Consultation Paper:
The Case for Demand
Based Tariffs
March 2015
Consultation Paper Network Tariff Strategy
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Ergon Energy is seeking further customer and stakeholder input as we progress our
future network tariff strategy.
There has been a major shift in the way Ergon Energy’s customers use the electricity
network over recent years. In response, to help ensure we can continue to meet our
customers needs into the future for the best possible price, we are changing the way
we charge for the use of the network. The changes will also make network charges
more equitable.
Our proposed changes aim to help our customers make informed decisions,
especially when making investments relating to their use of electricity. To do this we
are restructuring charges so that they better reflect the impact of a customer’s
electricity use on the electricity network.
Our reform journey has already started. Following consultation with stakeholders, we
introduced a number of new tariffs and made structural changes to some tariffs in
July 2014. We are now focused on further changes for 2015-16 and beyond.
This paper builds on the information provided to date, in the Consultation Paper
Future Network Tariffs, and other documentation available online. It includes further
detail around what makes a good tariff, what is a cost reflective tariff and what’s
wrong with Ergon Energy’s current tariffs. It also provides an overview on the
modelling that is being used to determine the tariff option that supports the best
possible price for all, in a way that is fair and equitable, and the strong case for a
change to demand based tariffs.
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Purpose of this document
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The purpose of this supplementary consultation paper is to:
 further explain the case for tariff reform, and how we are going about assessing the
options for network tariffs moving forward
 outline our proposal to bring forward the introduction of a voluntary seasonal time of use
demand tariff for residential and small business customers in July 2015
 summarise the reasoning behind why we want to fast-track the introduction of this tariff,
with reference to the Maximum Demand Tariff Analysis Report; available online
 provide an opportunity for our customers and other stakeholders to provide further input
into the potential roll out of a seasonal time of use demand tariff.
This paper builds on the consultation process undertaken to date. We are, at the same time,
consulting on Ergon Energy’s considerations in determining our Long Run Marginal Cost
(LRMC) and where and how it is applied. This and earlier consultation papers and associated
documents are available at www.ergon.com.au/futurenetworktariffs
Consultation Paper Network Tariff Strategy
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1. What are we consulting on now and why?
In December 2014 we released the Consultation Paper Future Network Tariffs that focused on the
changes we would like to implement from 1 July 2015, as well as our longer-term tariff development
and reform pathway. In this supplementary consultation paper we outline changes to one of the
proposals in the earlier paper.
In December 2014 we proposed simply preparing for the introduction of a seasonal demand tariff, for
our small residential and business customers (Standard Asset Customers – Small using under
100MWh per annum) in the future (circa 2016-17). However, due to the outcomes of the preliminary
modelling outlined in this paper, and the confidence this has given us about the best path forward for
tariff reform to deliver price relief, we are now proposing to introduce a seasonal Time of Use
demand tariff on a voluntary basis earlier, in 2015-16.
While this would have to be considered by the QCA and other retailers before being becoming a
reality in retail tariffs, it could deliver financial benefits to those customers who choose to be early
adopters of the tariff. It would also allow Ergon Energy (both the network business and the retail
business) and other retailers to use the voluntary nature of it to explore the customer benefits more
deeply, as well as how it could interact with the take up of new technologies.
Even if the tariff was only ultimately introduced at the network level, and not reflected immediately in
retail tariffs, we believe having it in place would still help us to work through the implementation
issues and ultimately help us refine and progress our longer-term network tariff reform strategy.
In this paper we revisit the first principles of what makes up a ‘good’ tariff and then use these
principles to assess our suite of existing tariffs. We then compare these tariffs to smarter demand
based tariffs – it is this additional analysis that has influenced our decision to propose that our
residential and small business customers have access to a seasonal Time of Use demand tariff as
soon as possible, if they want to.
2. What is a Network Tariff?
The cost of transporting electricity (both distribution and transmission) makes up the largest part of a
retail electricity bill. Retail costs, then electricity generation, and other fees and charges make up the
remainder.
Customers ultimately receive one bill from a retailer who bundles all the relevant costs together. Our
reform program focuses on the structures and components underpinning tariffs that Ergon Energy’s
network business charges the electricity retailers. The structure of these tariffs is usually passed on
to customers.
