DISCUSSION PAPER Planning in the Face of Uncertainty 18

years. Third, the costs, sizes, and availability of resource
possibilities have changed; projects that have been delayed are no
longer available in the original target year. This plethora of

alterations illustrates the need for frequent review of the plan.

Regional risk management emphasizes the development of
options. Resource possibilities whose costs remain in the cost-
effectiveness range spanned by the upper and lower bound forecasts
are likely to be acquired at some point, though slow demand growth
may delay them for a time. On the other hand, if the economics of
power supply change dramatically, an option may be priced out of
the evolving market. For instance, federal hydro projects
introduced an extremely low cost resource to the Northwest,
lowering the cost of electricity substantially; the escalating
cost of Projects 4 and 5 of the Washington Public Power Supply
System, in contrast, undermined their viability in the regional

market.

The risk management approach also uses the information
produced by forecasting in a novel way. The stress now lies on
using the bounding estimates to define the range of resources and
options needed in each target year. The traditional reliance on
best-estimate forecasts has meant that high and low cases were
selected casually. There is considerable room for improvement in
choosing defensible upper and lower bound forecasts. Asking
experienced forecasting modelers for consensus judgments on input
data is a first step: what is the range within which the

population trend is nearly certain to lie? how much and little


DISCUSSION PAPER Planning in the Face of Uncertainty 12

Upper bound forecast >

BPA Regional
Energy
Demand

(avg MW)

< Lower bound forecast

-~ eee ere tee < Resources in bein

planning target 10 20
year year
TIME (years)

Figure 1. Upper and Lower Bound Forecasts.

resource by the year in which it is listed.

o A regional plan developed in this fashion must be reviewed
frequently -- perhaps annually -- so that the mix of options
and resources acquired can be adjusted in light of new
information. Important kinds of new information include
changes in the existing power system; revised lower and
upper bound forecasts; data on costs and schedules of
resources acquired; data on the costs of options and their
availability for the year planned; and new resources and
options developed since the last review.


DISCUSSION PAPER Planning in the Face of Uncertainty 22

ratepayers of the Northwest?
The key questions are those that surround measures to

increase planning flexibility, especially resource options:

° Who will find it sensible to provide options, and under what
conditions? What are the legal, economic, institutional, or
psychological barriers that inhibit the development of
options?

o Are options compatible with the Regional Power Act? Is the
language of Sec. 6(f) , providing for reimbursement of res-
ource development expenses, adequate as a legal framework for
using options?

° Are options compatible with regulatory rules? Approval for
major generating facilities usually requires a determination
of the need for power -- a determination that is eschewed in
flexible planning. State and federal regulations could thus
be a significant barrier to regional risk management.

° Presumably, the front-end costs of most power supply projects
are small near the time of initiation: design, siting, and
licensing are-all activities that require far less expend-
iture than construction. So an option could be purchased at
modest cost. But are conservation programs like this? What
about experimental resources that may involve substantial
research and development costs? More generally, what
determines the cost of an option in a technical sense?

° Why would a project sponsor be willing to delay or halt a
project once it is begun, and do so on the basis of regional
criteria interpreted by the council or BPA? In part, this is
a matter of what the region is willing to pay for the option
in the first place. So, more generally, what negotiating
factors influence the price of an option?

° How reliable are the cost and schedule estimates of options?
Can they be made at least as credible as those for projects
proposed for acquisition or billing credits under the act?

° Some options involve few direct costs beyond those of negoti-
ation, such as contractual arrangements for power sales or
purchases. What options for the Northwest are to be found in
the plans of utilities in neighboring regions such as
California or western Canada? Note that this question is
similar to that of load diversity, but the focus is on
planning rather than operations.


DISCUSSION PAPER Planning in the Face of Uncertainty

quired, together with careful consideration of what kind of
resources are suitable for responsible planning in the face of un-
certainty. This paper is meant to stimulate discussion of how to

do this better.

