Will solar face a price reform shock?

With what could be huge implications for the economic attractiveness of solar systems, the Australian Energy Market Commission has released its draft determination on how it believes charges for power network infrastructure should be reformed.

At present, for most residential and small business electricity customers the vast bulk of the costs of network infrastructure are recovered via a charge per unit of energy (kilowatt-hour or kWh) consumed. These charges make up, on average, about half the cost of the price customers pay per kWh.

These charges escalated dramatically in the last five years. In response, a large number of households purchased solar photovoltaic systems to supply them with energy instead, thereby lowering the amount of kilowatt-hours taken from the grid and the amount of money they pay for network infrastructure.

This avoidance of network charges via installation of solar PV has caused considerable concern among network businesses, and energy suppliers more generally. This had led them to push for tariffs to be adjusted to reduce the extent to which solar could be employed to avoid network charges.

The argument has been that solar owners are free-riding; still needing to make use of the network to meet their power needs when solar output was low but avoiding having to pay for this network infrastructure.

The Australian Energy Market Commission has supported this argument of solar as a free-rider but with an interesting caveat – it depends on whether the panels face north or west. They also note that there are other ways – most importantly via air-conditioners (free-rider cost of $683 per annum for 5kW system) – that some consumers can free-ride off network infrastructure at the expense of others.

The chart below from the AEMC’s draft determination looks at the extent to which a solar PV system lowers a consumer’s network charges on their bill (based on current per kWh pricing) in blue, versus the extent to which it reduces the actual cost of network infrastructure required to service that customer’s demand in black.

Demand for network capacity tends to peak on hot days in the afternoon and early evening rather than the middle of the day. By rotating panels to the west a solar system will generate less power overall but will generate more power later in the afternoon, providing a larger impact in lowering peak demand on the network than north-facing panels.

Figure 1: Consumer bill reductions vs network benefits for north and west-facing 2.5kW solar system

Graph for Will solar face a price reform shock?

What this clearly means is that changes in tariffs which just shifted charges from being based on kilowatt-hours to being a fixed daily charge don’t make much sense – this wouldn’t provide any incentive for people to reduce their load on the network during peak times and, indeed, could lead to further inefficient investment in network infrastructure. Also, applying fixed charges on someone simply for owning a solar system doesn’t make much sense, either, because solar systems could actually work to reduce network capacity if orientation was changed – and they aren’t the only, nor the most important, factor that allows for free-riding.

The AEMC, instead, are keen on network tariffs which charge a retailer based directly on their customers’ demand for grid electricity during peak periods, irrespective of the technology they might own. The AEMC doesn’t specify a specific form of tariff structure but rather a set of principles to guide how network businesses should charge electricity retailers for transport of power over the network. The AEMC state:

The key factor that will determine how much consumers pay for network services would be their individual usage pattern or load profiles. Consumers who use a lower than average proportion of their energy at peak times are likely to face lower network prices under the draft rule.

Potential new price structures the AEMC believe might arise include capacity charges (where a consumer is charged based on its maximum use rather than its total use) or critical peak prices (where a consumer is charged lower prices most of the time and higher prices on a few days a year).

However, it is important to note that these charges would not necessarily flow through to end-consumers. They are charges borne by power retailers who are then free to decide how they might pass these costs through to end-consumers in the prices they charge. However, according to the AEMC:

...because network charges are retailers’ largest cost, they will have a significant incentive to pass on network price signals to consumers when deciding how to structure their retail prices.

Overall this sounds very logical. But you can’t help but worry that leaving network businesses to design power tariffs based on broad principles will lead to tariffs that won’t particularly encourage consumers to reduce peak demand, while undermining possible competitors like solar, battery systems and other forms of demand management products and services.