Congestion pricing might be an answer to power network gold plating

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Electricity network pricing has been a hot topic in the last six months. The key issues have been regulation and demand side management. On regulation, Prime Minister Julia Gillard is taking a package of reforms to COAG this week, claiming that this will save families $250 per year.

For demand-side management, the focus has been on smart meters and “real time” power prices. My earlier comments on these are here and here.

But there is a disconnect. Network pricing makes up more than half of our electricity bills. And network investment, to cater for peak demand, has been one cause of rising electricity prices. However, there is no serious discussion of congestion pricing for the network.

Congestion pricing for transmission would mean that, if the network becomes congested, the price that users pay for “the wires” goes up. It also goes down (in theory, to zero) when the transmission system is not congested.

Network congestion is likely to arise when there is a strong demand for power. So spot electricity prices (which currently do vary) will be positively correlated with network congestion charges. But currently network charges (generally) do not vary with demand.

So introducing real time pricing for electricity networks would create a double incentive to conserve power at peak times. This would lead to more efficient investment in generation, transmission and transmission substitutes.

What is an example of the latter? Well – batteries. Apparently battery research is moving ahead (albeit the good old lead-acid battery still leads the pack). Potentially, batteries provide a substitute to peak usage of power and peak transmission investment. If cheap enough and reliable enough, households or businesses could invest in batteries that charge when the network is not congested and/or the spot electricity price is low. Then, when the network is congested and/or the spot price of electricity is high, the battery substitutes for grid-based power.

Now I am not suggesting that this technology will be the alternative, but the best way to encourage the development of such alternatives is to let the market work. But to do this, electricity network prices have to reflect congestion.

Are network congestion charges possible? In a “full nodal” network every part of the transmission and distribution system would be priced in real time. But this can be pretty hairy stuff (I will let the engineers argue about its feasibility). But even in the absence of “full nodal pricing” we can do better than “flat” pricing for networks. Even rough multi-part tariffs based on congestion in a region are likely to be better than flat tariffs.

Of course, the key for congestion pricing for electricity networks, as with real-time pricing for the electricity itself, is to have the smart meters in place so customers can react to the prices. But, as I discussed before, I think that can be solved by letting the market deal with the smart meter problem as well.

Stephen King is a Professor in the Department of Economics at Monash University

This is an updated version of a blog post which appeared on Core Economics. It was cross-posted from The Conversation with permission

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  • Lex – Solex Carnarvon Solar Farm

    This is the first bit of sense I have seen. The problem that the utilities face in accepting dispersed embedded solar pv is economic not technical.

    Sadly Rome appears to be fiddling while Nero burns. No thought appears to be present in the prime directive – stop atmospheric pollution. We can work the economics out later. Now we are tuning the instruments while the ship sinks.

    I suggest a ‘line hire’ for the VAHs support as in water rates, shire rates and the like.

  • Warwick

    Stephen, do you regard the existing market for inter-regional settlement residues to be a form of congestion pricing? Surely, they would meet some of the criteria? There is a quarterly auction process where market participants purchase an entitlement to the financial flows between regions that are caused by transmission constraints between the states. Any surplus of funds from the process are paid to the transmission companies.

    Earlier, we had unregulated interconnectors such as Directlink and Murraylink which relied upon transmission constraints to provide scarcity in transmission and hence value in inter-regional flows. That said, they didn’t prove to be stellar investments and eventually applied for regulated status.

  • Beat Odermatt

    What would happen if smart people would replace smart meters? What would happen if people would start using their brains and stop using their washing machines, dryers and other power hungry tools and toys during times of peak power demand. I watched recently a documentary about the massive peak demand in Britain caused by millions of people turning on their kettles to make their cup of tea during the add break of a TV soapie. The peak demand had an impact across Europe and could only be met by importing power from France.

  • DHW

    An absolutely critical development. If we can correct the other major retail market distortion of including network costs and overheads within energy tariffs ($/kWh) and instead move to a model such as firm access pricing at the retail end it would solve many problems. To explain, the standing charges to customers would largely be based on the power level (kW) that they want access to during peak periods. Other fixed costs and overheads would also be lumped into the standing charge. This way, energy prices per kWh would be for energy only and more closely reflect wholesale prices, say 5-10c/kWh. This pricing would displace domestic natural gas and make electric cars cheaper to run. There would therefore be big shifts from transport fuel and natural gas use to electricity, which can be de-carbonised with renewables while the others cannot. Planet saved, sorted.

  • Chris Fraser

    The idea of TOU reflecting demand is genius. But how do i get over the problem of buying energy from a retailer who tries hedge my risk by charging me too much in the off-peak period and not enough in the peak period ? If it was just Us vs the Generators we could pay 2c/kWh in the small hours and $12.50/kWh for only 40 hours a year on hot days – although the decision to consume then is always ours. Can a smart meter handle a broader range of pricings and AEMO-style time increments ? I doubt my smart meter could.

  • John D

    Ask yourself:
    What changes would we really make at home if power costs doubled in peak demand/congestion periods? How much difference would these changes make to peak demand?
    Ditto for the place you work at.
    Market tragics can get sucked into elaborate plans that sound good but, in reality make little difference.