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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

constraints. Customers, on the other hand, benefit from the availability of services that meet their needs, possibly at lower costs than standard offerings. This is quite different from existing COS pricing structures, which primarily induce firms to place more assets in the ground.

Environmentalists and others fear that any pricing scheme that lowers the volumetric charge will hurt DG technologies by making them less competitive. But this argument lacks vision; like the old labor union saw that automation costs jobs (thereby hurting the economy), it may be true-but only in the short run. In the long run, innovation and automation have produced one of the most profitable periods in our economic history. Would that have happened in the presence of widespread featherbedding? Undoubtedly not. Similarly, lower, more cost-based volumetric charges in the context of an institutionally and technologically restructured industry will revitalize demand, which will enhance the need for both renewable and fossil-based DG technologies.

Of course, DG is a two-way street; it reduces a retail customer's grid consumption while transforming that customer into a small producer in need of grid access. One of the unexplored but essential benefits of the grid lies in its ability to arbitrage the value of power among users at any given moment: User A has excess power, while user B (or the grid itself) needs power. Properly supported by information technology and appropriate metering, the distribution network, like any efficient market, will facilitate transactions instantaneously, thereby raising its value and the value of DG assets.

Nevertheless, just as the automobile has altered but not eliminated the need for public transportation, DG will not obviate the local grid-at least not in the foreseeable future. Indeed, in contrast to the automobile and public transportation, DG may produce new roles for the grid, just as proliferation of distributed computing-the PC-created new, previously inconceivable demands for telecommunications.

In the end, efficiency (with equity and fairness) therefore must mark the paramount objective in distribution pricing-not just whether a particular technology is helped or hurt. Though renewables can play an important role in our nation's resource portfolio (as I have argued in this journal and elsewhere), it is also counter-productive to try to promote them through featherbedding-setting regulated retail volumetric rates arbitrarily high. The resulting welfare losses simply are too great.

As mentioned, the transition to lower volumetric charges and higher demand-based access charges provides significant welfare gains-on the order of $12 billion nationally. This potential welfare increase is real; so is the attractiveness to UDC managers of the relatively fixed revenue stream provided by a set of inelastic demand-based access charges that will, among other things, significantly lower the UDC's cost of capital. These factors can become the basis for a quid pro quo for funding renewables-based DG and achieving other societally desired objectives. UDCs will be keenly interested in rates that recover most, if not all, of their fixed costs through a fixed charge. Regulators can use this carrot to negotiate support for renewables and other DG.

Given the magnitude of the welfare gains produced by transitioning to cost-based tariffs,