The majority of customers in regional Queensland benefit from the Queensland Government’s
Uniform Tariff Policy in which regulated retail prices for small regional customers reflect the costs of
supplying customers in the south-east of the state.
The Queensland Competition Authority (QCA), when determining notified retail tariffs, takes this
policy into account, meaning that Ergon Energy’s rates and structures may not be fully reflected in
the customers’ bill. However, they have put forward new tariffs in their Draft Determination for 201516, based on the proposals in our December 2014 Consultation Paper Future Network Tariffs.
Consulltation Paper: The Case for Demand Based Tariffs
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Our network tariff reform program recognises the process for setting Notified Prices for 2015-16 is
well underway, but we also see an imperative to signal the most cost reflect network tariff
arrangements as soon as possible for market customers/retailers and for the QCA to consider when
looking at future notified price structures and outcomes.
3. What makes a good network tariff?
Simplicity
A good network tariff is simple. That is, a good network tariff is not so complex as to confuse
customers to the extent that they are unable to respond to price signals. A simple tariff has relatively
few components and is relatively consistent between days and between months.
Stability
A good network tariff is stable in both the short term and long term. Short term stability means that
customer bills do not vary significantly from bill to bill. Long term stability means price rises are
constrained – our ability to deliver for the best price possible is especially important to Ergon Energy
to benefit all customers.
Business costs
A good network tariff has low business costs for both networks and retailers. Keeping business costs
low can avoid price rises for both the network and retail components of bills and has a direct
relationship with long term stability.
A good network tariff, therefore, does not require overly expensive upgrades to billing systems and
meters relative to the benefits it provides.
Cost reflectiveness
A good network tariff is cost reflective, ensuring that customers pay for the costs they place on the
network and are not subsidised by other customers.
Cost reflective tariffs are price signals which give customers visibility of the costs they impart on the
system and enables them to respond accordingly, if they so wish. They produce more efficient
investment on the customer and network side and so therefore can reduce overall price rises and
improve long term stability.
Trade-offs
Tariffs which are most cost reflective tend to be more complex and less stable on a seasonal basis.
Cost reflective tariffs also impart additional business costs to upgrade billing systems and meters.
However, cost reflective tariffs reduce cross subsidies and price rises over the longer term, which are
critical issues for both customers and Ergon Energy.
Developing the best network tariff for Ergon Energy necessarily involves trade-offs between these
criteria.
Consulltation Paper: The Case for Demand Based Tariffs
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4. What is a cost reflective tariff?
A cost reflective tariff signals to customers the relative cost of their energy demand to the network
depending on time of day and time of year.
Network investment is driven by the maximum demand on the network, known as peak demand. The
cost of meeting an additional unit of demand at peak is known as Long Run Marginal Cost (LRMC).
Under a cost reflective tariff, a customer is charged at LRMC for every additional unit of demand they
place on the system at peak times.
A cost reflective tariff has both a peak charge component and a residual component.
What is a peak charge?
A significant network investment is made to ensure we are able to keep up with the demand for
power in the summer months. We want to make our price signals reflect this so that throughout the
year we are only charging customers what we need to cover future ‘augmentation’ costs.
A peak charge is the amount a customer must pay at peak times; this is set based on the LRMC.
This encourages customers to invest in demand management technologies or change their
behaviour only to the extent that it is cheaper (or more valuable to the customer) than the cost to
Ergon Energy of increasing network capacity.
A cost reflective peak charge set at LRMC produces the most economically efficient result for the
community. If the peak charge is set above LRMC then customers are incentivised to reduce demand
at a higher cost than it would otherwise be for Ergon Energy to increase network capacity, which
could give rise to inefficient levels of investment by customers. Conversely, if the peak charge is set
below LRMC customers would not be sufficiently incentivised to reduce demand through options
which are more cost effective than an increase in network capacity.
What is a residual charge?
In addition to the costs of supplying peak demand, networks must recover residual costs, due mainly
to sunk costs. To allow for this, a cost reflective network tariff also has an efficient residual charge
component.
An efficient residual charge is not influenced by consumption behaviour and therefore, in theory, is
independent of consumption or demand. Fixed charges are therefore often advocated as the best
means of recovering residual costs from a theoretical perspective.
