Charging volatility and retail margins

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Client EdF Energy
Dates 2012
Service(s)Policy & Economics, Regulation & Competition
The predictability of energy network charges is an important issue for GB gas and electricity suppliers as this impacts on what level of costs they must seek to recover from their customers. As a large element of their retail cost base, and a largely unhedgeable risk, charging volatility can create significant risk for suppliers of eroding the profitability of their supply contracts, particularly where they are operating with fairly low profit margins.

CEPA worked with EDF Energy to understand how the risks associated with network charges are captured in the overall approach electricity suppliers adopt to set their margins in domestic as well as non-domestic customer contracts. We developed a model of how a supplier might approach a pricing decision where there is trade-off between charging a lower price to gain customers and charging a high risk premium in the contract profit margin to mitigate against unknown future network charges.

We also looked at the different options for how charging volatility might be mitigated through network operators' price controls. For example, through a fixed notice period that requires the network operators to publish their tariffs more than two-years ahead which would require the network operators to manage the risk of charging volatility under their price control rather than through suppliers contract margins. This work was presented to Ofgem as part of the electricity distribution price control (RIIO-ED1).