Distribution Networks
Tariff Design in the Era of
Decentralization:
A Business Model Approach
Rolando Fuentes
November 2020
Doi: 10.30573/KS--2020-DP24
2
Distribution Networks Tariff Design in the Era of Decentralization: A Business Model Approach
About KAPSARC
The King Abdullah Petroleum Studies and Research Center (KAPSARC) is a
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facing the world today and tomorrow, through unbiased, independent, and high-caliber
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This publication is also available in Arabic.
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position of KAPSARC.
3
Distribution Networks Tariff Design in the Era of Decentralization: A Business Model Approach
This paper addresses the question of how distribution networks can best be priced in the context of
technological disruptions in the power sector. We suggest a framework for analyzing the unexplored
two-way relationship between distribution network tariff design and the emergence of new business
models in the power sector (Figure 1). This paper provides a novel approach that links the deployment of
new technologies, new business models in the power sector, and pricing mechanisms for the reinvention of
the grid. The key ndings are:
The increased penetration of distributed generation opens up opportunities for aggregation. Distribution
networks can be priced based on more granular cost components while allowing competition in new
segments of the value chain, where possible. This is essentially the same idea that gave birth to the
electricity standard reform model taken, but more granular.
If, in addition to distributed generation, households install digital technologies, the distribution network
can be transformed into a platform business model. To get the full benets of a platform through
network effects, a distribution network could be operated as a subscription model, as such a model can
reduce the transaction costs of digital platforms.
If in addition to the two measures above, households install batteries, there are ‘behind-the-meter’
business opportunities. Distribution networks would need to nd a way of monetizing the standing value
the grid has for consumers, based on the decoupling of the industry’s value creation from its energy
component.
Key Points
Figure 1. Tariffs and business models are mutually interdependent.
Source: Author.
Initial tariffs facilitate adoption of
certain technologies
Method
Deployment
of beneted
technologies opens
new unfullled needs
that are addressed by
business models
Business models impact the
use and role of the grid
Alternative ways to price and
repackage grid services
Ways to reduce
regulatory arbitrage
business models
1
2
34
5
4
Distribution Networks Tariff Design in the Era of Decentralization: A Business Model Approach
In this paper we discuss the unexplored two-way
relationship between distribution network tariff
design and the emergence of new business
models in the power sector. Distribution network
tariffs have traditionally used a cost accounting
method. We suggest, instead, the use of a business
model framework to analyze the extent to which
emerging business models in the power sector
change the way electricity distribution network
services are priced and packaged. This approach
will help us to move away from trying to ascertain
whether consumers pay the right amount for what
they receive (from the distribution network) to the
question, Are they paying for what they want? (Lehr
2013).
Distribution network tariffs are the second-best
constructs. Due to their cost structure, marginal cost
pricing, the criteria for efcient pricing, does not
lead to cost recovery. Tariffs have been designed to
allocate costs across different types of customers
based on their electricity use. Tariffs are then
designed based on the combination of different
cost components (energy, demand, capacity, time
variance). This ends up being a combination of xed
charges and increased volumetric prices, for which
regulators balance trade-offs between efciency,
cost recovery and fairness.
Theoretically, for any second-best solutions, some
inputs will be overcompensated and will therefore be
overused (the Averch-Johnson effect). There will be
overinvestments in technologies that perform better
in these overcompensated inputs. For example,
photovoltaic (PV) solar generation provides energy
but not back up capacity. If the energy component is
overcompensated, this technology will have a higher
penetration than others that mainly serve as back
up. The penetration of some technologies will crack
a previously monolithic, vertically integrated power
sector. These cracks will open up new customer
needs and therefore new business opportunities.
Each resulting business opportunity will use the grid
differently to how it was originally conceived. We
provide an analytical framework for how to price the
services the distribution networks provide.
Summary
5
Distribution Networks Tariff Design in the Era of Decentralization: A Business Model Approach
The pricing of distribution network services is
a challenging task, given the grid’s economic
characteristics and competing objectives for tariff
design. The issue becomes even more complicated
when one considers the changing environment of
the grid due to emerging business models and the
growth of distributed resources. Emerging business
models affect the cost recovery of the grid, under
its existing tariff design, and its future costs. A
plethora of literature in recent years has focused on
how to develop a distribution network tariff in the
presence of distributed energy resources (DERs),
the combination of local generation technologies,
such as solar photovoltaic (PV) generation, storage
and digitalization (for a review see Burger [2019]).
