Long-run marginal costs (LRMC) are often the starting-point for setting electricity distribution tariffs because LRMC-based prices contribute to efficient decisions by end-users on the use of electricity and investment in electrical equipment. However, because LRMC is forward-looking, a tariff based only on LRMC would not recover the total cost of providing the regulated services or (equivalently) the approved revenue. The difference between the total approved revenue and the revenue that would be raised at tariffs based only on LRMC is termed the “residual” cost. The Australian Energy Market Commission (AEMC) asked us to prepare a report on how electricity distribution network tariffs can be structured to recover residual costs.
We have reviewed some 140 items in the academic literature on network tariffs, reached out to two dozen industry experts, and researched how utilities in different jurisdictions recover residual costs.