The Uncertain Environment

From the late '40s until approximately 1970, demand for
electricity in the United States grew in parallel with the gross
national product. Growth reflected the fact that electric power
was a good buy. Not only was electricity convenient, but the real
cost of supplying power steadily declined, as new technology
captured economies of scale. In the Northwest, the dominant
resource was (and remains) hydropower, developed on a large scale
since the federal government launched Grand Coulee Dam during the
New Deal.' Northwest hydro projects, built during an era of low
construction costs and low interest rates -- often backed by the
federal government -- produced the cheapest electricity in the
nation. As steady economic growth gave way in the '70s to
stagflation and energy crisis, the conditions underlying utility
planning changed. Planning should have changed too, but it lagged,

with serious consequences for utilities and their ratepayers.
Seven conditions shape the futures:

1. Federal sponsorship remains limited in reach. Despite
the region authority to acquire resources under the
act, the initiative still rests with utilities, local



DISCUSSION PAPER Planning in the Face of Uncertainty 19

can electric energy users respond to changes in rates? Additional
information comes from analyses of the relative costs of over- and
under-building. A power shortfall of, say, 3000 megawatts does not
have the same impact as a 3000-megawatt surplus. One could choose
bounding forecasts so that the upper and lower bounds reflect
equivalent costs to the regional economy. Using economic
forecasting to set limits for planning is a more modest task than
identifying a precise target. There is reason to hope that
approaches such as those sketched here would lead to estimates that
are more scientifically sound and less burdened by political

ideology.

In sum, the schematic risk management approach illustrated
here replaces the concept of a single best forecast with an

iterative three step process:

1. Use the best forecasting data and methods available to
project the highest and lowest plausible cases. These
upper and lower bound forecasts should reflect a range of
demand broad enough that the actual demand can be confid-
ently assumed to fall between the bounds.

2. Develop a stack of resource possibilities to fill the
span between the lower and upper bounds for each year in
the plan. The region should retain the right to delay
acquisition in light of additional information about
expected costs and demand. Options to sell part of the
output of large facilities, together with purchase
options -- regional financing of project initiation costs
-- can facilitate the development of resource possibilit-
ies while retaining flexibility.

3. Make decisions as necessary on resource possibilities, so
that there will be resources acquired to meet the lower
bound forecast, and so that there will be a combination
of resources and options capable of covering demand
ranging as high as the upper bound forecast in each
target year. Acquisitions should be trade following the


DISCUSSION PAPER Planning in the Face of Uncertainty 21

lead one to the rather different approach suggested here. On
account of both the external effects of planning and the problem
of second best, it is wise to be cautious about the value of flex-
ibility. But a flexible approach has obvious merit in the

uncertain environment faced by the Northwest.

Practical questions

Regional risk management is clearer conceptually than
practically. The ideas discussed in this paper are familiar and
well-established in business, especially in finance and other
cyclical industries. Yet applying them to the complex web of
technological and institutional relationships that constitute
electric power in the Northwest will be challenging. The promise
of the risk-management approach is large: it is the one conceptual
framework that offers significant, and achievable, strengths in

facing uncertainty.

The council will be served best by a vigorous critique of
the regional risk management concept. What are the barriers that
stand in the way of using these ideas to structure the regional
plan? What special advantages might accrue from using a risk-man-
agement approach, and what special disadvantages are attached to
using it? Who will benefit, and who will lose, if a risk-manage-
ment philosophy is adopted? Most of all, is flexible planning
practical given the regional power system as it is, and will a

system shaped by regional risk management be a better one for the


DISCUSSION PAPER Planning in the Face of uncertainty 16

the bulk of the money is spent on construction; if a sales option
can be obtained by that time, the region can proceed, knowing that
there is an assured market for part of the project when it comes
on line in the target year. At the same time, an option to sell
also decreases one's flexibility, since the option is likely to
include an assurance that the power will be available to sell in
the target year. Without such an assurance, the price of the
option would probably be so high that the Northwest would gain

little from having it.

