Cost Allocation & Methods for Distribution and Supply

Cost allocation is a basic step towards the setting of prices. The objective, transparent and nondiscriminatory
tariff structure depends on how we define the precise costs, what criteria we use for
their allocation, price differentiation and how the entire pricing arrangement is harmonized.
Consequently it reflects the right signals to the consumers and makes the electricity system reliable
and more efficient.

There are different models or structures of the electricity market in the different countries.
Some of them still have the vertically integrated power companies, while some have already
unbundled their energy company according to the technological stages: generation, transmission,
distribution and supply. Supply activity usually is separated into two types: an independent supplier
and a public (last resort) supplier. Independent suppliers participate in the market and sell electricity
on the basis of negotiated prices, while the public suppliers are obliged to sell electricity to all or
some (depending on the rules in the country) customers, based on regulated prices. This
reorganization of the electricity sector is a precondition of a competitive market.

Electricity pricing should be modeled accordingly. Competition is possible where there is the
potential for more market participants, such as in the generation market, but not in the transmission
and distribution market, where it is irrational to build parallel transmission or distribution networks.
By this logic, the generation and supply activities should be free from price regulation, whereas the
transmission and distribution services should be regulated;, The latter services are called as natural
monopolies. This Issue Paper will mainly be focused on cost allocations – for the unbundled
market structure.


ERRA Tariff and Pricing Committee, Kayabas, Cetin; Parrish, Denise; Zubaviciute, Aistija

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  distribution     generation     supply     tariff     tariff structure     transmission     unbundled market structure     unbundling     vertically integrated