However, recovery of residual costs via fixed charges alone has two main shortfalls. Firstly, fixed
charges can disadvantage small, and potentially vulnerable consumers. Secondly, fixed charges may
inadvertently drive disconnection from the network and place an additional burden on the broader
community.
There are a variety of alternative residual component mechanisms, such as off peak demand, off
peak consumption or a combination of one or more of these components with a small fixed charge.
Consulltation Paper: The Case for Demand Based Tariffs
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5. What’s wrong with current tariffs?
Ergon Energy currently has a range of network tariff options which vary by tariff class and in terms of
cost reflectiveness.
Current tariffs for small customers
Small residential and business customers’ network tariffs are volume based. These customers are
charged based on total consumption no matter when it is consumed.
Volume based tariffs, especially those which do not vary with time of day and season, are not cost
reflective as they do not signal the cost of peak demand to consumers. This means that the customer
who is most expensive for the network to supply does not necessarily pay the most for their
electricity.
Current tariffs for large business customers
The current tariff for large business customers features a peak charge based on monthly maximum
customer demand, which applies all year round, as well as an anytime energy charge and daily fixed
charge.
The tariff sends signals to consumers to reduce their own peak demand every month, rather than just
the peak months which, for Ergon Energy, only occur over summer.
Further the current tariff is not set based on LRMC and therefore tends to incentivise demand
reduction beyond economically efficient levels.
The case for change
Ergon Energy’s current tariffs are not cost reflective, with each having at least one component which
encourages inefficient consumption and investment patterns and behaviour.
The inefficient consumption and investment behaviour under these tariffs not only increases the
overall cost of supplying electricity, but also increases cross subsidies between customers. The level
of cross subsidisation is exaggerated when customers actively invest to reduce their bills, while
others either choose not to, or worse still, cannot invest.
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Air Conditioning Case Study
One cross subsidisation example is the
residential customer who installs a large air
conditioning system. On the inclining block tariff,
the customer will pay an additional $463 a year
($282 in network charges). The customer
decides this is a reasonable amount to pay for
the extra comfort they will receive. However, this
same decision will cost the network $447 a year
due to the increased demand the air conditioner
will place on the system.
Under current network arrangements, the
network’s $165 shortfall is recouped from all
customers via an increase in average network
prices. The other customers in this scenario
(who have smaller systems or have not invested
at all) face an increased bill to partially pay for
the improved comfort of the customer with the
large system.
Figure 1 – Impact of Investment in Air
Conditioning
Solar Case Study
Similarly, in another example, a residential
customer on an inclining block tariff choosing to
invest in solar photovoltaic (PV) systems does
their sums and realises that they will save
$1,516 per year as a result of their investment,
$910 of which will be in savings off their network
bill. This saving more than makes up for the
$975 per year in annual ‘payments’ for the solar
system. However, this decision will save the
network only $105 per year due to the slightly
decreased demand the customer places on the
network during peak times. Any saving could be
diminished altogether in the circumstance that
additional investment is required to address the
impact of volatile utilisation caused by solar.
The $805 (plus) shortfall in the revenue required
must therefore be recouped from all customers
via an increase in network prices the following
year. The other customers in this scenario
(without solar PV) face an increased bill to pay
for the savings to the solar PV customer.
Figure 2 – Impact of Investment in Solar PV
This situation could be mitigated by a cost
reflective tariff, which would ensure that the
increase in the customer’s network bill is
proportional to the increased network costs. In
this case, the active customer still invests in
their large air conditioner (but may be a little
more careful with its use), and the other
customers are not impacted financially.
This example has been used because air
conditioning has been a major driver of network
investment in the past. Moving forward,
however, without tariff reform, any new
customer technology that creates a significant
new ‘load’ at peak times could create this same
impact (electrics vehicles, etc).
Consulltation Paper: The Case for Demand Based Tariffs
This situation could also be mitigated with a cost
reflective network tariff, which ensured the
decrease in the solar PV customer’s network bill
was proportional to the decreased costs on the
network. In this case, the active customer still
invests in solar PV (but may purchase a smaller
system), while the other customers face no
additional cost.
Again, without tariff reform, this example could
be applied in the future to other new customer
technologies that, in this case, reduce energy
consumption overall but do not address peak
demand.
