A combination of a New Year break and attempting to digest
the barrage of dramatic political news with the inauguration of the new US
President has limited my writing time in the last few weeks. I am going to
restart 2017 with a few further reflections on the problems of network
charging, picking up on the first comment received below. [2 February 2017.]
Trends in renewable energy and decentralised generation are a huge threat to the conventional business model for power utilities. There is no read across from mobile telephony and some major challenges for public policy.
Network charging promises to
be a subject that, with a growing proportion of renewable energies, and especially
with the growth in decentralised and off-grid systems, is simultaneously
important, intellectually challenging and controversial. It may be worth
starting with a few comparisons with charging structures for mobile telephone
networks. Prima facie some people assume that the questions should be very
similar, and that there is therefore an easy read-across between these two
types of network.
After all both
can be considered, as a first approximation, as dominated by high fixed cost
elements and near zero marginal cost. But there are also some profound differences.
1. The capital
costs sunk in the fixed asset part of mobile network are smaller – a few masts
as compared to a complex structure of overhead and buried lines, wayleaves,
transformers and substations, plus physical connections to each property/
consumer. This is one explanation that mobile telephones, unlike landline networks,
and unlike gas and electricity distribution networks have never been regarded
as a natural monopoly. The social and other constraints placed on the operation
of a natural monopoly that is also an essential service are a major factor in
explaining why charging structures have developed differently.
2. When you buy
a mobile phone service, one of the main choice you are making, and a major part
of the service you are buying, apart from the phone itself, is the network
coverage. So paying a fixed charge, which may differ between providers
according to the quality of their overall geographical coverage, makes
intuitive sense. You are paying for connectedness when you yourself may be in a
wide variety of locations. You are not paying for a dedicated local connection.
3. Most of the
time mobile phone networks are operating well within capacity. The same is
often true of electricity networks although there are increasing pressures to
manage peak loadings through time of day tariff incentives. But perhaps the key
difference here is that mobile telephony consumers are accustomed to a much
higher degree of unreliability than is acceptable for utility services like
power and water. It is also difficult for consumers to differentiate between
signal, handset and capacity limitations. So there is inevitably less
consumer pressure and less economic or commercial incentive for providers to
use price to manage consumption.
Whatever the
differences in these economic structures, there seem to be some big consequential
differences in the approach to pricing. Mobile telephony places a much higher level
of emphasis on fixed or “standing” charges, while the tendency in gas and electricity
networks is to average the fixed costs over the units (kWh) of consumption.
There are at least two plausible explanations.
Historically and politically the impact
of regulated monopoly is important.
A fixed charge
for connection and distribution has always been seen as regressive, since it
appears to penalise small consumers. “Cost averaged” kWh charges look more
equitable. There has always been a strong
"political" resistance to even quite small standing
charges. Per unit charges would also have been built into the charging
structures of the early (monopoly) local utilities as a good marketing
tool to get more people connected in the first place, ie downplaying the
fixed charge component. And of course regulation of the sector monopolies has
had a major impact in imposing universal service obligations or their
equivalent, and also very high levels of system reliability.
This model is
now under threat, partly because the potential impact of consumer self-generation
and “off grid” activity threatens the monopoly model. It is usually only
monopolies, de facto or otherwise, that are able to cross-subsidise one group
of consumers at the expense of another.
The real key may be the threat of adverse
selection in the competitive markets that constitute mobile telephony?
Mobile telephony
is a competitive market, so that any provider getting the structure of charges
wrong will suffer adverse selection. This might tend to favour a fixed
charges approach as follows. Many or most consumers place a high value on
having access to a network even if they are relatively low or infrequent users,
but the marginal value to them, ie price they would be prepared to pay for an
additional minute of conversation time is very small. So any charging pattern
based solely on usage would attract the low usage customers, lose the high
usage customers to other providers, and consequently fail to cover fixed costs.
In other words the
risk of adverse selection forces competing companies to adopt pricing
strategies that are closer to their real cost structure. There are some quite
complex tariff structures that do relate to volume but these tend to reflect at
least in part an attempt to price discriminate by extracting a higher cost
recovery from high users who are in fact less price sensitive and prepared to
pay a little more. And they often take the form of a higher upfront charge
with a higher free usage entitlement, usually without a marginal charge
attaching to a particular call.
Problems for future electricity distribution
networks?
What is now happening
therefore is that more people are going partially “ off grid” and in consequence
undermining the traditional network pricing model. This is analogous if not
identical to the adverse selection issue. The “off grid” consumers still
want connection to a network qua network, and the back-up provision of power
that that network provides. But the per kWh pricing structure allows them to
escape having to pay the real cost. So the loss of monopoly is undermining the regulated
utility business model. The situation is potentially unsustainable and poses
some major public policy and regulatory issues, especially if network utilities
are forced to revert to a much higher reliance on a fixed charge component of
their tariffs.
