Iran, 00989122140496, aspersica@gmail.com
Sumita Barahmand, Sharif University of Technology, No.31, Beest Metri Dovvom Ave.,
Kooye Manzarie, Tabriz, Iran, 00989143110944, barahmand@ce.sharif.edu
Hoda Vaziri Bozorg, Sharif University of Technology, Koocheye Shahid Shiripoor, North Varzi
Ave., Ferdos Blvd., Tehran, Iran , 00989125496537, hoda.vaziri@gmail.com
Abstract
Presently in Iran, gas-driven power stations and combined-cycle power stations compete as they
share a common budget allocated by the government for their establishment. With the
government offering gas at subsidized rates, the cost price of electricity production at gas-driven
power stations is comparatively lower, thereby enhancing their attractiveness for the investor.
Therefore, despite their decreased efficiency, the establishment of such power stations is on the
increase which in turn imposes additional costs for the government. On the other hand, it would
be in the best interest of the government to help increase investment in combined cycle power
stations which are far superior in terms of efficiency, and which, in the long run, would be
profitable. In this paper we present a model and suggest policies for the government through
which a decrease in energy intensity can be achieved without incurring additional costs for the
government. We suggest practical ways to optimize existing methods of power production by
diverting subsidies offered by the government.
Introduction
Main Variables
e Power Station: By power station we mean the power station producing electrical energy
divided into two sets of cycles: combined cycle power stations and gas driven power
stations. Other power stations are not of concern in this paper.
¢ Unit of measurement: Numbers (to simplify the modeling, every power station is
assumed to produce a definite amount of electrical energy, for instance, 2000 megawatts
and this amount is considered as one power station.
¢ Current production: The sum total of gas-driven and combined-cycle power stations,
practically indicating the number of existing power stations and based on the above
assumption, this number along with a specific coefficient can express the rate of
production.
© Investment: The fixed amount of annual investment required for the installation of a new
power station or optimization of existing power plants is considered, which for the
purpose of our model is taken as 2500 units. Investment may be for the installation of
gas-driven or combined-cycle power stations. Similarly, investment for optimization
includes both conversion of gas-driven power stations to combined-cycle power stations,
optimization of an existing power station without any essential changes in the method or
storage/savings.
e Savings of investment: The amount of annual investment not utilized per year is saved in
this stock variable. These savings can be used to invest in new forms of energy, the
discussion of which is beyond the scope of this paper.
¢ Cost price of electricity: The cost price of one unit of electricity at every power station
(gas or combined cycle) which is related to the cost of gas consumed, efficiency of the
power station, cost of installing the power station, and expected viability of the power
station.
e Attractiveness of the power station: The attractiveness of the installation of a power
station, combined-cycle or gas-driven, is determined by taking into account the amount of
profit obtained from the sale of electricity. The lower the cost price of producing
electricity, the greater the profit obtained and the greater the attractiveness of that kind of
power station for the investor.
© Opportunistic cost of gas consumption: In this model, the government is the producer of
gas and the gas extracted and prepared for utilization by the government may be used by
power stations, sold domestically, or exported. The most profitable use of gas in Iran is
its export. The difference in cost of gas exported and gas sold to electric power station is
in effect the cost which is created indirectly for the government and is termed
opportunistic cost of gas consumption in power stations.
e Subsidy: Here we assume that the government sells gas to electric power stations for a
price lower than that of export gas, and also makes electricity available to the consumer
free of charge. The sum total of these two costs is termed subsidy.
Dynamic hypothesis and cause effect model
At any given time in any country, a certain amount of electricity is required and in some
countries like Iran, the amount exceeds the amount currently produced. The amount of electricity
required is termed desirable production. The discrepancy between current production and
desirable production leads to increased investment which in turn results in a reduction of this
discrepancy, followed by a decrease in investment for the installation of new power stations.
This decrease in investment has delayed effects which become evident in the number of gas-
driven power stations: the rate of their increase decreases and, as a consequence, current
productions will decrease. This behavior which is a purposive loop, exists as a similar process in
combined cycle power stations too. Both loops are illustrated in the figure below.
