Does the answer to renewable energy lie in our humble utility rate codes?

This is a guest blog by environmental legal expert Ted Robinson

Most environmentally conscious consumers know about the benefits of promoting renewable energy sources as well as energy efficiency and conservation programs.[1] However, there is another aspect of utility services that also has a significant impact on the environment, utility rate structure. The Pennsylvania Public Utility Commission (PUC) is currently accepting comments on alternative ratemaking methodologies through May 31st at docket M-2015-2518883.

In order to explain why rate structure is important, I am going to focus on electricity rates, though the concepts can be applied to gas and water as well. In Pennsylvania, the cost of electricity is separated into the generation/transmission on one hand, and its distribution on the other. The generation/transmission component is the cost of producing the electricity as well as the cost of transmitting that electricity from the power source to the local distribution system. The distribution cost is the cost of running and maintaining the local distribution system including the polls, wires, and meters.

Total Electricity Bill = Generation/Transmission Costs + Distribution Costs

Since distribution companies are monopolies, the prices they are allowed to charge are regulated by the Public Utility Commission, and are supposed to be just and reasonable. Traditionally, the rates are set by determining the company’s overhead costs (labor, materials, taxes, etc.), and adding a fair profit margin. So for example, if Duquesne Light (the distribution company in Pittsburgh) requires $10,000,000 in costs/profits and its 20,000 customers use 200,000,000 kwh, it can A) set the price of distribution at $.05 per kilowatt, B) charge a flat rate of $500 per customer, or C) use a combination of a per kwh and flat rate.[2] Though the revenue may remain the same, the rate structure significantly impacts consumer decision, particular in customer based solar and energy efficiency upgrades.

The first issues arise from the breakdown of the bill, between fixed (flat rate) and variable costs (a per kWh rate). Typically, the cost of a distribution system (especially in cities with stable populations) is fixed.[3] For the most part, Duquesne Light needs to spend the same amount of money maintaining polls and wires, responding to downed lines, cutting vegetation, reading meters whether their customers use 180,000,000 kWh or 220,000,000 kWh. This supports using a rate structure where consumers mostly pay a flat fee to use the distribution system.[4] However, a flat rate structure discourages the use of distributed solar and energy efficiency. For instance, if a homeowner puts up enough solar to cover half of their electricity usage, they would cut their distribution costs by half under a per kWh structure, but would not save a cent of distribution costs under a pure flat rate. Minimizing or eliminating the fixed portion of the bill does result in reduced usage.[5]

The debate of flat versus variable pricing has special implications for low-income consumers. Generally, low-income consumers use less electricity than the average consumer and therefore pay lower rates when more of the bill is a variable rate. However, if enough high and medium income consumers have installed solar, low-income users can end up paying a disproportionate share of the distribution costs because they now represent a greater share of the users.

If we decide to minimize the fixed rate, the question now begs, how do you determine the per kWh cost? Typically, the revenue goal is divided by the estimated amount of kWh usage to determine the price ($10,000,000/200,000,000 kWh = $.05 per kWh). However, this creates an incentive for the distribution company to maximize consumer usage and fight against energy efficiency programs. For example, at $.05 per kWh, if customers use 210,000,000 kwh instead of 200,000,000, a distribution company would make $11,000,000 instead of $10,000,000. A potential solution to this is revenue decoupling, which adjusts the per kWh cost based on actual usage. For instance, if actual usage is 210,000,000 kWh, the per kwh cost would be ($10,000,000/210,000,000 kwh or $.0476 per kwh). On the other hand if a distribution company is successful with an energy efficiency program and usage drops to 180,000,000 kwh, the per kwh cost would increase to ($10,000,000/180,000,000 or $.0555 per kwh) to account for increased costs. There are many different ways to decouple that are more nuanced than this explanation,[6] but all remove distribution company’s incentive to promote increased usage.

As costs for solar technology continue to decrease, we need to create a policy environment that encourages their adoption. And though there are many important subsidies, loans, tax rebate policies to lead the way, a more fundamental change in how we calculate electricity could have a prolonged impact on our energy choices.  If you wish to dive deeper into this subject, a much more detailed paper can be found here. Comments already received by the PA PUC can be found here.

 


[1]    If you are currently not purchasing renewable energy, a list of suppliers can be found at http://www.papowerswitch.com/shop-for-electricity. Generally, most residential consumers benefit from fixed rate offers that last 12 months or more.

[2]    Commercial rates are calculated using demand instead of consumption, which is explained here.

[3]    Some would argue that many of the costs are not fixed but sunk costs and that over the long-term most costs are truly variable, for example this article by Synapse Energy.

[4]    Ontario is completely moving to fixed distribution rates by 2019 as explained here. Another view on the benefits of fixed rates can be found here.

[5]    Paul, Anthony C. and Myers, Erica C. and Palmer, Karen L., A Partial Adjustment Model of U.S. Electricity Demand by Region, Season, and Sector (April 1, 2009). RFF Discussion Paper No. 08-50. Available at SSRN: https://ssrn.com/abstract=1372228

[6]    An extensive guide to the different flavors of decoupling can be found here.

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