Project 3, like project 1, provides the possibility of a
purchase option: an agreement to initiate a project with regional
financing, subject to later review. The point of no return,
economically speaking, occurs soon after the acquisition decision
indicated. Project 4 was optioned in an earlier planning year, and
the final acquisition decision is still some way off; no decisions
need to be made in the current planning year. Note, however, that
information obtained since the last planning year may have shifted
the costs and schedule of project 4® its position in the stack may
thus be different from a year earlier. Project 5 is also a
resource possibility for which no decision need be made. It is
high enough in the cost stack, however, that -- on the basis of
current information -- a future sales option may not permit the
Northwest to recover the full cost of the project; this is clearly
information with a significant bearing on the acquisition
decision. Finally, project 6 requires an option decision in the

current planning year. As with project 2, payment to keep project


DISCUSSION PAPER Planning in the Face of Uncertainty 8

quired resource except in the way it is handled by the Bonneville

Power Administration and the council.

An option is treated differently by the region in two
respects. First, the option agreement authorizes the region to
decide to accelerate, delay, or cancel the project, as part of a
cost-effective regional power program. The early stages of
developing a conservation program or generating resource are
typically far less costly than the construction or implementation
phase. An option agreement might therefore schedule a regional
decision on whether to proceed, and how rapidly to do so, before

construction begins.

A second way in which the region treats an option differently
from an acquired resource is that the project sponsor may be
compensated for the risk that the project will be rescheduled or
terminated. An option is a form of insurance to the region, since
it improves the ability of the regional planning process to meet a
range of loads. The risk payments to the sponsor are insurance

premiums.

Regional resource options are an important means of improving
the flexibility of planning, but there are additional ways to do
so. Smaller projects and resources available on short lead-times
both make it easier to respond to changing circumstances. Cons-
ervation seems unusually flexible because the size of the resource
can be adjusted; if loads grow more rapidly than anticipated, a
more aggressive -- and expensive -- conservation effort can be

pursued with little lead-time, if this possibility has been


DISCUSSION PAPER Planning in the Face of Uncertainty

face of uncertainty.

Principles for managing risk

Regional planning can be organized around eight
principles, several drawn directly from the Regional Power Act.
These principles form a coherent framework for dealing with the
uncertainties facing the Pacific Northwest. To facilitate

exposition, they are first listed briefly:

1. In place of deterministic planning, there should be a
regional risk-management process that stresses flex-
ibility.

2. In particular, the planning process should prepare the

region to meet a_wide range of loads in all the years
encompassed by the plan, instead of relying upon a most-
likely demand forecast.

3. The regional plan should shift the burden of risk from
individual project proponents to the region as_a whole, as
a form of regionwide insurance.

4. The act establishes a fundamental priority for resource
planning: to minimize expected cost, giving first priority
to conservation; second, to renewable resources; third, to
resources utilizing waste heat or generating methods of
high fuel conversion efficiency; and fourth, to "all other
resources."

5. The act also creates an institutional structure for de-
centralized implementation of a centrally written plan.

6. In place of the conventional bias toward economies of
scale in power generation, planners should search for
cost-effective combinations of conservation and resources
that can provide planning flexibility. When comparing
projects that are equally costly to the region, those
available on short notice should be given priority over
those with long lead-times; small projects should be
preferred to large ones; and programs that can be slowed,
halted, or reversed should be more useful than those
entailing inflexible commitments.


DISCUSSION PAPER Planning in the Face of uncertainty

governments, and other project sponsors.

2. The marginal cost of power is rising, but its magnitude
for any given project remains uncertain. The troubles
of the Washington Public Power Supply System have ignited a
citizen revolt, drawing attention-to rising rates.

3. Conservation entails the stimulation and coordination
of activities undertaken by thousands of individuals
and firms. The utilities have had relatively little
experience with conservation or decentralized sources of
supply, and both planning and regulatory oversight have been
hesitant and often confused.

4. Although the Northwest has a strong tradition of
public utility ownership, the open planning process
created in the Regional Power Act is unfamiliar and
uncomfortable for the utilities, especially now.
Openness and a complex agenda make the planning
process difficult for the council to manage, as well.

5. Forecasting demand has become extraordinaril
difficult. We re the smooth and rapid growthof the ‘50s
and 60s allowed planners simply to extrapolate
historical behavior, the period beyond the mid-'70s
continues to be elusive, despite ever more sophisticated
methods of analyzing past demand patterns.

