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April 20, 2016
Article by Brattle Consultants on Tariff Structures for Achieving Economic Efficiency Published in Economic Analysis and Policy

Brattle Principals Toby Brown and Ahmad Faruqui and Associate Léa Grausz have authored an article published in the December 2015 issue of Economic Analysis and Policy that reviews different methods for ensuring economic efficiency when devising tariffs for distribution network services while meeting the revenue constraint.

In the article, the authors discuss how a distribution network tariff based only on long-run marginal costs (LRMC) – a long tradition in economics of setting prices to achieve economic efficiency – would likely fail to recover the total cost of providing the regulated services. This creates a challenge for policy makers and networks alike to recover revenue equal to total cost while minimizing distortions to marginal cost pricing.

Through assessing five stylized tariff options against three primary criteria – efficiency, fairness and gradualism – the authors find that the five options each satisfy the assessment criteria, and while the tradeoffs between the criteria are different for each option, there is no single option that is unambiguously best. They conclude that in practice, regulators have to strike a careful balance, making trade-offs to reflect relevant policy considerations. Additionally, transparency in how this balance has been struck, and in how fairness is being interpreted, would be helpful in clarifying the respective roles of tariff design and other policy instruments in achieving desirable outcomes.

The article, “Efficient Tariff Structures for Distribution Network Services,” is derived from an August 2014 Brattle report prepared for the Australian Energy Market Commission (AEMC), which reviewed how electricity distribution network tariffs can be structured to recover residual costs. While the analysis presented in this article relies on data from Australia, the approach and findings presented would be applicable to other networks worldwide.