Tackling Tariff Design

Over the course of an eight year price control, distribution network companies will recover around £41.2 billion from consumers to provide the electricity and gas distribution networks - the pipes and wires that connect consumers’ homes to the central transmission system.

As a comparison, this is the same as the anticipated cost of the HS2 train line and a third more expensive than replacing Trident. The average consumer will pay £310 a year on network costs, around a quarter of their total energy bill. Because networks are monopoly businesses, there is little competitive pressure forcing these costs down.

Citizens Advice represent the interests of all consumers at the highest levels of energy policy making. Today, we publish research on the fairness of how this money is recovered from domestic consumers through distribution tariffs. This research suggests that regulator and industry attention will turn to reforming the distribution tariffs in the coming years, as technological change transforms the energy landscape and they focus their attention on ensuring that payments made by consumers reflect the costs of providing the distribution system to them.

In particular, technological change may fundamentally alter the way that we consume electricity. The cost of rooftop solar panels has plummeted by 70 per cent in five years. Widespread adoption of solar and other forms of distributed generation could transform the electricity network from a one-way journey from generation source to consumer – instead, becoming a complex balancing act between consumers, traditional generators and households exporting excess energy back into the grid. Meanwhile, integrating large-scale intermittent generation – solar and wind farms – present challenges for meeting consumer demand when the sun isn’t shining or the wind isn’t blowing.

These challenges may lead to reform of the way we pay for the distribution system – particularly in electricity – to make sure that tariffs reflect the costs of a radically different energy system. Smart meters will also make innovative tariffs possible. Consumers currently pay for the distribution system through a modest standing charge and a unit charge per kilowatt hour (which forms the majority of the bill).

We identified four feasible reforms to tariffs:

• A higher standing charge, while reducing the unit charge proportionately;
• A peak demand tariff, where consumers are charged based on their peak usage of energy over a monthly bill period;
• A time of use tariff, where consumers are charged higher costs at ‘peak time’ and lower costs at all other times;
• A rising block tariff, where consumers are charged a lower cost for essential energy usage and then a higher amount for all usage beyond that.

Many of these options can make a case for better reflecting the costs of the distribution system. Time of use and peak demand tariffs could reduce the burden on the network at peak times, reducing the need for capital investments in future and perhaps assisting in integrating intermittent generation. Higher standing charges could reflect the fact that the cost of the current distribution system is largely fixed – it remains the same regardless of how much energy consumers are using.

Our research looked at the distributional impacts of these different options. Our modelling suggests a higher standing charge would (on average) increase the costs facing the lowest income consumers by 10 per cent. All other options would decrease their average costs. While changes in bills would be modest overall for the average consumer, some consumers would face distribution charge increases in excess of 100 per cent under some tariff reform options.

We also found that technological change is crucial to understanding how different tariff options will affect different consumers. For example, domestic take-up of distributed generation could shift the costs of the distribution system dramatically. Distributed generation reduces its owners’ contribution to the cost of the distribution system, shifting this cost to the remaining consumers. Our modelling showed that tariff options that reflect costs well for existing infrastructure fare much more poorly when that landscape changes.

What are our key takings from this research? Firstly, we recommend that tariff reform should be technology-led: look at the changing technological environment and adjust tariffs accordingly.

Secondly, all tariff reforms create some big winners and big losers. Significant primary research will be needed – particularly ensuring that the impacts on low-income consumers are mitigated. Thirdly, new tariffs should be gradually phased in, alongside a robust consumer education plan to make sure consumers are aware of the change.

Our research primarily focussed on the redesign of the distribution tariff. However, in a dramatically changing energy system, its distributional analysis also provides insights for consumers’ entire energy bill. As smart meters make more and more innovative tariffs possible, our modelling can also point the way on how these tariffs might affect consumer bills – leading to learning for the industry as a whole.