6. Large, capital-intensive resource projects now pose
sub-stantial risks. Costs anschedules have been
difficult to control. Moreover, with the slowing of
load growth, arrangements for fully utilizing large
facilities have become unexpectedly important.

7. A consequence of the last two points is that commitments to
large resources a decade or more in advance -- standard
practice now -- are no longer tenable without substantial
change.

Despite the explosion of uncertainty -- indeed, because of it
-- it is more urgent than ever to plan on a regional basis. A
central feature of the Regional Power Act is the ability to plana
cost-effective mix of resources on a regional basis. The uncert-
ainties listed above imply a need for regional risk management as

well -- a process for insuring long-term cost-effectiveness in the



DISCUSSION PAPER Planning in the Face of Uncertainty 17

6 available will have to be made out of order in the cost-

effectiveness stacking. The questions that arose earlier in the
discussion of project 2 are thus relevant. The answers to these
questions may be different, however; both the high expected cost
of project 6 and the fact that no sales option may be available

for it decrease its desirability.

These resource possibilities have been discussed in the
abstract. Considerations such as the geographical location of the
projects, how they fit into the priority classes mandated by the
Regional Power Act, and the operational characteristics of the
overall resource mix if these projects should be acquired have all
been put aside in this schematic example. These complications
matter, of course, and would need to be analyzed in detail, using
information developed by SPA, the council, the utilities, and

other project sponsors and analysts.

It is also important to keep in mind that the regional risk
management process is a dynamic one. As new information comes in
about resources and about the outlook for demand, it should be

used to adjust plans and commitments.

Consider what is likely to happen in the next planning year.
There is now more information about each target year, though it is
still incomplete. Upper and lower bound forecasts have shifted;
usually, the distance between upper and lower bounds will have
narrowed, since each target year is now closer to the point of the
V. Second, the expected resources in being may have changed;

changes in one target year affect the resources in be*ng in later


DISCUSSION PAPER Planning in the Face of Uncertainty

risk-management philosophy should not obscure its essential
simplicity, however: in an unpredictable world, the ability to
adapt is valuable. This is an accepted, even conventional notion
in finance, where the sharp economic fluctuations of the past

decade have demonstrated the value of flexibility.

A planning concept that provides flexibility in the utility
context is the resource option. The Regional Power Act provides a
mechanism for acquisition of conservation and generating
resources. A resource option is an acquisition contract that
explicitly provides for regional control of the timing and

magnitude of the project.

In order to be usable in planning an option can be no less

real than any other resource in the plan. The experience of the

last 15 years indicates that resource plans regarded by the
utilities as "real" cannot be counted on. If the regional planning
process cannot improve upon this record, one of the main hopes in
the Regional Power Act will have been dashed. Thus, if there are
unresolved technical questions -- like the feasibility of stack-
gas scrubbers on coal plants -- a credible research and
development program should be underway to settle them. If there
are uncertainties in cost and schedule, these must be managed on
the same basis for an option as for an acquired resource. If there
are institutional hurdles -- such as approval of a site by a state
licensing authority -- these must be addressed in a timely fashion
whether the project is an option or an acquired resource. In

short, a resource option should be no different from an ac-


DISCUSSION PAPER Planning in the Face of Uncertainty 23

° Are there institutional arrangements other than contracts
that can facilitate options? Are there conditions in which
having shared ownership is advantageous? The aluminum
industry has played an important role in the Northwest
power system by providing a market for reserves that had no
alternative market; are there similar industry-utility
compatibilities with respect to resource options?

° If options are obtainable, which characteristics are most
valuable? What is the relative value, for instance, of cost
as compared to lead-time? of size compared to the
uncertainties of completion on time? Does putting a high
value on flexibility lead to unanticipated results?<2> This
essay has implicitly assumed that cost and flexibility were
the only relevant variables, but clearly that is not so.
What would one want from an option? what makes an option a
valuable form of insurance to the region?<3>

° What sort of options might be helpful if the lower bound
forecast indicates declining demand in the region?