Investment in cop combined Cycle
Installation Power Station
f )
Investment in GP a
" + Gas Power Station
Installation
/* iy 4
Investment in New oo Current
Power Station Installation Production
Difference of CP
with DP +
Desired
Production
Figure 1: Balancing loops for investment in new power stations.
As shown here gas-driven power stations and combined-cycle power stations compete with each
other as they share the common budget, which is referred to as investment for installation. The
competitive advantage here is the amount of profit determined from the cost price of electricity
production and the selling price of electricity.
Since in Iran, as in many other countries, the price of electricity is determined by the government
so as to combat the natural monopoly that exits is this sector the price of electricity can be
considered an extraneous variable and the cost price of electricity production by gas and
combined cycle power stations directly affects the extent of installation of that type of power
station. The lower the cost prices of electricity production at power stations, the greater the
investments for the establishment of such power stations.
However, as mentioned in the section pertaining to the description of the major variables, the
cost price of electricity production is obtained from the initial investment for the establishment of
the power stations, expected life of the power station and efficiency of production which
determines the amount of gas consumption. Of these three factors, initial investment of gas-
driven and combined-cycle power stations is clear for this reason, in order to reduce the cost
price of electricity production, practically it is the expected viability of the power station as well
as the efficiency of production that contribute in this dynamic model. In order for power stations,
whether gas or combined cycle, to maximize profitability they should produce electricity with
the least possible cost price. Therefore, every power station aims at increasing its viability and its
production efficiency. This optimization becomes feasible only when the costs justify time for
optimization. This process occurs with both gas-driven and combined cycle power stations and
creates two purposive loops for each. In the next figure, the two loops relevant to a gas-driven
power station can be seen.
Gas Power Station.
+ Life Time
i)
Ga Power Station
Efficiency -
Investment in Electricity Cost of ‘Gas
Renovation Power Station
+ ap
+
Tendency to Ratio of Energy Cost to
Renovation + Renovation Cost
Figure 2: Balancing loops for investment on renovation.
But gas-driven and combined cycle power stations themselves have limitations in expected
viability and efficiency which determine a ceiling for their viability and efficiency.
Regarding the efficiency of gas-driven power stations, however, by virtue of the possibility of
their conversion to combined-cycle power stations with greater efficiency, this ceiling can be
raised. The conversion is accomplished when the process can be justified economically.
We continue with an elaboration of the flow-savings model, and having explained the variables
in the model, we will proceed to reveal the problem of energy intensity and its effects in Iran and
conclude with suggested policies for reducing the energy intensity in this area.
Flow model
As demonstrated earlier, there are several kinds of loops in this model the cause and effect model
of which was illustrated before. Here, the flow model of these loops with several more variables
will be shown.
In figure 1 and 4 the first kind of loop is shown. As can be seen, in this model the delay in the
installation of power stations is delay of the first degree, which is different in gas-driven and
combined cycle power stations. One stock variable termed investment savings is shown in figure
4. Since the amount of annual investment is considered to be fixed, in any given year the input
investment/capital may not all be utilized. The amount saved can be invested to produce power
stations with recyclable fuel.
‘GP Installation
Cost
Time to Establish
GP
‘GP Life:
a \)
Gas meoL_™,
GP Investment
er Rate
GP
Attraction
CCP
Attraction
Proces ca
rocesS _! GP Completion
Station
GP Depreciation
_,
Al
Rate of Investment in
Conversion
‘Conversion
Budget
Investment in
Installatation HET)
Power
Station Conv,| gy
cess .
Time to Convert
Conversion
Completion Rate
Cycle
CCP Investment
Rate
oe”
‘CCP Installation
Cost
Stat
‘Combined
Power ———S wr)
tion _}CCP Depreciation
“s CCP Completion
Time to Install
ccP
CCP Life:
Figure 3: Flow Model: Life of power stations.
‘Gas Power
Station
Desired
Production
Investment hy Zé
Function CP to DP Ratio
sf
Installation Ratio
Total Investment
Current «<——
Production
‘Combined Cycle
Power Station:
Power Station
Conv. in
Process:
Gas Power
Station
Tendency to
Convert
ge
Investment in Conversion
Optimization
Investment in
——__—» Installatation
Budget
CD
Investment in New
Energies
a,
Saving Rate
ee
Investment in Existing
Power Station
Money
Figure 4: Flow Model: How to invest for power stations.