This research investigates the traditional cost
causation logic and proposes that DER owners
should be compensated according to future avoided
costs. This means that DER penetration, location,
concentration, and the size of their impact on
network costs can be either negative or positive,
depending on the technology deployed (Picciariello
et al. 2015; Abdelmotteleb et al. 2018). As such, the
distribution rm decides whether to build capacity
or buy energy from households, while households
decide whether to purchase power from the utility or
install DERs (Ros et al. 2018).
Our approach departs from the cost accounting
logic of previous research. Instead, we use a
business model (revenue) logic to propose pricing
mechanisms for distribution networks. A business
model describes the way an organization delivers
value to customers, encourages customers to pay
for value and converts those payments into prot
(Teece 2010; Casadesus-Masanell and Ricart
2009; Chesbrough 2010). Business models start by
identifying opportunities for satisfying customers’
needs. After their needs are identied, companies
nd ways to fulll them while generating a prot.
This business model approach helps us to move
away from the question of whether consumers pay
the right amount for what they receive from the
distribution network, to whether they are paying for
what they want (Lehr 2013).
The introduction of a business model framework
helps us understand the economic consequences
of technological development on the use of the
distribution grid. Two key questions that we try
to address are, 1) Does technological progress
cancel the natural monopoly status of power grids?
And, 2) if so, would they no longer have to abide
by the pricing rules for natural monopolies? While
distribution networks would continue to have the
cost structures of natural monopolies, the services
they provide might not. For example, while it would
not make sense to install another parallel grid, it is
possible for consumers to obtain services, such as
reliability, through other means.
We rst discuss how tariff structures can facilitate
the adoption of certain technologies. We then
elaborate on how different combinations of DER
penetration can lead to a diversity of business
opportunities. To do the latter, we decompose
potential scenarios and analyze business
opportunities with the penetration of individual
technologies and those that arise when multiple
technologies are deployed. We then assess the
impact of the resulting business model on the
grid and examine what role the grid plays in that
model. Based on the results of that assessment, we
suggest ways to package the resulting grid services,
as if they were separate business models.
Throughout the paper, a constant argument will
be that disruptive technologies change the nature
of the energy industry. This calls for new ways of
understanding the industry’s products, with services
decoupled from the energy component, and a
shift from pricing inputs to pricing outputs. This
Introduction
6
Distribution Networks Tariff Design in the Era of Decentralization: A Business Model Approach
Introduction
allows us to depart from cost pricing and, instead,
to price services based on values. Since services
are intangible, instantaneous, and unrepeatable,
the actual cost of production is less relevant for
price setting than the valuation of this service. This
approach will necessitate looking at tariffs in a more
comprehensive way.
Tariffs can facilitate the adoption of new
technologies by removing barriers that prevent
adoption. If tariffs were set at the efcient point,
where price equals the marginal costs – the
necessary and sufcient condition for efcient
pricing – the resulting technology mix would also
be optimal. But because of the cost structure
of distribution networks, the marginal cost of
distribution network service provision is below the
average cost, and, therefore, investments are not
recovered. How to solve this conundrum is still an
unresolved question (Ortega et al. 2008), and tariffs
are consequentially second-best approaches.
Second-best tariffs often lead to a situation that
some inputs are overpriced (e.g., energy) and some
are underpriced (e.g., capacity). This increases
the tendency for opportunistic behavior. When
this happens, the resulting behavior is not welfare
enhancing if some users’ actions lower their costs
but raise other users’ bills. For example, households
may decide to install certain technologies if that
helps them to reduce their bills, for example by
avoiding some parts of the retail tariff. This does not
necessarily reduce the total system cost, however.
Distribution tariffs should not therefore encourage
opportunistic models. They should be conceived
in such a way that only those models that create
system value and are in line with wider energy policy
can survive.
7
Distribution Networks Tariff Design in the Era of Decentralization: A Business Model Approach
In this section, we discuss why the pricing of
distribution networks is still an unresolved issue.