° This essay has implicitly assumed that central planning for
the whole region will prevail. But it is likely that large
utilities will continue to operate autonomously within the
Bonneville service area. How are they affected by a shift
to a flexible planning process? Neither their
technological. or economic ability nor their willingness to
participate in a centrally directed risk management
strategy can be assumed.

° Can the fragile and complicated regional utility industry
structure absorb the complexities of flexible planning? If
the region's utilities were a single organization, this would
be a question of corporate strategy. Within the existing
fragmented situation, there is a danger that this system-
level institutional question will not be considered seriously

2. For instance, flexibility can be enhanced by choosing
technologies that have low capital costs and high running
costs. That way, a project that is little used does not
exact a high penalty. So- risk management may be an
unrecognized argument for burning oil in combustion
turbines, a resource possibility that conflicts with the
national goal of limiting dependence on imported petroleum.

3. The insurance value of an option should decrease with the
cost of power. A low-cost option is like y to be developed,
and thus the ability to delay or terminate it is less
valuable than for an option that produces power at higher


DAN | ANS NORTHWEST POWER PLANNING COUNCIL

Robert (Bob) Saxvit

‘Chairman Vice-Chairman
Washington idaho

Coline SUITE 200 * 700 SW. TAYLOR STREET

W. Larry Millis,
Washington PORTLAND, OREGON 97205 + (503) 222-5161 Idaho

‘Keith Cobo Roy Hemmingway

Gerald Mueer Herbert Schwab
March 16, 1982 Oregon

Dear Interested Party:

At the Northwest Power Planning Council January 7th meeting
in Olympia, Washington, the Council began discussing a planning
methodology that could deal with the growing uncertainties associ-
ated with electrical demand forecasting and resource development.
The Council continued this discussion at its February 17th meeting
in Portland, Oregon, and March 4 meeting in Missoula, Montana.

As a result of these Council discussions and working papers
prepared by the Washington State Energy Office and the Council's
Central staff, a contractor to the Council has prepared a discus-
sion paper for circulation to the public.

The paper, prepared by Dr. Kai N. Lee of the University of
Washington, outlines a process for establishing a range of
electrical energy needs and a program of acquiring resources and
options to meet that range. The paper also identifies a number of
questions raised by the planning concept.

The paper is intended to stimulate discussion on a planning
methodology prior to any formal Council action. The Council would
appreciate your review and comments on this discussion paper.

The Council is particularly interested in reactions to the
questions raised on pages 22 and 23 and identification of other
questions or problems raised by the discussion paper.

The Council would appreciate your comments by April 7th.
Would you please address your comments to me at the address above.
If you have any questions, please don't hesitate to contact me or
Jim Litchfield.

Thank you for your assistance.

oy

Cdk LL

Edward Sheets
Executive Director

Enclosure


DISCUSSION PAPER Planning in the Face of Uncertainty 10

supply is more valuable to some industrial customers than others
can form the basis for a futures market, in which costly resources
can be developed on behalf of those willing to bear the risk of
paying for them in order to assure supply. Conversely, there may be
consumers willing to purchase interruptible power, who have not had
access to lower-quality power in the past; their purchases can

provide peakload reserves and flexibility in planning.

The flexible, risk-managing approach differs from determ-
inistic planning in one important economic respect: risk manage-
ment does not minimize short-run costs. But if the future is
really uncertain, a flexible combination of projects can lead to
much lower costs than a least-cost investment that turns out to be
based upon mistaken assumptions. The concept of portfolio
diversification -- not putting all one's eggs in the same basket -
- embodies the same risk-managing philosophy. A diversified
portfolio may not earn the maximum return, but greatly decreases

the probability of substantial losses.

Of course, one can hedge one's bets foolishly as well as
wisely. Regional risk management is not self-implementing. But the
deterministic approach, in the face of the uncertainties that

confront the region, may guarantee failure.

Putting these principles into a workable planning process
will require technical, organizational, and governmental changes.
As a first step it may be sensible to consider a deliberately
oversimplified example of how a regional plan could be more flex-

ible.