Another process possible is the conversion of gas-driven power stations to combined-cycle ones.
This conversion can be accomplished if justified economically. Figure 5 of the model represents
this issue.
Conversion Cost
Ratio of CE to
Difference of GP with Function of
CCP Tendency to Convert
<Electricity Price 7
fr CCP>
for CCP Difference of GP
WELCSE Tendency to
= Convert
<Electricity Cost
for GP>
Figure 5: Tendency to convert gas-driven stations to combined-cycle stations.
In fact it is the ratio between amount of savings in costs and conversion costs that push power
stations toward conversion. Although this power can enter the model as an external factor, in
order to see the dynamics better, external pressures are excluded from consideration.
Subsidy for GP Subsidy for CCP
Electricity Selling CCP Interest
Price
GP Interest Ratio of CCPI to CCP Attraction
GPL
Attraction Funetion for
CCP Installation
Gas Price _ GP Attraction
aa
Rekovation Cost Renovation ce ‘ost n
GP Efficiency ____— I for GP
GP Installation
Cost. | ——_
CCP Efiiciency
GP Lite —
smanct fo RC Ratio of , Cost cP Lite
to RC for CCP ~
GP Lift Punction “CP Lite Function / CCP Eifcieney
ee Function
Tnvedtment in
Single CCP
GP Efficiency
Function
Investment in ‘Sino Investment in CCP
Sir aaa ——F ——
nee ‘Combined Cycle
ees in GP
Renovation
Inve
Pc
Figure 6: Deciding on how much to invest in each kind of power stations.
In figure 6, two loops of the second kind are illustrated for both combined-cycle and gas-driven
power stations. These loops affect the cost price of electricity production. Moreover, the
attractiveness for investment in combined-cycle and gas-driven power stations , based on the
amount of profit obtained by calculating the difference between selling price and cost price is
also shown in the figure.
The last figure (figure 7) is the exponential model for monitoring the situation. Since in such a
model it is assumed that the government pays a subsidy to households for electricity, the costs
for the government, the subsidy plus the opportunistic cost of exporting gas, is monitored as an
important variable in this figure. Another important variable is energy intensity in the industrial
sector.
Continuing with the section on the behavioral analysis of the model, it will be shown that
through formulating specific policies for the government, energy intensity can be decreased with
no increase in costs and if anything, with a decrease in costs. In fact, the main purpose of the
present paper is the formulation of these policies.
Intemational Gas
‘Gas Price:
‘Combined Cycle Price
Power Station> ———. CCPs Gas
perme
<CCP
Efficiency
Total Oportunity
Cost
ToulGas
"
Total Cost for
Government
>
GP GPs Gas
Efficiency Consumption
‘Gas Powel Curre “
Station
ose duction Total Subsidy Produetior®
‘Subsidy for ——————_»
\ . ly ae GPs Pe
Electiiy Subsidy
‘Current
Electricity
Selling Price>
Electricity Seling
Subsidy for CCPs Price to People
Sibety bea
CCP.
Figure 7: Monitoring the situation for amount of subsidy government pays.
Behavioral analysis
As indicated earlier, the cost price is an important variable in this model in which other variables
are influential. The cost of gas and expenses associated with installation are extraneous variables
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and the efficiency and viability are internal which can be influenced by system dynamics in a
loop. But all these variables are not equally influential. When the cost of gas is very cheap, (as is
the case in Iran today), it is the expenses associated with installation that determines the cost
price. In this situation, the efficiency of the power station is not a determining factor for
installation, and it is the expenses associated with installation that makes a particular type of
power station attractive. In such a situation, the opportunistic cost to use gas is high but is
overlooked. That is, the crucial factor determining investment in the establishment of a power
station is costs associated with installation, while in otherwise normal situations, the efficiency
of the power plant would be decisive.
