10 Things you need to Know to Ask about Electricity Tariffs

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  • 4 years ago
  • Posted: January 28, 2015 at 10:52 am

One of the remarkable things about the human being is his ability to manipulate energy to his own ends, positive or negative and one of the forms of energy he manipulates is electricity. There is no doubt that electricity drives the world and we owe a lot to pioneers of electricity such as Benjamin Franklin, Thomas Edison, and my favorite Nikola Tesla, the unappreciated genius. Did you know that there are still 1.3 billion people in the world who do not have electricity and about 25% of Kenyans still do not have electricity? Now, the key challenge, especially here in Kenya is the lack of transparency when it comes to setting the electricity tariffs. Tariff determination is the process of selecting the price of electricity to the consumers. So what questions do you need to ask towards understanding electricity tariffs better and better be able to manage your consumption or at least be comfortable in the knowledge of the same? First, let me list ten essential elements in tariff determination:

-Tariff determination process

-Tariff objectives

-Methodology

-Utility costs

-Utility performance

-Tariff structure

-Support for renewable energy

-Support for energy efficiency/demand-side management

-Marginalized sectors/National goals

-Subsidies and cross-subsidies

Everything you need to have a significant understanding of electricity and its consequent pricing is listed as above-mentioned. So, what are the questions you need to ask?

WHAT IS THE TARRIF DETERMINATION PROCESS?

Electricity rates are best determined through a veritable process of transparency that best serves the public interest-it should be accountable and participatory. So, companies like Kenya Power and Lighting Co. need to be provide a semblance of procedural clarity that identifies legal frameworks, key decision-makers, and the methodology of setting and revising tariffs, not mention procedures and consumers allowing both consumers and stakeholders to participate in decisions, appeal decisions, and seek redress for their grievances. So, three things to gain perspective when asking this query:

-Clarity about institutional roles and the process of tariff determination

-Chance for stakeholder comments and inputs into the tariff-designating process

-The availability of appeals and consumer-grievance redress mechanisms

WHAT ARE THE OBJECTIVES OF THE TARIFF DETERMINATION?

Tariff-setting bodies have multiple tasks-improving utility performance, improving service quality, promoting investment, enhancing energy security, improving the financial well-being of electrical utilities, encouraging energy efficiency, expanding services, and alleviating poverty (remember the recent KPLC initiative to provide electricity to slum dwellers at the Coast at a subsidized cost). It is imperative that the objectives for setting the tariffs are clearly stated, not to be lost in ‘jargonic’ fluff, but rather a simple way of saying why we are setting the price that we have chosen with openness and accountability. Because a crystal clear statement of tariffs helps all stakeholders assess the appropriateness of tariff proposals and therefore the consequent tariff set. The reason why we need such a clarification of objectives is so that it can establish predictability and ameliorate stakeholder confidence in the regulatory process.

WHAT IS THE TARIFF-DETERMINATION METHODOLOGY?

From a public perspective, the method used to determine the tariff is vital. There are several methods used, each with its advantages and objectives:

-Price cap- it allows the utility to alter its tariff based on an index that is typically composed of an inflationary measure combined with a profitability offset (Jamison et al.). This means that tariffs are adjusted according a price cap index that reflects the overall rate of inflation in the economy, the ability of the utility operator to acquire efficiencies, and the inflation in the operator’s input prices (like the price of oil, which has gone down significantly, deflated, so it stands to reason the price of electricity should go down).

-Rate of return-it is based on cost of capital and operating costs. More often than not, regulators or others charged with determining tariffs tend to review tariff after considering a claim by a utility that its cost of capital is higher than its rate of return or when a consumer group claims the vice versa.

-Performance-based approach-this a comparative approach in which a particular operator’s performance is compared with other operators’ performances and therefore the penalties or rewards are predicated on an operator’s relative performance, for instance in cost efficiency (but in Kenya we do not have such a situation because of the outdated Single-Supplier Model used by Kenya, if only there were more companies like KPLC, then you and me would enjoy a favorable cost platform) (Ahluwalia and Bhatiani, 2000).

-Cost-plus method/cost of service-this balances future extrapolated revenues with costs incurred by the utility. The downside of using this approach is the difficulty is accurately establishing costs that indicate efficient performance and by result precluding excessive costs (operating and/or investment) from being reported by the utilities.

HOW ARE THE UTILITY’S COSTS CONSIDERED IN THE TARIFF?

