Tuesday, February 7, 2017


MikeDG, commenting on my last blog on this subject, focuses on other competition analogies in telephony, and poses the question of how much difference there is likely to be between transmission and distribution networks. So I will try to partially answer this question while at the same time reflecting on the conflicting objectives to which network charging in the power sector might be subjected. I cannot pretend to have a clear and unambiguous answer, and it is probable that no solution will satisfy all the objectives, but it is at least worth rehearsing the questions.

One set of basic challenges stems from the fact that there is a strong case for using network pricing to convey economic messages for energy production and consumption, given the network structure that is already in place, but also to influence future investment in production and consumption and in the network infrastructure itself. The problem is that these worthwhile objectives can themselves produce conflicting answers, for the simple reason that there is a huge gulf between short run marginal costs, which matter for operational purposes, and long run marginal costs, which include the much larger capital costs associated with constructing or reinforcing transmission and distribution networks.

The other set of challenges stem from the history of the electricity sector, and the high voltage transmission and lower voltage distribution networks within it, as regulated monopolies. On the one hand this means that private investors have to be guaranteed a “reasonable” rate of return on their investment. But it also means that they are subject to a number of constraints that reflect social objectives, such as requirements to provide something approaching a universal service, and to set prices that are deemed to be fair and equitable, even if this conflicts with economic efficiency.

It is also in this context that competition issues are most likely to arise. Electricity networks are usually assumed to be natural monopolies, and this assumption is now generally much stronger than it is for mobile telephony. The competition issues are not about competing networks but relate to regulatory and licence requirements for network operators to provide broadly similar non-discriminatory terms to all parties in those competitive markets, such as power generation and retail supply of electricity, which depend on the network for transport to their customers. 

Given these potentially conflicting objectives and constraints for network pricing, the transformation to a low carbon power sector is going to pose some new problems, not least because of the additional electrical loads associated with electric vehicles. Here are a few.

1.       Network operators want to encourage consumers to avoid overloading networks at peak times, and can impose time of day charges for network usage that are highly differentiated and reflect operational objectives, short term costs and capacity constraints. But with conventional approaches to time of day tariffs, attempts to smooth peaks can be highly unstable, requiring regular tariff adjustments which undermine the incentive properties as far as consumers are concerned. Large commercial consumers can shift their load significantly through battery technology and other demand management measures, but if the utility is relying on highly differentiated prices to recover its allowed revenue requirement it will be forced back to higher reliance on fixed charges, negating any investment the consumers have put.

2.       The basic structure of network costs is that they are dominated by the fixed costs associated with the network, essentially the costs associated with installing wires and transformers. The future of the power sector is one which is increasingly dominated by fixed rather than variable (fuel) costs in generation and storage as well as in the networks, and this will put an increasing pressure on utilities to reflect this in charging structures. If they do not, then they may be vulnerable to cherry picking and adverse selection problems from customers going “off-grid” and paying too little for the back-up services they receive.

3.       Traditional regulatory pressures will militate in the opposite direction, continuing to seek an equitable approach to pricing that essentially equates to an averaging of costs over all units consumed.

4.       There is evidence that some new loads, including electric vehicles and heat pumps, will pose particular issues in rural networks, which have relatively tight thermal and voltage constraints. Dealing with this may require much more differentiated pricing signals, but this will run against traditional practices and also raise discrimination questions.
We should expect these factors to generate an increasing number of analytic and policy issues as we move towards an increasing electrification of the energy economy.

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