The consequences of this process in the construction of a power station are displayed in the
following figures. The cost of gas is assumed to be 30 Rials (at present in Iran). The purchasing
cost of electricity from both power stations, combined cycle and gas-driven, are considered to be
equal and fixed. The other data pertaining to the both types of power stations are obtained from
true ratios.
Gas Power Station
10
8.5
5.5
0 10 20 30 40 50 60 70 80 90 100
Gas Power Station : Fixed-Price-Gas
Figure 8: Gas Power Station.
Combined Cycle Power Station
0 10 20 30 40 50 60 70 80 90 100
Combined Cycle Power Station : Fixed-Price-Gas
Figure 9: Combined cycle Power Station.
It is clearly obvious that the number of power stations with increased efficiency has not
increased over time and power stations with low costs of installation have grown in number. The
general growth in production is desirable and reflects the fact that current production is
approaching levels of desired production. This process is demonstrated below.
Current Production
20
11
0 10 20 30 40 #50 60 #70 80 90 100
Time (Year)
Current Production : Fixed-Price-Gas
Figure 10: Current production.
9
However, this is occurring at the expense of decreased efficiency. Furthermore, in such a
situation, since more and more power stations are created, the costs for the government will also
increase.
Total Cost for Government
6,000
5,000
0 10 20 30 40 50 60 70 80 90 ~=100
Time (Year)
Total Cost for Government : Fixed-Price-Gas
Figure 11: Total cost for government.
Policy formulation for solving the problem
In the preceding section, the prevailing conditions in Iran and the direction current trends are
taking were shown. The increased costs fore the government will be inevitable. But the snag in
the process is the increase in the number of gas-driven power stations in contrast with combined-
cycle ones despite the fact that the production efficiency of combined cycle power stations is
nearly twice as much as that of gas-driven ones. This leads to increased costs incurred for the
optimization of gas-driven power stations and instead of a reduction in energy intensity an
undesirable increase in energy intensity is observed.
10
Energy Intensity
0.4
0.35
0.3
0.25
0 10 20 30 40 50 60 70 80 90 100
Energy Intensity : Fixed-Price-Gas
Figure 12: Energy Intensity.
But where does the problem stem from? As indicated earlier, the low price of gas makes the
costs associated with the utilization of gas seem negligible when compared with the costs of
installation and this issue leads to optimization being sacrificed for lowered costs of fuel. By
selling gas at subsidized rates to power stations, electricity is bought for a low price and it is
assumed that by decreasing the cost of gas, the price of electricity has been decreased. The only
cost for the government is considered to be the subsidy granted to a power station for cost of
producing electricity. This view has led to the growth in power stations with low efficiency as
well as a surge in energy intensity. However in practical terms, the cost for the government is not
only in the form of this subsidy but loss of possible revenue from exporting gas should also be
added. This opportunistic cost is actually the difference between the profit obtained for the
government when gas is exported and sold to other countries and the cost associated with selling
gas at reduced prices to power stations.
It is necessary to note that under these conditions (low price of electricity), the government
expends more for power stations with decreased efficiency which utilize more gas.
The solution we propose for this problem and the policy we suggest the government consider is
that rather than granting subsidy on the fuel used for producing electricity at power stations,
subsidy be granted for the purchase of electricity from power stations. In this way, obstacles
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mentioned above will be eliminated and the dynamics of power stations will move toward
enhancement and decreased energy intensity. With this policy, the government is still able to
exercise control over the price of electricity (to prevent pressure on the consumer). The only
costs imposed on the government would be the subsidy offered for the purchase of electricity and
no subsidy will be offered for gas utilized by power stations.
The general problem associated with subsidizing electricity is not of concern here and is beyond
the discussion of this paper. However, by inducing the above changes, no change will arise in the
cost of electricity sold to people and accordingly in the dynamics of subsidizing electricity.
We predict that the implementation of this model will lead to rapid movement toward combined
cycle power stations, enhanced performance, decreased energy intensity all at the same or
reduced costs for the government.
With the increase in cost of gas, the already existing gas-driven power stations will undergo
losses. Therefore, at least for a limited time, the government should be supportive to such power
stations. In order to support this sector, the government could consider greater costs for buying
electricity from these units for a limited period of time within which these units can proceed
through the stages of converting to combined cycle power stations. Obviously such support
would be limited and time-bound.
