In pursuit of a long-lasting distribution network tariff design

This paper addresses the question of how distribution fixed costs can best be priced, in the context of technological disruptions in the power sector.  The vast majority of network utility costs to serve residential and small commercial and industrial customers are fixed, and this means a first-best solution is unattainable. This is because distribution is a natural monopoly, meaning that it has a peculiar cost structure, of declining average costs. In this setting, marginal costs are lower than average costs, which suggests that efficient pricing -where prices equal marginal costs- would not lead to cost recovery. Second-best solutions have been sought in order to balance this trade-off. Tariffs have been designed to allocate costs across different types of customers based on their causality. This opens up the question of fairness, in addition to efficiency and cost recovery objectives. Balancing these competing goals suggests using a combination of fixed charges and increased volumetric prices. Different combinations have been suggested: from average cost pricing, and Ramsey pricing to fixed charges, tiered pricing or minimum bills.

The emergence of technological disruptions in distributed energy resources (DERs) complicates things further. These technologies allow customers to reduce their reliance on utilities and their grid: customers can self-generate power, trade electricity in excess with other users or sell it back to the grid. DERs are subject to tariffs originally designed for a world without them. The starting point of traditional tariff design is an assumption on the load that would lead to cost recovery. With DERs, this no longer can be assured. Moreover depending on the penetration, location, size and type of technology, having DERs installed could have positive impacts, as they could delay expensive expansion of the grid, which would end up reducing network costs, in which case, owners would need to be compensated. The issue of DERs is yet to be resolved, when other technological trends are expected to disrupt the power sector even more. The penetration of other decentralized technologies such as Electric Vehicles and batteries, the issue of digitalization, and the electrification of other sectors of the economy like heating and cooling, call for innovative ways to price distribution network services. This is important because network tariffs structure can be a facilitator or an impediment to efficient decentralization and decarbonisation.

Since technologies would always be improving and changing, tariff design would always be one step behind. In this paper, we propose our own model of distribution network tariff design. We aim to propose a pricing mechanism that allows for a more permanent and more stable solution that is not only resistant to technological changes but also does not impede an efficient decentralization and decarbonisation. We also challenge some of underlying assumptions of traditional pricing, for example:

  • Cost allocation:  Is this the key issue to solve? If this is the case, would blockchain developments help?
  • Unbundling:Should the unbundling of the value chain continue, at all levels, as the basis of costing electricity provision? Shouldn’t distribution networks be treated differently than transmission networks given their complexity and their role in decentralisation? For example: does it make sense to bundle distribution, retail and behind the meter services as a single package with a price?
  • The new commodity:To what extent data generation would be the focus of future pricing of network service rather than the commodity power itself?

We will leverage from New York’s Reforming the Energy Vision to illustrate answers to these questions.

By: Rolando Fuentes , Rahmat Poudineh , Anupama Sen