We provide an overview of the different cost
accounting components of distribution networks and
argue how tariffs can combine these components to
facilitate the adoption of certain technologies over
others.
It is useful to establish the difference between
electricity prices and network tariffs. Usually, in many
jurisdictions, end users are not directly exposed to
network tariffs. Under most existing arrangements,
retail suppliers, not end users, are exposed to
network tariffs. However, large consumers and those
providing power to distribution networks are exposed
to these tariffs. The expectation is that retailers will
design their tariffs to account for the network costs.
The economics of networks has traditionally been
a challenge for economists because of their cost
structure (a xed/sunk cost) (Borenstein, 2016).
First, it is not possible to establish efcient network
pricing. When average costs decline with production
but are always higher than the constant and
negligible marginal costs, then this is the denition
of a natural monopoly. Setting prices equal to
marginal costs, i.e., efcient pricing, would lead to a
non-recovery of costs.
A second complication is that a network’s ‘supply’
does not respond to price changes. By denition,
supply is xed and cannot adjust to short-term price
increases or decreases resulting from changes in
demand. In other markets, if prices go up due to
increased demand, producers would increase market
supply and take advantage of high prices. Grids are
therefore reactive, not proactive.
These complexities have led producers to focus their
tariffs more on cost recovery by adopting a cost-plus
tariff approach instead of complying with the efciency
criteria (Demsetz 1968; Hogan 2008). This practice is
similar in other industries with large sunk xed costs
that also lead to natural monopolies.
The cost accounting of the grid is not as
straightforward as cost recovery, given that it serves
different purposes, including delivering energy,
assuring reliability or meeting peak demand and
providing spare capacity for contingencies. Costs
are usually broken down into the categories detailed
below.
Energy charges: volumetric charges based on
the consumption (i.e., kilwatthours [kWh]). The
assumption is that increases in grid utilization raise
the cost of maintaining and operating the grid. The
volumetric charge can be at, or it can change over
time to reect network conditions at different times.
Capacity charges: a charge on peak demand (i.e.,
kilowatts [kW]) during the billing period. Investment in
networks is primarily driven by capacity magnitudes
rather than energy magnitudes. Capacity is a better
proxy for customers’ contributions to network costs.
Individual peak consumption may not necessarily
coincide with the system’s peak. This is why capacity
charges need to be peak-coincident to encourage
users to avoid times of network constraints. It
is inefcient to signal to customers to reduce
consumption when the network is underutilized.
Fixed charges: not a function of customers’ load or
energy consumption. They are levied regularly on
different temporal bases to cover expenses such as
the cost of connecting the user to the grid; they are
not intended to alter consumption. They can also be
applied when volumetric charges yield insufcient
revenues.
There might be other charges in addition to the above
categories. For example, the network operator may
wish to apply demand charges based on a level of
contracted capacity. This is to incentivize users to
choose their contracted capacity in an efcient way
and thus avoid signicant unutilized network capacity.
Setting the Common Ground
8
Distribution Networks Tariff Design in the Era of Decentralization: A Business Model Approach
Setting the Common Ground
A tariff is a formula that assigns different weights (or
prices) to each of these components. These tariff
categories then affect the investment and operation
incentives for grid users in different ways. Depending
on how these components (capacity, energy and
xed components) are combined, tariffs can benet
the adoption of some technologies by removing
their barriers, or they can prevent their adoption by
increasing the cost of some technologies. Overall,
some technologies perform better than others in any
of these categories. In extreme cases, disruptive
technologies can also make some of these functions
altogether obsolete.
For example, King and Datta (2018) discuss how
tariffs can minimize the total cost of electric vehicle
(EV) ownership by reducing refueling and grid
reinforcement costs. Tariffs can also incentivize
certain technologies by overcompensating for some
of their characteristics. For example, storage could
be used to mitigate demand charges, stabilize grid
frequency, shift or improve control on renewable
power, or store energy from residential solar
installation (Aprile et al. 2016). A tariff designed
with more granular elements can help to better
compensate these stack values. Faerber et al.
(2018) discuss how different network pricing can
help deploy smart grid technologies. They highlight
the importance of data sharing and the reduction of
privacy settings to reduce the cost to consumers.
