Signaling future or historical distribution grid costs via tariffs? A welfare analysis of long-run incremental cost pricing

The economic efficiency of distribution network tariffs may be enhanced by applying marginal cost pricing principles. This paper investigates the Long-Run Incremental Cost (LRIC) methodology, a marginal cost-based approach that has been applied in Great Britain since 2012. The long-term social welfare achieved under a coincident peak tariff set according to three different methods, i.e., LRIC, traditional historical cost-based allocation, and a theoretical benchmark, is analytically derived. The resulting social welfare is compared for a range of key system characteristics and the underlying mechanisms are discussed. The results provide evidence that LRIC is more efficient than historical cost-based allocation.

Automated summary

The study finds that applying marginal cost pricing principles can enhance the economic efficiency of distribution network tariffs. By investigating the Long-Run Incremental Cost (LRIC) methodology implemented in Great Britain since 2012, the paper analytically derives the long-term social welfare achieved under three different tariff-setting methods. The study compares the resulting social welfare based on a range of system characteristics and discusses the underlying mechanisms, revealing that LRIC is more efficient than historical cost-based allocation.