Electricity tariff, in general, needs to reflect the true cost of supply in order to ensure maintaining an adequate level of security of supply and the financial viability of the electricity sector including private and public entities. The true cost of supply needs to be determined accurately by an independent body. This is the role of the regulatory agency responsible for setting the tariff, taking into consideration the welfare of all stakeholders.
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Economic theory states that any commodity or service must be priced in accordance with the value it has to the buyer. This price varies between two upper and lower values. The lower value is the actual cost of producing the commodity or delivering the service. On the other hand the upper value is the maximum value that market conditions or competition allows. In between these two values is the right price.
Electricity tariff is similar to pricing any commodity or service but yet it is quite different. It is similar in the sense that it is the source of the power company's revenue, which generally includes a certain return on investment plus a recovery of operating costs. However, it is different than pricing any commodity or service in the sense that in a regulated market tariff setting is subject to regulatory concession. Moreover, it is reviewed annually or every two years, and it is also subject to public acceptance in one form or another. In an open competition market, tariff is determined largely by market forces and strong competition.
As power industry is investment-intensive, requiring large investments, competition will never be absolute as in other sectors. In other words some sub-sectors may be subject to complete competition but not all. Moreover, it is not fair to request a distribution company to invest heavily in a distribution network in a certain geographical area and then allow another company to provide service in the same area. The other distribution company may be allowed to provide service in another area. This situation is not open competition since the two companies can not supply electricity to the same consumers. Once a consumer selects to live in a location he/she should deal with the company working in his area. Usually the license agreement with the distribution company designates the geographical area within which it will work.
In generation the competition is open due to the different investment structure of each company. Moreover, all produced power will be purchased from the generating companies. The contracted price for purchasing power is subject to long-term conditions, including time of delivery, capacity, power quality, and lead time to deliver additional capacities.
Power exchange also plays a significant role in determining power purchase prices. All these factors of “near open” competition and legitimate monopolies indicate the complexity of the electricity tariff. Furthermore, the issue of fuel switching between electricity and other energy forms complicate the issue even further. Sometimes macroeconomic policies or social issues interfere in the electricity tariff setting procedure (Train, 1991). In other instances emergency conditions and security issues have a say in setting electricity tariff.
Electricity pricing is based on achieving certain objectives as follows: (1) to guarantee efficient allocation of national economic resources; (2) encouraging the adoption of certain EE measures; (3) fair return on the utility's investments; (4) fair allocation of costs among the various consumers; (5) simplicity and convenience in implementation (Yusta, 2005).
There should be clear distinction between retail electricity tariff and bulk supply tariff. The former is the tariff used for retail consumers including households, commercial, offices, services, etc. Bulk consumers are mainly distribution companies, which in turn sell electricity to retail consumers. They are charged according to the bulk tariff. In many countries large industrial or commercial consumers are also charged at the bulk tariff.
Electricity tariff, in general, needs to reflect the true cost of supply in order to ensure maintaining an adequate level of security of supply and the financial viability of the electricity sector including private and public entities. The true cost of supply needs to be determined accurately by an independent body. This is the role of the regulatory agency responsible for setting the tariff taking into consideration the welfare of all stakeholders.
It should be borne in mind that the electricity tariff has a structure based on certain elements. The fixed part of the tariff is related to the fixed costs of the utility. Another part is related to the energy consumption. A third part is related to peak demand or capacity charge. Many countries have selected to use combined tariff of energy and capacity charges for industries, commercial, and service sectors, but use only energy-based tariff for households.
Tariffs may be different for different seasons of the year. Or they may be different for different geographical zones. They also could vary according to time of use, or voltage level. In some countries special tariffs are granted as incentives for some productive sectors.