Glass et al. (2018) discuss ways to incentivize the
deployment of ‘mini grids,’ while Gilliam and Yozwiak
(2018) argue that time-sensitive dynamic pricing is
an essential component of a decentralized energy
system, as it provides price signals for customers.
Table 1 synthesizes these options and categorizes
the main messages of this section.
Component What does it
price? Aim Metric How? Benets/
incentives Cost Which technologies
are beneted/
deterred?
Fixed Operations Cover costs
exogenous to
consumers
$/period Billing Guarantees a
level of revenue
for utilities,
despite DER
adoption
Ignores the potential
benets of DERs Exogenous to
consumers
Capacity Peak
demand
Recover
network
reinforcement
costs
$/kW Non-
coincidental
Reduce individual
peaks Can reduce
consumption
when network is
underutilized, and can
negatively affect low-
income consumers
EVs: if tariffs focus
on pricing distribution
network peaks and
not entire system
peaks. Can incentivize
storage by reducing
bill savings.
Coincidental Reduce individual
peaks that
coincide with
system peaks
Can affect inexible
consumers
Demand
charge
Maximum
contracted
capacity
Recover the
cost of user
capacity and
reduce idle
capacity in the
network
$/kW One-off
charge
as part of
connection
costs
To incentivize
users to choose
their contracted
capacity
efciently
Consumers might
misjudge their future
demand
Batteries
Energy Consumption Cover variable
costs
kWh/t TOU Shift peak to low
price periods
Equity: poorer
consumers pay higher
tariffs due to the
higher consumption of
well-off consumers
Benets EVs if owners
have separate bills.
Encourages the use of
storage to avoid peak
period charges.
Source: Author.
Table 1
9
Distribution Networks Tariff Design in the Era of Decentralization: A Business Model Approach
In this section we show how a business model
framework is a useful approach for designing
network tariffs in the era of decentralization. A
business model has two important components. The
rst is the customer value proposition: A business
can create value for its customers by giving them a
solution to a fundamental problem. In economics,
value is created as long as the price paid by
consumers is below their willingness to pay for
that product. The second key element is the prot
formula, or how the company creates value for itself.
The prot formula chooses the right combination of
price and quantities, and the cost structure, i.e., the
key resources required in the business model. The
value proposition and the prot formula dene value
for the customer and the company (Johnson et al.
2008; Osterwalder et al. 2005).
New business models in the power sector do not
appear unexpectedly. Emerging business models
are often an afterthought for both incumbent and
new entrant rms, and result from the introduction
of DERs into the previously monolithic,
vertically integrated power sector. The deployment
of new technologies on top of the traditional
electricity sector structure provides new services
for consumers and opportunities for rms.
DERs, which comprise PV panels, batteries and
demand response devices, have the potential to
be disruptive because they allow a household to
become independent from the grid. Depending on
to what extent DERs are deployed and their internal
capacity mix (PV, PV and storage, PV and storage
and digitalization), they could elicit new roles for the
grid and new business opportunities in the power
sector (Glachant 2019).
Distributed generation leads
to aggregation
We assume that distributed generation is owned by
households. The growth of household generation,
such as solar PV, provides an opportunity to bridge
demand and wholesale trade through aggregation.
A Business Model Framework
Source: Author.
Figure 2. Penetration of distributed generation can enhance the aggregation business model.
0
0
0
100
100
100
PV
Digitalization
Storage
Technology penetration Resulting business model
Aggregation
10
Distribution Networks Tariff Design in the Era of Decentralization: A Business Model Approach
A Business Model Framework
By combining the load, distributed generation,
and storage capacities of many participants, an
aggregator can optimize the performance of the
entire portfolio in ways that would not be practical or
cost effective for individuals, thereby participating as
another player in the wholesale markets.
Aggregation reduces transaction costs and opens
up trade in new types of products targeted at
specic customers. Aggregators build portfolios
of private clients and have exclusive reselling
franchises. In the past, wholesale demand
participation was conned to big interruptible
customers. However, aggregation changes this
to include retail consumers in wholesale demand
participation.
Digitalization leads to
platforms
Digitalization would facilitate direct peer-to-peer
trading between small units, with the large number of
transactions managed by blockchain. Peer-to-peer
trade facilitates direct interactions between individuals
and does not require them to have close proximity to
one another.