DISCUSSION PAPER Planning in the Face of Uncertainty

planned for. Renewable resource projects promote flexibility as
well, when they are smaller than thermal projects. Some uncert—
ainty remains, however, on how much conservation and renewable

resources can be developed at cost-effective levels.

It is worth noting, moreover, that large central-station
plants can be made more flexible through institutional changes,
including option arrangements. Obtaining approval for sites and
for engineering designs is a time-consuming part of a power plant
project. If sites and licenses can be approved and then "banked,"
to be used for full-scale development later, the lead-time for
large projects can be substantially shortened. Similarly,
marketing part or all the output of a power station to utilities
outside the Northwest decreases the effective size of the com-
mitment shouldered by the region. If these marketing arrangements
include contingency arrangements, perhaps along the lines of the
call-back provisions in the Canadian Storage Power Exchange,, both
size and timing can be made flexible. Regional control of banked
sites and callback options enhances the risk-management

capability.

In addition, there are institutional arrangements with
consumers that can improve planning flexibility. For instance,
rate schedules that are implemented only when a shortage looms can
be used to hold down demand on short notice, if loads surge
unexpectedly or supplies sag. Such contingent rates would require
advance approval by public utility commissions, however, to make

them usable as regional options. The fact that secure power


DISCUSSION PAPER Planning in the Face of Uncertainty

7. The planning process should manage the burdens of financ-—
ing, licensing, and institutional change by making
regional commitments on a schedule that reflects the
slower load growth that characterizes a period of rising
real rates.

8. The integrated hydro system has been augmented with
thermal generation developed on a piecemeal basis. The
Regional Power Act -- and the risk-management approach in
particular -- seems to lead to a_substantially more
complex regional power system, one encompassing activities
and actors unfamiliar to the utility community. The
challenge of this additional complexity must be taken
seriously in the planning process.

The paradox of regional planning and decentralized execution
can be resolved in two somewhat different, but complementary,
ways. First, there should be liberal use-of markets and market--
like incentives. Second, the plan and planning process should be
instruments of political leadership, articulating purposes and
mobilizing the energies of the diverse interests whose partly
independent activities constitute the implementation of the plan.
Decentralized execution will not be easy to achieve, but there is
an important opportunity for council leadership in the fact that
the economic interests of the region parallel the goals of the

act.

The shift from deterministic planning to regional risk man-
agement is fundamental. This paper focuses on planning, but a
flexible approach implies significant changes in the way that
projects are developed and programs managed. Regional risk man-
agement also requires coordination of operations with planning, in
order to permit adjustment of both plans and operational policies

to respond to emerging conditions. The broad ramifications of a


DISCUSSION PAPER Planning in the Face of Uncertainty

cost-effectiveness and resource priorities set forth in
the Regional Power Act.

Regional risk management brings to the fore the question of
whether it is possible to put a great deal more flexibility into
the acquisition process. Before discussing some of the practical
issues raised by the idea of options, one should pause to observe

that flexibility may not be desirable in all cases, nor may it be

obtainable on favorable terms. First, electric power planning does
not take place in a vacuum; there are costs and benefits to
others, and these costs and benefits depend upon how utility
resources are scheduled. For example, Northwest electroprocess
industries invest large sums in capital equipment on the
assumption that. power will be available to utilize it. The
Regional Power Act recognizes the value of secure supply to the
direct-service industrial customers. More generally, flexible,
risk-oriented planning benefits some and imposes risks and costs

on others.

Second, a flexible, incremental approach encounters the
problem of "second best": that is, incremental decisions, each of
which is rational, may lead to a suboptimal outcome. Second best
is the economists' version of the road paved with good intentions.
For instance, vigorous attempts to improve the accuracy of
forecasts -- a rational program -- may lead planners to have an
inappropriate confidence in their estimates of future demand;

thus, incremental improvements in the single best forecast do not

20


DISCUSSION PAPER Planning in the Face of Uncertainty

in the Columbia River and its tributaries. Steady growth made
for simple planning: build more for a brighter tomorrow. And
when the potential of the region's rivers was fully harnessed,
it seemed sensible to turn to nuclear and coal, supplies that
promised to facilitate further growth at higher -- but still
reasonable -- cost. But even as the Regional Power Act was
emerging from Congress, the era of steady growth ended, a

victim of rising power costs and an unstable economy.

