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 and 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.