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Pricing Reform for the Local Disco: Setting Rates That Will Support Distributed Generation

The Proposed Distribution Tariff
Fortnightly Magazine - July 1 2000

first bottle, is charged only $1 and hence realizes a welfare or consumer surplus of $2 ($3 - $1). The envelope of willingness to pay is the demand curve for this player. Given the $1 price, she will buy three bottles for a total surplus of $2 + $1 + 0.10 = $3.10. If the price were raised to $2, our player would buy only two bottles, and her consumer surplus gain would drop to $1 + 0 = $1. She then might go elsewhere-presumably further away-to find the third drink for $1, or bring her own water. In either case, the vendor loses a profitable sale and our thirsty player loses surplus gained from buying the additional water she would like.

In the case of electricity, we may not know a consumer's willingness to pay, but when the volumetric charge is reduced, he or she realizes a consumer surplus gain in much the same way. Using the figure below, if the volumetric (kilowatt-hour) charge is reduced from $3 per unit to $1, the consumer will increase electric consumption from one unit to three, and realize a consumer surplus gain of $3.10, just as the tennis player did. Part of the increased welfare comes at the expense of the utility's shareholders, whose profits on existing sales are reduced. But another part (known as the Harberger triangle, and shown in the figure on p. 48) represents a net societal welfare gain that accrues from the extra consumption. -S.A.

The proposed demand-based access charge is cost-based, reflecting the cost of meeting peak customer needs. That also means that it is non-discriminatory: It does not necessarily increase the bills of low-usage customers, an inherent problem when the traditional fixed customer charge is raised. As mentioned, the new (higher) access charge leaves unchanged the monthly bills of both low- and average-usage customers. This pricing approach therefore mitigates the traditional objections of consumer advocates to initiatives aimed at increasing the "fixed" charge. Indeed, it seems that both consumer advocates and environmentalists who traditionally have supported appropriate cost-based electricity pricing should find the access charge attractive.

Distribution Augmentation: A Role for the UDC?

It has become quite clear by now that like transmission, distribution assets compete with generation. In fact, most regulators and economists would agree that the wires companies should be independent of generators. Nevertheless, there remains an unclear area- 12-where it may make sense to allow UDCs to own or at least control a certain amount of generation. Well-conceived DA applications can strengthen the network and improve overall service reliability. So the question becomes, when can the installation of a microturbine be attributed to improving voltage stability and when is it for the purposes of competing with bulk generators in a remote part of the grid? These obviously are thorny issues. State regulators must deal with them-including regulators in those states where utilities have divested generation assets, leaving a set of state regulated retail wires companies.

There is no doubt that in many cases DA will be a useful and cost-effective alternative for increasing capacity