1 June 2015

Should Electricity Charges be Energy or Capacity Based?

 Richard Ford, Principal at Sageline consulting asks if there is an optimal way to structure electricity charges

Electricity supply companies struggle to find the best structure for electricity charges. On the one hand they aim to allocate costs to the consumers that cause that cost. On the other hand they aim for simplicity. It is the tension between these two aims that leads to the myriad of rate designs around the world.

In Ontario residential customers pay a variable energy rate (three bands high, mid, and off peak) set by the regulator plus additional charges to recover transportation and regulatory charges. The rate for the distribution component is part energy, part fixed although the regulator has ruled that this component will become entirely a fixed charge by 2020.

In the UK where there is open competition between supply companies, there was initially a huge increase in available rate structures as each supplier developed rates that they felt would look most attractive to customers. The resulting customer confusion led to the regulator reducing the variety of available rate designs.

So why is rate design so difficult?

The simplest fixed rate - $X per month – provides the supplier with a fixed income but no control over the volume (and hence cost) of the energy supplied. This design (in the form of unlimited data plans) works for internet service providers because the cost of usage is only a small component of their overall costs. In this model, low usage customers may feel that they are subsidising high usage customers.

The simplest energy rate – X cents per kWh – hedges the supplier against the cost of supplied energy but leaves uncertainty over its ability to cover its fixed costs; especially if customers reduce demand in response to high energy prices. In this model, high usage customers may feel that they are subsidising low usage customers.

Ultimately there is no single perfect rate design. And it falls to both regulators and consumer advocates to hold suppliers to account if their offered rates are not serving the customer needs.