Peer-to-peer trade bypasses the control of
traditional utilities and could change the role of
networks from grids to platforms. The costs of
establishing a platform business are mainly centered
around software, consumer enrolment, database
and process management. As it creates a low
transaction environment, a platform business can be
quite small. The products, platform characteristics
and the rules for the operation of platforms need
to be dened, along with the characteristics of the
product and the trade process, including delivery
and settlement.
Figure 3. Coupling distributed generation and digitalization can transform distribution networks into platform
business models.
Source: Author.
0
0
0
100
100
100
PV
Digitalization
Storage
Technology penetration Resulting business model
Platform
11
Distribution Networks Tariff Design in the Era of Decentralization: A Business Model Approach
A Business Model Framework
Figure 4. Full DER penetration can open up unexplored behind-the-meter business models.
Source: Author.
Full DER deployment leads
to behind-the-meter business
opportunities
‘Behind-the-meter’ business opportunities
may arise if, in addition to installing distributed
generation and digitalization devices, households
install behind-the-meter storage. This is a departure
from the unilateral control that electricity grids and
system operators have had on exchange schemes
by virtue of the fact that their infrastructure supports
unavoidable delivery loops (Sionshansi 2017, 2019).
Behind-the-meter storage bypasses the traditional
electricity system, including its grids and the energy
regulators, enabling innovation and experimentation
while not requiring a regulatory sandbox.
0
0
0
100
100
100
PV
Digitalization
Storage
Technology penetration Resulting business model
G
T
D
R
Behind
the
meter
12
Distribution Networks Tariff Design in the Era of Decentralization: A Business Model Approach
The grid is the quintessential example of
infrastructure: an asset that underpins the
way society works. As infrastructure enables
modes of production, when the latter change, so
does the underlying infrastructure (Haskel and
Westlake 2018). In this section we discuss how the
use and the role of the grid are affected by the three
scenarios described in the previous section, and the
unfullled household needs that emerge. We devise
potential ways to monetize services the grid would
provide in each scenario. For each scenario, the grid
would be used for roles it was not initially conceived
for, and under some scenarios, it would be used
less than it is now. Given that the network would
be used less, the average cost of the grid would
increase. While the marginal cost of operating the
grid does not change, having new roles for the grid
could also mean that the relevant marginal costs
would lie elsewhere in the system.
Aggregation: a bi-ow use of
the grid
In this section we discuss the conceptual process
of establishing prices for the distribution network
if the business model is aggregation. Aggregation
puts the upstream sections of the value chain in
closer proximity to the wholesale market, including
the downstream market and retail, as it allows
households to participate more in that market.
This would potentially help to solve a long-standing
problem. In the standard reform model, competitive
price signals from generation and retail are distorted
in the transmission and distribution segments,
which remain monopolies. This clouds the two-way
price signals that should exist between generation
and retail, and may explain why liberalization has
had negligible or mixed efciency impacts. Some
authors estimate the gains from market liberalization
to be around 5% of costs (Pollit 2012). In our view,
the role of the distribution network in this scenario
is similar to the traditional use of the grid, with the
difference that energy ows both ways.
To nd ways of pricing the distribution network’s
new role, we rely on the basic idea of the standard
reform model, which is that not all components
of the electricity sector are best suited to a
natural monopoly. There are segments for which
competition can be allowed in order to achieve
competitive pricing. We will therefore try to
determine whether there are any new areas of the
value chain suitable for competition, and whether
this can be solved by having a better, more accurate
or more granular application of the traditional cost
accounting paradigm.
Returning to this subsection’s question, Has
technology opened up new sections of the value
chain that are more prone to competition? As
we have argued, new business results from the
deployment of DERs on top of the previously
monolithic, vertically integrated power sector. Figure
5 shows another schematic of the power sector,
where G is generation, T is transmission, D is
distribution and R is retail. Are there new functions
to be costed that are adjacent to the formal value
chain (described below as X or Y)?
Impact on Grids
13
Distribution Networks Tariff Design in the Era of Decentralization: A Business Model Approach
Impact on Grids
Figure 5. The value chain in electricity can become more granular.
Source: Author.