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6. The right tariff for Ergon Energy customers
Ergon Energy is currently considering a number of potential cost reflective network tariff options
across all of its tariff classes.
Selecting the right tariff will involve trade-offs. Current tariffs tend to be simple, have low business
costs and offer short-term stability, but tend to introduce cross subsidies and corresponding network
price increases. If nothing is done, these cross subsidies and price rises will continue to grow and will
be increasingly difficult to unwind.
6.1 Options
Volume based energy tariffs
Most legacy tariffs for residential and small business customers are characterised by a fixed charge
and an energy charge. This energy charge could be flat, or based on inclining/declining blocks (block
tariffs charge customers at different rates for each block of consumption within a billing period). The
common characteristic of these tariffs is they do not align prices with peak times in which future
investment is more likely.
All volume based energy tariffs are relatively simple and stable in the short term as rates do not vary
month to month. Further, they can be implemented with current billing systems and metering
technology and therefore have low business costs. However, they score low on cost reflectivity as
consumption is not a major driver of costs to the network, especially if this consumption occurs in off
peak times.
The inclining block tariff can also lead to instability. Revenue recovered in the first block tends to be
more stable and difficult for customers to avoid. However, revenue recovered in the second and third
highly valued blocks can be more easily avoided leading to revenue fluctuations and corresponding
price rises.
The declining block tariff tends to be more stable than the inclining block as the fluctuations in the
third block are not as highly valued. Revenue from the first and harder to avoid block is more stable.
While stable revenue gives rise to long term benefits, in the short term it can disadvantage smaller
customers whose entire consumption is in the first block.
Time of Use Energy Tariffs
Time of Use energy tariffs charge customers for consumption depending on the time of day. An
example of a Time of Use network tariff is shown in Figure 3.
Off‐Peak
Shoulder
22:00
20:00
18:00
16:00
14:00
12:00
10:00
08:00
04:00
02:00
06:00
Summer Weekday
$0.7
$0.6
$0.5
$0.4
$0.3
$0.2
$0.1
$0.0
00:00
Unit Consumption Charge ($/kWh)
Figure 3 – Time of Use Energy Tariff
Peak
Consulltation Paper: The Case for Demand Based Tariffs
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In this example, a peak charge applies from 4pm until 9pm with a lower shoulder charge either side
of this. The lower off peak charge applies for all other times.
The times of day when higher peak and shoulder charges apply reflect the times when the network is
more likely to experience peak demand conditions. In Ergon Energy’s case this would only apply
during summer months in the early afternoon and evening for residential customers and summer
months during the middle of the day on weekdays for business customers. For the remainder of the
year, including all weekends, customers would be charged at the off peak rate for all times of day.
A seasonal Time of Use energy tariff is more cost reflective including both a peak charge and
residual charge. However the residual charge, if set too high, can tend to distort customer behaviour
resulting in actions to offset consumption all year round which have no benefit to the network and
have the potential to lead to network price rises.
Seasonal Time of Use tariffs are relatively simple, but do vary from bill to bill, potentially resulting in
high summer bills, but offset by lower winter bills.
Seasonal Time of Use tariffs also require changes in billing systems and new metering technology to
measure and charge for energy use based on half hourly time periods.
Maximum Demand Tariffs
Maximum demand tariffs charge customers based on their maximum usage within a given time
period. The peak charge component of a maximum demand tariff is expressed in kW, rather than
kWh, representing the maximum rate of consumption rather than total consumption. An example of
how the tariff applies is shown in Figure 4.
Daily Summer Weekday Average Profile (kW) Figure 4 – Maximum Demand Network Tariff
8.0
Network Peak Period
7.0
6.0
Max Monthly Peak Demand
5.0
4.0
3.0
2.0
1.0
0.0
0:00
2:00
4:00
6:00
8:00
10:00
12:00
14:00
16:00
18:00
20:00
22:00
In this case, a demand charge is applied to the maximum demand of the month during the peak
period of around 6kW. The actual customer peak of 7.5kW on this day occurs outside of the network
peak period and therefore does not affect the charge.
A cost reflective maximum demand tariff applies the demand based charge during times of network
peak. Demand outside of the peak period is not considered.