Electricity tariffs more often than not depend on a utility’s costs, which can include generation, distribution, and transmission. So, however these costs shape the tariff depends on the methodology used in tariff determination, the structure of the electricity sector, and the performance and efficiency of the utility. Let’s look at two types of utilities that reveal how structure affects tariff: vertically-integrated utilities and non-vertical utilities.

Vertical utilities-this is where costs related to generation, distribution, and transmissions are separated not being easy to be identified, to ultimately be determined by one or more regulators to become defined tariffs. Conversely, non-vertical utilities have costs that are easily identifiable and can be determined in varied ways. In any case, all information must be revealed with regard costs.

HOW DOES THE UTILITY’S PERFORMANCE AFFECT THE TARIFF?

The performance of a utility in terms of energy services, financial performances, environmental and social impacts, including operations do in effect influence consumer tariffs.

HOW HAS THE TARIFF STRUCTURE BEEN DETERMINED?
Tariff structure or rate design is a collection of rules and procedures that determine how much different categories of consumers are charged. Obviously, the prices paid by consumers are determined by the categories in which they fall.

HOW DOES THE TARIFF SUPPORT RENEWABLE ENERGY?

The determination of tariff can support renewable energy in two ways: Firstly, a policy initiative such as feed-in-tariffs (FIT), which only means that if you install a low-carbon or renewable electrical technology towards the production of electricity, then the energy supplier gives you money. Second, by providing incentives such as rebates.

HOW DOES THE TARIFF SUPPORT ENERGY EFFICIENCY, DEMAND-SIDE MANAGEMENT, AND DEMAND-RESPONSE MEASURES?

Tariff structure plays an important role in capturing savings by promoting energy efficiency, demand-side management, and demand-response measures, which in turn allow end-use electric customers to reduce their electricity usage in a given time period or shift that usage to another time period in response to a price signal. Such tariff designs include time-of-day tariffs, block tariffs, and demand-response tariffs, all of which are quite elusive in the country. To mitigate power shortages, for instance, the government of China has adopted a variety of tariff design measures and incentives to promote energy conservation, including time-of day tariffs, seasonal tariffs in areas where seasonal demand fluctuation is evident, and compensation for users who avoid peak hour consumption, something that could work quite well in Kenya.
HOW DOES THE TARIFF SUPPORT MARGINALIZED SECTORS OF SOCIETY AND BROADER NATIONAL GOALS?

Because electricity has become an essential service, it is important to consider the impact of tariffs on poor and remotely located residents, who spend a relatively large percentage of their income on electricity, like recurrent charging of phones. Subsidies and cross-subsidies of consumed electricity are the most common forms of support and can include subsidies for free connections and “lifeline” amounts of electricity for very poor consumers as well as provision of off-grid goods and services such as solar lanterns. Pakistan, for instance has adopted an inclining block tariff structure designed to protect lifeline consumers by minimizing per kWh user charges for residential consumers who utilize less than 50kWh of electricity per month, while here in Kenya, slum residents in Mombasa will pay a subsidized connection charge of 1,116KES, a laudable gesture for KPLC. The “lifeline” tariff rate has been criticized, however, since a minimum charge for lifeline users has been implemented making the average cost of electricity for many lifeline users far higher than other users. Periodic evaluations and reviews of lifeline tariffs are important to ensure that their intended benefits are being delivered and tariff objectives are being met.
WHAT ARE THE SUBSIDIES IN THE TARIFF?

The electricity sector is capital intensive and natural resources intensive. Several countries use preferential pricing (i.e. selective access to lower-cost resources) or overt subsidies to assist low-income groups to access electricity. Subsidies are sometimes offered to electricity generators to encourage them to deploy new technologies, and to energy-related sectors such as coal mining, water supply, and fuel transportation. Subsidies may also be offered to industries to encourage investment, and to farmers to promote food production. Furthermore, many countries cross-subsidize electricity, whereby one group of consumers pays higher rates for electricity to cover or subsidize lower rates for other consumers. This could include lower tariffs for residential use by low-income or vulnerable residential consumers and higher tariffs on industrial or commercial consumers.
Success in the electricity sector has long been defined by ensuring a secure and reliable supply of electricity at a low cost, enabled by investment attracted to low risk, stable returns.
Grids in Africa will need to invest in smarter management of the diverse sources of supply and demand that they connect.

What is your opinion on the topic?
Stefan Wolf
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