Step 5: Examine billing determinants and block design to assess whether economically efficient

The intent of rate design is to incent efficient use of the system, while also providing utilities a fair opportunity to recover their costs. Once costs have been allocated to the various customer classes, the next step in the rate design process is to specify a structure for retail tariffs by defining billing determinants. Typically, billing determinants allocate a portion of the customer class revenue requirement between volumetric energy charges (per kWh, based on each customer’s usage), customer charges (per customer, regardless of usage), and sometimes also capacity/demand charges (based on the maximum kW a customer uses in a particular period).
Volumetric energy charge (per kWh):
charged based on the amount of electricity consumed, the volumetric energy charge can be flat, whereby all units of consumption are priced the same, or alternatively, blocks of consumption can be defined and priced at different levels. There are two basic block tariff structures – declining and inclining:
  • declining block rate: establishes progressively decreasing rates for larger blocks of consumption, and thereby provides a lower average price for large users. The rationale for this approach is that because large users tend to have flatter load profiles, their ratio of capacity requirements to consumption, and therefore their average cost per kWh, is lower than for small users. As such, this approach enables cost reflective tariffs; or

  • inclining block rate: establishes progressively increasing rates for larger blocks of consumption, thereby providing a higher average price for large users. This approach is the most common form for residential rates worldwide, largely due to two key reasons. First, an imposition of higher prices for increased consumption serves to motivate energy conservation. Second, because small users tend to have lower incomes than larger users, an inclining block rate structure provides a mechanism for cross-subsidization that is relatively easy to administer.
Customer charge (per customer):
accounts for costs incurred by the utility that are independent of electricity usage, such as costs related to metering, billing, and collection. This charge applies to all customer classes regardless of their usage levels.
Capacity/demand charge (per kW):
charged based on the individual customer’s highest peak demand – this is typically only charged to large commercial and industrial customers.
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