Cost-Reflective Network Tariffs: Experiences with Forward Looking Cost Models to Design Electricity Distribution Charges

Abstract:

To better reflect local grid conditions to consumers, many regulators are reforming their distribution network tariffs. In this literature review, we start by discussing the difference between short-run and long-run marginal pricing for distribution grids. Short-run marginal pricing is first-best but hard to implement in practice. Several authors therefore argue to that it makes sense to signal long-run marginal costs through a forward-looking charge based on a forward looking cost model. After, we compare four implementations of forward looking cost models that are currently being used in Great-Britain. Finally, we discuss the link between cost models and charge design. We formulate two conclusions. First, forward looking cost models are complex both for the regulator as the grid users. Designing cost-reflective distribution tariffs can help, but tariffs are regulatory tools with limitations. Second, we identify a gap in the literature. There is more academic work on charge design than on forward looking cost models.

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