Take, for example, storage as one of the ‘new’
building blocks of the value chain. Storage is neither
part of distribution nor of retail. It could either be
treated as part of the network or as a generator. We
can therefore think of more granular tariffs in terms
of space and time, volume, time of day, and so forth.
The new tariff building blocks can be built around
storage uses. For example, 1) to meet instantaneous
discrepancies between generation and load, 2)
to rm renewable power, 3) to store energy from
residential installations, 4) regulate frequency, or 5)
to shave the peak (demand charge management).
Each one of these activities can be regulated or
opened up to competition.
Platform: network effects/
matchmaking
The deployment of solar PV and digitization
technologies could transform the power markets
into a series of nested markets. These markets
could be connected through different platforms as if
they were ‘multiple-sided’ markets. A multiple-sided
market is a meeting place for a number of agents
who interact through an intermediary or platform
(Rochet and Tirole 2004). This can lead to indirect
network externalities, whereby complementary
goods become more plentiful and cheaper as the
number of users of a product increases (Katz and
Shapiro 1985).
In this scenario, at volumetric electricity rates
with small xed charges would be insufcient
to align consumer incentives with the costs that
electric utilities face. Utilities might not be able
to recover their costs as the rate components
do not reect their costs to the system. This
is because utilities make capital investments
in expectation of cost recovery from assumed
consumer patterns of network use. In contrast,
products or services traded on platforms would be
more likely to be successful in this scenario. The
platform business model relies on charging small
R
D
D
D
D
D
T
G G G
T T
D
R
X Y
R
14
Distribution Networks Tariff Design in the Era of Decentralization: A Business Model Approach
Impact on Grids
commissions for matching suppliers with demand.
To reduce the transaction costs of potentially
numerous transactions, it makes sense to bundle
several services in a subscription package. This
subscription model has also been proposed by other
authors (Huber and Bachmeier 2018; Lo et al. 2019;
Farouqi 2019). Table 2 details hypothetical electricity
subscription packages.
Subscription pricing should be designed so it
can signal to utilities the amount and type of
infrastructure that needs to be developed (Lo et al.
2019). In such an efcient pricing scheme, prices
need to be able to signal scarcity. Since xed costs
are becoming a larger fraction of customers’ bills,
it is tempting to think that marginal costs are close
to zero. But having zero marginal costs does not
make economic sense. As we know, there is no free
lunch. Often the ultimate impact of technological
progress is in alleviating resource constraints, only
to push them somewhere else in the value chain.
The task then is to design subscriptions that reect
the scarcity of a given resource. Firms that are able
to gure out which resource this is are more likely to
succeed in this environment.
The example of Netix, a company with large sunk
costs and operating as a network, can illustrate this.
The marginal cost of adding each additional user
to Netix’s platform is close to zero. The price of
adding each additional user would equal its marginal
costs. We know that a subscription to Netix costs
around US$10 per month. The question then is,
What is US$10 the marginal cost of? At rst sight,
Netix membership could resemble an all you can
eat buffet, just all you can watch. But looking closer
at Netix, one can see that not all shows and movies
are available at any given time and every location.
This is an indication of a scarce resource, not
abundance. We also know that Netix invests large
Table 2. Hypothetical electricity subscription packages.
Source: Trabish (2019).
Attribute Unlimited savings Unlimited choice Unlimited premium
+EV
Fixed monthly price based on household prole
usage (the current average bill is $115/ month)
$115 per month for
36 months
$125 per month for
36 months
$145 per month for
36 months
30% clean energy with energy portal app 
100% clean energy
Free smart thermostat 
Access to free or discounted energy efciency
upgrades

Unlimited EV charging at home and in community
Maximum number of control days 30 15 7
Free control day overrides per year 357
15
Distribution Networks Tariff Design in the Era of Decentralization: A Business Model Approach
Impact on Grids
sums of money in television and cinema production.
Why would they invest so heavily in these areas
when they have a zero-marginal cost in their
production function? One explanation is that Netix
needs to keep its customers engaged and logged
into its platform. It can therefore be argued that the
relevant marginal cost of Netix is the cost incurred
in keeping (as opposed to adding) the customer
base plus one for one more month. This example
illustrates the type of analysis electricity rms could
employ when trying to develop business models and
deliver value for a subscription scenario.