There are no facts about the future, but it is widely believ-
ed to be uncertain and risky. If the growth rate differs by only
0.3 per cent per year from the anticipated rate, the gap between
anticipated and actual load amounts to the equivalent of a nuclear
plant in less than 15 years. The ability to forecast demand falls
considerably short of even this 0.3 per cent criterion. It now
takes more than 10 years to plan and build a nuclear plant; such a
major facility costs several billion dollars. The costs to the

economy of not having enough power are similarly huge.

The planning problem is thus a daunting one: the best one
can do with current methods seems to entail major risks of either
building too much or too little, with heavy penalties either way.
The Northwest is walking along a narrow ridge, in the image of Dan
Evans, chairman of the Power Planning Council; we can ill afford
missteps, but we cannot see as far as we stride. Thus, the
question of developing a regional plan goes beyond selecting
resources for acquisition by the Bonneville Power Administration:

it must also include thinking about how resources should be ac-—


DISCUSSION PAPER Planning in the Face of Uncertainty

How does one fill in the V-shaped space between the lower and
upper bound forecasts? Figure 2 demonstrates an approach for a
single target year. Looking at the target year from the vantage of
the planning year in Fig. 2, the planner ranks resource possi-
bilities in order of increasing expected cost.<l> The resource
possibilities vary in size, but when assembled they span the range
from resources in being -- the regional system projected for the

target year -- up beyond the upper bound forecast.

Lead times for these resources vary. Some projects have
already been optioned or acquired in earlier planning years,
though more are needed to reach the lower bound forecast.. Some
projects do not need to be started yet, such as project 1. In
three cases -- projects 2, 3, and 6 -- a decision must be made in
the current planning year. The process concentrates on these

decisions.

Thus, project 1 does not have to be examined in detail, even
though, among resources available in the target year, it is
expected to be lowest in cost. An acquisition decision has to be
made on project 2, however. Situations like this illustrate the

tradeoff between cost-effectiveness and flexibility. If project 2

1. This expected cost should include measures of the technical,
environmental, and institutional differences among resource
alternatives. Some of these factors cannot be measured in
monetary terms, however, although they are clearly relevant
to a decision. For example, where a given resource is located
can affect its accessibility to the regional grid, its
financing, and the political acceptability to local
populations of proceeding with the project. These factors are
put aside in this simplified example.


DISCUSSION PAPER Planning in the Face of Uncertainty

is acquired, an irreversible commitment will have been made,
before the region has purchased lower-cost power from project 1.
The dilemma is that the planning process cannot wait for the
project 1 decision point, for project 2 would no longer be
available in this target year, and higher cost resources, such as
project 5, might then have to be developed. How should one value
project 2? There is, unfortunately, no simple method for gauging
the relative value of flexibility and cost. Whether to acquire
project 2 is, nonetheless, a judgment that can be illuminated
through analysis. For example, it is possible to compare the
implications of acquisition and deferral of this project. Pulling
project '2 out of the resource stack -- the result if the project
is not acquired -- would necessitate the addition of more
resource possibilities, higher in cost than project 6, so that
the range between' lower and upper bound forecasts is still
covered. At the same time, deciding not to acquire project 2
could mean that it remains available for development in a later
target year, though probably at higher cost. Of course, foregoing
acquisition can lead to a lower cost regional system if load

growth falls in the low part of the range.

Note that Project 2 has a decision point for an option after
it is acquired. This indicates the possibility of a sales option
-- a contractual agreement with a wholesale power purchaser for
sales beginning in the target year. A sales option protects the
possibility of selling power at a given price. The sales-option

decision point is an opportunity to evaluate progress just before

15


DISCUSSION PAPER Planning in the Face of Uncertainty

The Path Along the Ridge:

Regional Planning in the Face of Uncertainty

ABSTRACT

In developing a plan for the regional power system,
the Northwest Power Planning Council faces critical
uncertainties, both in forecasting demand and in planning
for conservation and new generating resources. The risks
arising from these uncertainties can be managed on a
reg- ional basis, by selecting a combination of
programs and resources that yields a risk-resistant
and cost-effective regional system.