For Ergon Energy, this would be during summer months in the early afternoon and evening for
residential customers and summer months during the middle of the day for business customers.
Outside of these times customers would be charged at a different rate. This could be based on an off
peak demand charge, an off peak consumption charge, a fixed charge or combination of any or all of
these. The more cost reflective tariffs adopt residual mechanisms which provide weak price signals to
customers during the off peak times and therefore do not distort behaviour.
Consulltation Paper: The Case for Demand Based Tariffs
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Maximum demand tariffs have the potential to give rise to efficient investment on both the customer
and network sides and therefore reduce overall costs to the entire community. Maximum demand
tariffs ensure that customer network bills are proportional to the costs they impart on the network and
therefore reduce cross subsidies.
However, maximum demand tariffs tend to be more complex for customers to understand,
introducing the concept of demand based pricing and generally having several components which
vary depending on time of day and time of year.
6.2 Evaluating options
The case studies described in Section 4 provide examples of how current network tariff structures
result in cross subsidies and inefficient investment in technology. However, case study analysis is
limited in its ability to assess the full extent of these inefficiencies across the total Ergon Energy
network.
Ergon Energy is currently working with energy research and advisory specialists, Energeia, to
undertake analysis of tariff options. The analysis seeks to assess how each combination of peak
charging components and residual charging components performs in terms of reducing cross
subsidies and improving the long term stability of network prices.
The modelling projects the impact of each tariff type on behaviour in terms of distributed energy
technology adoption across Ergon Energy’s entire customer base. The modelling is accordingly able
to forecast the total technology uptake, the impact on network costs, network prices and ultimately
the impact on customers in terms of bills and cross subsidies.
We are using the modelling results to quantitatively assess the tariff options against the criteria of
allocative and productive and dynamic efficiency. This represents an industry-leading approach in
terms of quantitative evidence based design and selection of network tariffs.
6.3 Cost of inaction
The preliminary modelling results are revealing that there are significant costs associated with
retaining existing tariff structures, especially for residential and small business customers.
The results suggest that the current volume based tariffs drive inefficient wide-scale uptake of large
solar PV systems, but stifle investment in demand management, and storage technology in
particular.
The wide-scale solar uptake under current tariffs, as well as under investment in demand
management leads to an under recovery of network revenue without a commensurate reduction in
network augmentation costs. As a result, the unit price of network charges must rise each year to
allow Ergon Energy to cover the costs of sustaining a secure, reliable and safe electricity network.
Preliminary modelling of network price rises in the residential tariff class as shown in Figure 7 over
show prices up to 13% higher under the current tariff compared to the most efficient cost reflective
network tariff by 2025.
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Network Price Growth %
Figure 4 – Residential Network Price Rises (Preliminary)
25%
20%
15%
10%
5%
0%
2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025
Current Tariff
"Maximum Demand Tariff"
Customers who do not, or cannot, adopt distributed generation technology are the most burdened by
the network price rise, effectively subsidising those who have taken advantage of the current tariff in
their technology investment.
The preliminary modelling indicates that there is a strong case for cost reflective tariffs to be
implemented across all tariff classes. The preliminary modelling further suggests that steps towards
this change should be taken sooner rather than later to avoid future inefficient customer side
investment and corresponding cross subsidies which will be difficult to unwind.
6.4 The customer rewards
We are currently working through potential options for maximum demand tariffs for small residential
and business customers (using under 100MWh per annum), including various combinations of peak
charging mechanisms and off peak charging mechanisms.
One possible tariff structure is the average top four seasonal Time of Use demand tariff, as described
in Table 1. This tariff includes both the retail and network components.
Table 1 – Average Top Four Seasonal Time of Use Demand Tariff
Charge
Component
Definition
Rate
Average top four
peak demand
Applies to the average of a customer’s demand during the peak period for the highest
top four demand days for each of the three summer months.
$81.52 per kW
Off peak demand
with 2kW floor
Applies to maximum demand during each of the nine off peak months above 2kW.
Where the maximum demand is less than 2kW the customer is charged as if their
maximum demand was 2kW.
$13.13 per kW
Any time energy
Applies to all energy consumption regardless of season or time of day.
12.3 c per kWh
Fixed
Applies to all customers at the same daily fixed charge regardless of energy
consumption patterns.
