Economics of Electricity Self-Generation by Industrial Firms

This study develops, and econometrically tests, a model explaining the relative importance of several key economic and engineering factors that industrial firms consider when deciding whether to self-generate or cogenerate electricity. The model and empirical results (based on data from the chemical and paper industries) suggest that industrial self-generation is determined by the derived demand for electricity, price of purchased electricity, and marginal cost of self-generation. The buyback rate was found to be important only when certain economic and engineering conditions are met -- such as a relatively low marginal cost and/or a sufficiently high buyback rate. The evidence presented suggests that for most firms the buyback rate play’s no role in determining the quantity of electricity demanded or produced. The results indicate that policy actions related to industrial cogeneration should focus on the price of electricity and factors that affect the plant's marginal cost of producing electricity.