Behind the meter: making the
invisible visible.
In this subsection, we discuss how to price the
services the distribution network can provide when
households install technologies that allow them
to bypass the grid and utility services. While the
electricity industry’s business domain typically stops
at the customer’s meter, these technologies open
new possibilities beyond that point.
This section focuses on decoupling the grid’s value
creation from its energy component. It argues that
new value would not come from the physical use
of the network, but from its existing value, i.e., the
value that people attribute to it based on it being
readily available. The grid’s value therefore cannot
be derived from the sum of the sum of its parts
(energy, capacity, reliability) but from the (whole)
service it still provides. As of now, the grid is either
an intermediary good or part of the production
function in delivering electricity services. By moving
from pricing inputs to pricing outputs we are able
to suggest more comprehensive ways to design
electricity tariffs.
If the grid is bypassed more often than not,
consumer expenditure on it would be close to zero.
Theoretically, consumers spend close to nothing
on goods when the marginal utility they obtain from
them is negligible (or when they cannot afford them).
In a world where DERs are a perfect substitute
for the distribution network, in the absence of
uncertainty, close to zero expenditure on an item
might imply that there is a low marginal utility
derived from this good. However, there is some
uncertainty around DERs as they might fail. In
such a scenario, consumers would want to revert
back to the grid. Therefore, as long as grids and
DERs are imperfect substitutes, there is room for
alternative ways of pricing the grid and rethinking
the grid’s business model. A new business model
might transform the grid from an intermediary good
– a complement to capital – to part of the demand
function for reliability.
To arrive at an alternative business model, we need
to locate where the economic value of the new
grid lies, and how to repackage this value and nd
mechanisms to allocate it. The eld of environmental
economics has well-established methodologies
to deal with existing values. Economists measure
individual preferences for the conservation of the
natural environment (in our case, the maintenance
of the unused grid), or the consumer’s loss of
wellbeing from losing natural resources (in this
case, maintaining access to infrastructure). These
methodologies can be used to estimate the
economic value of the grid based on consumer
preferences as opposed to the cost of the grid.
However, just knowing the standing value of the
grid does not solve our problem of decoupling the
grid from its energy component. The network’s role
becomes a service, and as a service, it is intangible.
This service needs to be standardized in order to
facilitate trade. In other words, they need to make
the invisible visible. Business opportunities would
arise for rms able to monetize the standing value
16
Distribution Networks Tariff Design in the Era of Decentralization: A Business Model Approach
of the grid, and those that are able to reinvent
their business models, i.e., the servitization of
commodities.
An example from the business literature might help
clarify the challenge discussed in this subsection.
Johnson (2009) discusses the reinvention of
tool-manufacturer Hilti. Rather than selling tools, Hiti
turned to sell a service, “the tool you need when
you need it, no repairs or storage hassles” (Johnson
2009, page 2). They moved from a prot formula
based on low margins and high inventory turnover
to higher-margin rents and monthly payments to
repairmen. As such, Hiti’s value proposition moved
from selling commodities to selling a service.
There is a problem of people potentially freeriding
on other people paying to maintain the grid. To
avoid this problem, we propose internalizing this
externality by creating a market. Markets would
dene who gets what and at what price. Another
example can help to illustrate this point. It has
been argued that the distribution network would
be comparable to the reinsurance business.
Distribution network rms would be paid to ensure
reliable supply to ‘prosumers’ (consumers who also
generate electricity and sell it back to the grid) when
their own generation is too low, or their consumption
is too high. Fuentes et al. (2019) provide a
microeconomic framework for a reliability insurance
business model of electricity, an intangible service
in the power sector. The intangible service is “risk,”
the repackaging of the service is an insurance
contract, and the price formation is found through
the interaction between demand for and the supply
of this product.
Impact on Grids
17
Distribution Networks Tariff Design in the Era of Decentralization: A Business Model Approach
Summary
Price based on
tariff/incentive
Drives high
penetration of:
Business
opportunity
Product/service Impact on the grid Pricing
mechanism
network
Net metering PV Participation in
wholesale markets
Aggregation Same use/bi ow Find more granular
elements in the
value chain. Or
nd more granular
implementation of
combined tariffs.