Model behavior following implementation of suggested policies.
Here we explore the behavior of the model after the suggested policies are implemented. This
behavior can be seen in the following graphs. First is the behavior of gas-driven and second is
the behavior of combined cycle power stations, the growth in their numbers which will directly
affect the process of the system.
12
Gas Power Station
0 10 20 30 40 50 60 70 80 90 100
Time (Year)
Gas Power Station : Fixed-Price-Gas
Gas Power Station : Increased-Price-Gas
Figure 13: Gas Power Station.
Combined Cycle Power Station
20
0 10 20 30 40 50 60 70 80 90
Time (Year)
100
Combined Cycle Power Statio:
Combined Cycle Power Statio:
Figure 14: Combined Cycle Power Station.
13
As can be seen, this behavior is completely compatible with desirable behavior. This desirable
process can also be observed with regard to energy intensity.
Energy Intensity
0.4
0.325
0.25
0.175
0 10 20 30 40 50 60 70 80 90 ~=—100
Time (Year)
Energy Intensity : Fixed-Price-Gas
Energy Intensity : Increased-Price-Gas
Figure 15: Energy Intensity.
Desirable trends are not restricted only to this area. The target we pursue includes controlling
costs for the government apart from decreasing energy intensity and enhancing optimization.
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Total Cost for Government
6,000
5,000
4,000
3,000
2,000
0 10 20 30 40 50 60 70 80 90 100
Time (Year)
Total Cost for Government : Fixed-Price-Gas
Total Cost for Government : Increased-Price-Gas
Figure 16: Total cost of government.
As can be seen, although costs for the government overshoot and undershoot, in the long run
they tend to remain stable. The reason for this behavior is the same additional policy to provide
support to gas-driven power stations. However, as demonstrated above, this amount of increase
in costs is temporary and a large proportion of it is compensated for by the subsequent reduction
is costs.
Conclusions
In contrast to the general assumption that when difficulties arise in an establishment, it usually
has to do with a group of individuals who are the decision-makers, in many instances, it is the
very structure of the establishment that creates problems. One such long-standing problem in
Iran is the provision of subsidy to households for several consumer goods, which not only
imposes a heavy financial burden on the government, but also results in excessive consumption,
leading in turn to a regular rise in costs for the government. The elimination of subsidy from the
economic structure of Iran requires time, incurs heavy social and economic costs as well as
creating immense pressure on the government. That is why no government in Iran has been able
to focus attention on tackling this issue. In the present paper, we first explored the difficulties
associated with payment of subsidy for fuel utilized in power stations and demonstrated that a
subsidy on fuel hinders optimization of power stations, which, in turn, leads to an increase in
energy intensity in this sector. That is, the increase in energy intensity occurs on account of the
low cost of fuel and inattention to optimization results from it not being economical to the
investor. Next, we suggested a solution which not only circumvents the problem but also
15
involves the least side effects and in the long run, lifts the financial pressure currently on the
government. Therefore, rather than eliminating the subsidy, we propose a strategic and goal-
directed use of the subsidy to achieve the optimization of power stations. In the suggested
solution, fuel is supplied to power stations at the world price and we demonstrated that by raising
the price of fuel, greater optimization of the production and efficiency at power stations would be
possible, eventuating in a reduction of energy intensity in this sector.
Future directions
In this paper, only supply, that is power stations producing electricity, was taken into
consideration. However, policy makers would be able to arrive at the best decisions only when
the power industry is evaluated from the perspective of both supply and demand. As changes in
subsidy will impact not only the behavior of producers but also that of consumers, a resultant
increase or decrease in consumption is likely, but in our model, the behavior of the consumer is
taken to be stable. In future investigations, we intend to analyze the impact of subsidies in the
demand sector of electricity so that, by combining the two views on supply and demand, the
functional role of government subsidies in the behavior of the electricity market may be clearly
identified and the best policies for minimizing energy intensity and costs to the government as
well as for maximizing production and consumer satisfaction may be formulated.
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