50.8 c per day
Compared to the proposed Tariff 11 (currently proposed at $1.07 per day and 23c per kWh), this
voluntary tariff would reward usage behaviour that helps us manage the costs of responding to
demand on the network during peaks periods.
We tested this voluntary tariff against a sample small residential customer consuming approximately
4.7MWh per year, who chooses to switch from the current default Tariff 11 to this seasonal Time of
Use demand tariff. If they make no change to their usage behaviours, this customer’s annual bill
would increase by 3% or $41 as shown in Figure 8.
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However, if the same small residential customer decreases demand during the peak period for the
top four demand days per month by an average of only 1kW, their bill would be reduced by 13%
compared to the original bill or $186 as shown in Figure 9. This could be achieved by delaying the
use of a home’s dishwasher and washing machine until after 9.30pm.
Figure 5 – Small Customer Bill Impact
$1,800
Annual Customer Bill ($)
$1,600
$1,400
$1,200
$1,000
$800
$600
$400
$200
$0
SToUD
Fixed
Anytime Energy
Tariff 11
Off‐Peak Demand
Peak Demand
Figure 6 – Small Customer Bill Impact with Behaviour Change
$1,800
Annual Customer Bill ($)
$1,600
$1,400
$1,200
$1,000
$800
$600
$400
$200
$0
SToUD
Fixed
Anytime Energy
Tariff 11
Off‐Peak Demand
Peak Demand
We also analysed a medium residential customer with an annual consumption of 9.5MWh. Switching
from Tariff 11 to this seasonal Time of Use demand tariff will reduce this customer’s annual bill by 4%
or $87 without any behaviour change as shown in Figure 10. This customer is making greater use of
the network throughout the year in our non-peak period, which again helps us manage network costs
for all.
The medium residential customer’s bill could be further reduced by simple actions to reduce demand
during peak periods in summer months.
Figure 7 – Medium Customer Bill Impact
$2,500
Annual Customer Bill ($)
$2,000
$1,500
$1,000
$500
$0
SToUD
Fixed
Anytime Energy
Tariff 11
Off‐Peak Demand
Peak Demand
Consulltation Paper: The Case for Demand Based Tariffs
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In addition to these short term bill benefits, there are also longer term benefits under this tariff. Where
a significant number of Ergon Energy’s customers transition to the new tariff the overall cross
subsidies and economic costs of existing tariffs will be reduced, stabilising network price growth and
resulting in lower prices for all customers over time.
7. Opportunity to make a submission
Ergon Energy is committed to working with our customers and other stakeholders to ensure we
evolve our network tariffs in a way that delivers the best long-term outcome for regional Queensland.
To ensure we do this we would appreciate your input.
Our preference is for submissions to be lodged by email. Comments and enquiries regarding this
consultation paper are also welcome. Ergon Energy will consider all submissions received in the
submission period.
In the interests of transparency and to promote informed discussion, Ergon Energy would prefer
submissions to be able to be made publicly available wherever this is reasonable. However, if you do
not want your submission to be public, you should clearly claim confidentiality in respect of that
document (or part there-of). In the absence of any claims of confidentiality Ergon Energy will treat
any responses as being able to be made public either in their entirety or partially.
Email submissions (preferred): futurenetworktariffs@ergon.com.au
Written submissions:
Ergon Energy Corporation Limited
Group Manager Regulatory Affairs
PO Box 264
Fortitude Valley QLD 4006
The closing date for submissions is Friday, 27 March 2015.
8. Other reference documents available
The supporting documents, and any additional papers developed will be made public through Ergon
Energy’s website at www.ergon.com.au/futurenetworktariffs
Related documentation is available at www.ergon.com.au/networktariffs. This includes
Ergon Energy’s AER Approved Pricing Proposal 2014-15.
Consulltation Paper: The Case for Demand Based Tariffs
12
kW
kilowatt
kWh
kilowatt hour
LRMC
Long Run Marginal Cost
MW
megawatt
PV
Photovoltaic
QCA
Queensland Competition Authority
SAC-Large
Standard Asset Customers – Large
SAC-Small
Standard Asset Customers – Small
SToUE
seasonal Time-of-Use energy
SToUD
seasonal Time-of-Use demand
ToU
Time-of-Use
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