Monday, January 9, 2017


A combination of a New Year break and attempting to digest the barrage of dramatic political news with the inauguration of the new US President has limited my writing time in the last few weeks. I am going to restart 2017 with a few further reflections on the problems of network charging, picking up on the first comment received below. [2 February 2017.]

Trends in renewable energy and decentralised generation are a huge threat to the conventional business model for power utilities. There is no read across from mobile telephony and some major challenges for public policy.
Network charging promises to be a subject that, with a growing proportion of renewable energies, and especially with the growth in decentralised and off-grid systems, is simultaneously important, intellectually challenging and controversial. It may be worth starting with a few comparisons with charging structures for mobile telephone networks. Prima facie some people assume that the questions should be very similar, and that there is therefore an easy read-across between these two types of network.
After all both can be considered, as a first approximation, as dominated by high fixed cost elements and near zero marginal cost. But there are also some profound differences.
1. The capital costs sunk in the fixed asset part of mobile network are smaller – a few masts as compared to a complex structure of overhead and buried lines, wayleaves, transformers and substations, plus physical connections to each property/ consumer. This is one explanation that mobile telephones, unlike landline networks, and unlike gas and electricity distribution networks have never been regarded as a natural monopoly. The social and other constraints placed on the operation of a natural monopoly that is also an essential service are a major factor in explaining why charging structures have developed differently.
2. When you buy a mobile phone service, one of the main choice you are making, and a major part of the service you are buying, apart from the phone itself, is the network coverage. So paying a fixed charge, which may differ between providers according to the quality of their overall geographical coverage, makes intuitive sense. You are paying for connectedness when you yourself may be in a wide variety of locations. You are not paying for a dedicated local connection.
3. Most of the time mobile phone networks are operating well within capacity. The same is often true of electricity networks although there are increasing pressures to manage peak loadings through time of day tariff incentives. But perhaps the key difference here is that mobile telephony consumers are accustomed to a much higher degree of unreliability than is acceptable for utility services like power and water. It is also difficult for consumers to differentiate between signal, handset and capacity limitations.  So there is inevitably less consumer pressure and less economic or commercial incentive for providers to use price to manage consumption.
Whatever the differences in these economic structures, there seem to be some big consequential differences in the approach to pricing. Mobile telephony places a much higher level of emphasis on fixed or “standing” charges, while the tendency in gas and electricity networks is to average the fixed costs over the units (kWh) of consumption. There are at least two plausible explanations.
Historically and politically the impact of regulated monopoly is important.
A fixed charge for connection and distribution has always been seen as regressive, since it appears to penalise small consumers. “Cost averaged” kWh charges look more equitable. There has always been a strong "political" resistance to even quite small standing charges. Per unit charges would also have been built into the charging structures of the early (monopoly) local utilities as a good marketing tool to get more people connected in the first place, ie downplaying the fixed charge component. And of course regulation of the sector monopolies has had a major impact in imposing universal service obligations or their equivalent, and also very high levels of system reliability.
This model is now under threat, partly because the potential impact of consumer self-generation and “off grid” activity threatens the monopoly model. It is usually only monopolies, de facto or otherwise, that are able to cross-subsidise one group of consumers at the expense of another.
The real key may be the threat of adverse selection in the competitive markets that constitute mobile telephony?
Mobile telephony is a competitive market, so that any provider getting the structure of charges wrong will suffer adverse selection.  This might tend to favour a fixed charges approach as follows.  Many or most consumers place a high value on having access to a network even if they are relatively low or infrequent users, but the marginal value to them, ie price they would be prepared to pay for an additional minute of conversation time is very small. So any charging pattern based solely on usage would attract the low usage customers, lose the high usage customers to other providers, and consequently fail to cover fixed costs.
In other words the risk of adverse selection forces competing companies to adopt pricing strategies that are closer to their real cost structure. There are some quite complex tariff structures that do relate to volume but these tend to reflect at least in part an attempt to price discriminate by extracting a higher cost recovery from high users who are in fact less price sensitive and prepared to pay a little more. And they often take the form of a higher upfront charge with a higher free usage entitlement, usually without a marginal charge attaching to a particular call.
Problems for future electricity distribution networks? 
What is now happening therefore is that more people are going partially “ off grid” and in consequence undermining the traditional network pricing model. This is analogous if not identical to the adverse selection issue.  The “off grid” consumers still want connection to a network qua network, and the back-up provision of power that that network provides. But the per kWh pricing structure allows them to escape having to pay the real cost. So the loss of monopoly is undermining the regulated utility business model. The situation is potentially unsustainable and poses some major public policy and regulatory issues, especially if network utilities are forced to revert to a much higher reliance on a fixed charge component of their tariffs.

1 comment:

MikeDG said...

Thank you, this is interesting. I think another good analogy is with the fixed telcoms network which has moved from actual monopoly to some competition in broadband supply - both from large entities like Virgin and from entrepreneurial start ups operating in geographical territories such as Gigaclear. There has also been a large technological change from charging for usage as voice minutes to charging for capacity (megabits per second).
I also wonder if your analysis applies just to National Grid or to local distribution companies? I think the competition issues will differ - along the lines of the fractal grid that you and others have described.