Such an approach is attractive in concept, but it
differs substantially from established utility practice.
Discussion and criticism are needed, accordingly, to
assess the workability of the planning philosophy outlined
here.

Public Law 96-501, the Regional Power Act, responds to the
changing circumstances of electric power in the Pacific Northwest by
defining policy directions and creating new institutional
arrangements for regional power planning. The Northwest Power
Planning Council is the agent of the region in meeting the challenges
of planning under the act. This paper discusses the conceptual
framework of power planning, a task that confronts a degree of

uncertainty and risk without historical precedent.

For a quarter-century, electricity demand grew rapidly in the
Northwest, roughly doubling every 10 years. This growth was readily
met by the low-cost, abundant supply of hydroelectric energy

developed by the federal government and Northwest utilities


DISCUSSION PAPER Planning in the Face of uncertainty 24

enough.

The risks that face the Northwest are plainly visible.
Yet surprisingly, technical and institutional means of taking
account of these risks in regional planning have not been

clearly articulated. This essay attempts a beginning


THE PATH ALONG THE RIDGE:
REGIONAL PLANNING IN THE FACE OF UNCERTAINTY A

Discussion Paper*

(March 1982)

Northwest Power Planning Council
700 S.w. Taylor Suite 200
Portland, Oregon 97205
€800)547-0134 or (503)222-5161

* The Council welcomes comments on and criticisms of the
ideas presented in this paper. Please send responses
to Edward Sheets, executive director, at the Council's
Portland office.

This paper was prepared by Kai N. Lee, associate
professor of political science and environmental studies
at the University of Washington, where he is a Kellogg
National Fellow. Many of the concepts discussed here
were initially developed in Richard Watson, Steve Aos,
John Douglass, and Peter Downey, "Power Planning and
Uncertainty," an unpublished paper prepared at the
Washington State Energy office.


DISCUSSION PAPER Planning in the Face of Uncertainty 11

An example of flexible planning

In conventional utility forecasting the objective is to
estimate as accurately as possible the future demand for electric
power. A common approach is to make high, low, and intermediate
forecasts, using different demographic variables and assumptions
about consumer response to rate changes; typically, the intermed-
iate forecast is selected as the planning target. When uncertain-

ty is high, however, there may be insufficient information to

identify an appropriate intermediate case. That is, the region

may have to meet a demand for power 10 or 20 years in the future
that can lie anywhere within a broad range. It is reasonable to
think, however, that one can still identify a broad range within
which demand is expected to lie; the question for planning is how

to use this information.

Figure 1 shows a pair of schematic demand forecasts. They
are limiting cases, chosen on the basis of a consensus within the
forecasting community that actual demand will lie between the
lower and upper bound forecasts. Regional risk management proceeds

this way:

o The regional plan must assure that resources are adequate in
each year of the planning period to meet the lower bound
forecast demand. This requires resource acquisitions.

o The regional plan must also assure that a combination of
resources and options is available to meet the upper bound
forecast in each year of the planning period. This requires
development and acquisition of options, as well as resources.

o In order to be included in the plan, an option must meet
standards developed by the council. These standards should
insure that the option can, in fact, be converted into a


DISCUSSION PAPER Planning in the Face of Uncertainty

Q ==---=-- A

14

upper bound forecast »

Sales option
unlikely

sales option
will not recover
full cost

Q —----|-----. waa----- A ------- 4 already optioned
Regional fof fren
Energy O ewewnnnn A wenn n Pomme nnn == 3 purchase option
possible
Demand
(avg MW) .
A -------- 0 4--------------- 2 sales option
L- possible
——e a4
Already
A ------|--------------------;-<~---+ acquired
Resources in
being in target year
< lower bound forecast
Planning target
year year
Time (years)

Figure 2. Example of Resource Possibilities for a Target

Year,

with timing of decisions

to option (0) and to