Fostering Flexibility Through Electricity Tariff

Reimagining Tariff Structures: addressing the Imperative for Flexibility

In previous posts, we highlighted the impending prevalence of volatility within power markets, attributed to the escalating integration of wind and solar sources. Consequently, there is a clear need for heightened consumption-side flexibility, with existing remedies like the incorporation of electric vehicles. However, the pivotal role of well-structured tariffs in incentivizing intelligent electricity usage is paramount. Let’s explore together.

Sunday 2 July: historical low prices

On Sunday 2 July, a combination of low demand and high renewables, both solar and wind, pushed the market prices into negative territory for several European countries, including Germany, as depicted below.

Prices dropped significantly in Germany on 2 July 2023.

These negative prices led to some renewable curtailment, as we can see for the onshore wind in Germany. The blue and orange lines are forecasts, while the grey line is the real generation¹. We can clearly notice a drop, especially between 12 AM to 5 PM, when the market prices were the most negative.

Wind was curtailed heavily - grey line compared to the orange line.

Rather than limiting wind energy production, a more effective approach would have been to encourage higher energy consumption. It's essential to motivate individuals to utilize more electricity during these specific hours. This is where well-designed tariff structures can play a pivotal role in shaping these incentives. How can we strategically formulate these tariffs to achieve this objective?

Three components

In the structure of retail tariffs, we commonly discern three elements: the energy component, the grid infrastructure segment, and finally the taxes and levies.

Firstly, the energy component embodies the expenses incurred in power generation. Electricity suppliers must secure an adequate power supply to cater to their clients or portfolios. Each supplier adopts a unique strategy for apportioning power resources across short and long-term positions.

The grid component is divided into the distribution network cost and the generation cost. It includes all costs related to the transmission and distribution of power to the final clients.

Lastly, both national and local governing bodies possess the authority to impose an array of taxes and levies, such as Value Added Tax (VAT), charges aimed at bolstering renewable energy initiatives, excise duties on energy, and more.

Historically, and still, in application in many countries², the retail price³ is a constant price per kWh consumed independently of the time of consumption. Consequently, there exists no monetary encouragement to engage in consumption during opportune moments, specifically when renewable sources are generating surplus energy, resulting in lower prices.

A simple example

Let’s assume a family house for one day. We categorize three types of consumption: some baseload (i.e. fridges), some peak hour consumptions (i.e. cooking), and an electric vehicle.

Consumption without incentives

We assume the following hourly consumption pattern without incentives to shift consumption, for example in the case where the tariff is constant throughout the day.

No incentive, the EV is charged during the evening peak.

Hyperflexible - concentration during low prices

Let’s now consider that the consumption pattern can be very flexible. The family will consume when the prices are the lowest without much limit. We observe now that consumption is peaking during the afternoon, the time when solar generation is at its highest.

Hyper flexibility of the consumption, leading to high power demand.

Smart charging - power limits

Evidently, such behavior could be a difficulty for the local distribution grid. Indeed, the grids are designed to transmit a certain amount of power. Concentrating the consumption in only a few hours would require substantial grid upgrades. Therefore, there exists a trade-off between shifting consumption patterns and limiting power needs. Such a trade-off could be potentially met by shifting only part of the load and by limiting the total power use, as depicted below.

Flexible consumption, the EV is charged when prices are low while keeping the power demand reasonable.

A global objective with local constraints

This simple example shows us that flexibility will be somehow a tradeoff between a global objective (consuming renewable energy when available) and local constraints (the grid must be sufficient).

How can we incorporate such observation into the tariffs? There is no simple answer, especially since we might have other objectives for the tariffs such as simplicity, fairness, etc.

A simple framework for the tariffs

We suggest the following simple framework concerning the tariffs:

1. Energy part. This component should reflect the value of the electricity in real time. Therefore, a dynamic tariff should be the norm.

2. Network component. The network reflects the investments required to bring energy to the consumer. The main part of the budget for the grid operators is the capex and therefore, the consumer should mainly pay in terms of capability to consume (EUR/kW) and not in real consumption (EUR/kWh consumed). Of course, the grid has also losses, so, we could also imagine a combination of EUR/kW and EUR/kWh.

3. Taxes and other levies. This part should not distort the incentives set by the first two components. Therefore, these taxes and levies should ideally be set in % of the electricity bill (similarly to VAT) with the percentage revised on a regular basis.

Open questions

The aforementioned framework presented is only setting some general guidelines and there are many practical questions and technicalities that are worth exploring more. Hereunder are some of them:

• If a dynamic tariff for the energy part is the norm, can it simply be linked to the day-ahead market? Or should it include a combination of day-ahead, intraday and even balancing markets? If it is only based on the day ahead, could such a dynamic tariff introduce a bit of instability as a demand response might be “too high”?

• In case the local grid is not overloaded, having a price on the capacity would limit its full utilization. Should we consider a cost based on real local constraints? Or should we harmonize the grid charges independently of the local constraints (fairness between consumers)?

• Should the grid losses be paid in a similar way that the energy component part, through a dynamic tariff⁴?

• In a world with high renewables penetration, would dynamic tariffs, potentially exacerbated by taxes and levies in percentage, lead to a situation where we consider that price fluctuations are too high? Or will suppliers bear part of the market fluctuations and offer more stable prices?

Still a long way

There is no simple answer to the challenge of tariff setting. Nevertheless, it is clear that a world with high renewable penetration would require a much larger demand flexibility, and the traditional fixed tariff, or even peak/off-peak tariff, is not fit for the challenge. With the current surge of renewables, especially solar, as well as the electrification of mobility and heating, this topic will be key to achieve our objectives.

1. Data is from the Entso-e transparency platform.

2. Still in application in my house in Belgium.

3. The combination of the three aforementioned components.

4. The Belgian TSO made such a proposal recently.