Time-based tariffs PV and
digitalization
Peer-to-peer trade Platforms Less distance
traveled/more use
of local networks
Platform
commissions lead
to subscriptions
that reduce
transaction costs
Multiple-part tariffs PV and
digitalization and
storage (including
EVs)
Unexplored
behind-the-meter
opportunities
Intangible services Less network
expenditure but
economic value
stands
Monetize the
standing value of
the grid
Source: Author.
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Distribution Networks Tariff Design in the Era of Decentralization: A Business Model Approach
In this section we discuss four insights from
this paper that policymakers should be aware
of:
Path dependency. We have shown there is a
relationship between tariff design and technology
deployment business models, where the starting
point determines the result. Policymakers need
to know that their actions today have far-reaching
effects, and that these effects are difcult to
undo. Focusing on short-term issues leads to
suboptimal outcomes.
If globally efcient tariffs are not possible,
try locally efcient tariffs. If tariffs were set
at the efcient point, where price equals their
marginal costs – the necessary and sufcient
condition for efcient pricing – the resulting
technology mix would also be optimal. Because
this is not possible, policymakers must pursue
second-best solutions. If a globally optimal
tariff is not possible, locally optimal tariffs,
within additional layers of restrictions, must
be pursued. These additional restrictions
could be environmental constraints and/or
equity constraints. Network service pricing
can be designed in a way that achieves an
optimal outcome with respect to the most
important energy policy objective, and accepts
sub-optimal outcomes with respect to other
objectives.
No arbitrage. The goal of setting prices to align
cost minimization for the consumer with reduced
system costs and increased system benets is
not new. Distribution tariffs should be designed
in a way that only those models that create
system value and are in line with wider energy
policy emerge and survive (i.e., opportunistic
models become unprotable).
Policy outcomes. Distribution network services
pricing is not independent from energy policy
objectives, even in a changing business and
technological environment. The different
technology mixes that result from tariff design
and new business models have different policy
outcomes in terms of efciency, environment
and equity. Thus, an alternative way of looking
at this problem is to rank design criteria in
order of importance, according to the particular
policy context. Jurisdictions that have strong
decarbonization policies would probably rank
sustainability above all other criteria; countries in
which affordability and access to electricity are
considered the most important objectives would
probably rank efciency as the most important
objective. The latter would be the case in most
developing countries.
Policy Implications
19
Distribution Networks Tariff Design in the Era of Decentralization: A Business Model Approach
Conclusion
In this paper we discuss the extent to which
emerging business models in the power
sector change the way electricity distribution
network services are priced and packaged. The
emergence of new business models could affect
the design of distribution tariffs. However, tariffs
can also trigger new business models as they can
nudge consumers to adopt certain technologies.
We propose a framework of analysis based on
the business opportunities that arise when new
technologies are deployed in the formerly monolithic,
vertically integrated power sector. These business
opportunities result from the physical deployment of
these technologies and their impact on grid use. We
propose different ways to monetize the resulting new
role the grid would have in each of the scenarios we
analyze. Future research could focus on developing
some of the ideas proposed in this paper.
20
Distribution Networks Tariff Design in the Era of Decentralization: A Business Model Approach
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About the Project
Saudi Arabia’s policymakers aim to transform the electricity sector by pursuing a dual agenda
of electricity reform and decarbonization, supported by an ambitious deployment of renewable
technologies. The Kingdom is pursuing this agenda in the context of a rapidly changing electricity
sector worldwide, where emerging renewable and distributed technologies are testing the limits of
existing market, business and regulatory frameworks.
To this end, this project investigates the innovative market designs, business models and regulatory
frameworks that could embrace new technologies to enable competition in a less carbon-intensive
power sector.
About the Author
Dr. Rolando Fuentes
Dr. Rolando Fuentes is a visiting fellow at KAPSARC, where he researches
business and regulatory models in the Innovation in Electricity Transitions
program. He has extensive experience in the energy and environmental
sectors as an academic and policymaker. Rolando holds a B.A. (Hons)
from Tec de Monterrey, an M.Sc. from University College London and a
Ph.D. from the London School of Economics. He was awarded a United
Kingdom government Chevening Scholarship in 2001.
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Distribution Networks Tariff Design in the Era of Decentralization: A Business Model Approach
www.kapsarc.org