Electricity Network Tariff Architectures A Comparison of Four OECD Countries

Abstract

The study is motivated by the question "what is the optimal tariff design?" While we do not offer an answer to this question, we use the different designs in four select countries to illuminate the issues involved in designing electricity network tariffs. Electricity networks are a resource shared by all network users. A tariff design that is clear to network users and well understood by them can help them make efficient decisions. A design that sets up conflicting or perverse incentives results in economic distortions. We find that there are a variety of choices and trade-offs while designing the electricity network tariffs for any electricity system. The tariff design must not only be influenced by the technical and economic characteristics of the system, but also the secondary policy objectives that policy makers wish to achieve, while allowing network companies to recover the costs of building and maintaining the network. A design that sets up conflicting or perverse incentives results in economic distortions. * Corresponding author, MIT Technology and Policy Program and the MIT Center for Energy andA main constraint on the tariff design is the overall budget constraint: the total of all charges to all users must be sufficient to cover the costs of the network and afford the network company an adequate return on its capital. On the other hand, the total of all charges should be kept reasonable, in the sense that the network company is not extracting monopoly profits.Transmission networks are different from distribution networks in terms of their technical requirements and usage patterns. Tariffs may therefore be designed differently for the two types of networks to provide specific incentives to the respective users. We discuss tariff designs for both types of networks.To set the stage for the description of alternative tariff designs, it is beneficial to revisit the issues arising out of the economic characteristics of electricity networks and the consequent regulatory provisions.Page 5 of 108 NETWORK CHARACTERISTICS Natural MonopoliesElectricity networks -both transmission and distribution -are treated as natural monopolies because of the existence of economies of scale and scope in the delivery of electricity. Economies of scale exist when a firm's average cost of production declines as output increases. Economies of scope exist when it is cheaper to produce combinations of different products within a single multi-product firm, than to have specialty firms produce the different products (Panzar and Willig 1981).Electricity networks achieve economies of scale when their capacity is sized to meet the demand for all network users within their network territory. For a given network capacity, the average cost of production decreases as the capacity utilization increases, and is lowest when utilization is maximized. The average cost of production is lowest if the network company sells to the entire market, that is, when it meets the total demand. Competition in electricity networks for a particular se...

Regulatory Objectives and the Intensity of Unbundling in Electricity Markets

“…7 Sakhrani and Parsons (2010) analyze the network tariffs of four OECD countries in much detail; for both the EU member states included in their selection, Portugal and Spain, they find total access fees to be a mark-up on the power price paid by consumers that solely consist of price-independent capacity charges (e/kW/year, capacity constrains the power production, we finally suppose the two downstream generators to share the existing network units equally (Cremer and De Donder, 2013).…”

Market-based valuation of transmission network expansion. A heuristic application in GB

“…For example, the New England system undertakes market efficiency upgrades (investments designed to reduce bulk system-wide costs) where the net present value of the reduction in system costs exceeds the net present value of the transmission investment; Sakhrani and Parsons [53].…”

“…But this may be a mixed blessing; since expansion costs are nonlinear, incentives toward free riding can easily arise; Bushnell and Stoft [13]. The incentives to co-operate and undertake beneficial investments further depend on the business models adopted in different electricity markets (Wu et al [60]) and on network tariff architectures (Sakhrani and Parsons [53]). 6 There would be no further problem in using our model for a yearly period on an hourly basis (8,760 steps) apart from the increase in the time required for computation.…”

Regulation impact on distribution systems with distributed generation

“…One is connection charge for DG, which is paid by DG producers once when they require network access to compensate for the costs of connection. The other one is use-of-system (UoS) charge, which is paid by DG producers periodically to compensate the operation cost of network and capital expenses for new investment [32]. Who designs the tariffs and how the tariff structure should be designed depend on regulation.…”

“…To evaluate the reinforcement that may be required at different network levels a system impact study is usually conducted [32]. How the reinforcement cost caused by DG should be recovered depends on regulation.…”