Plug in Hybrid – Saving Carbon and Dollars?

I am in the market for a new car. At a recent visit to a Ford dealer I was confronted with the choice between the regular hybrid-electric version of the C-Max (think standard Prius but made in the USA!) and the plug-in hybrid electric version of the same model. The only difference between the two is the plug-in, well, plugs in. You get a 7.6kWh battery under your now largely non-existent trunk, which you can charge using a supplied cable from any standard electric outlet. This lets you drive an advertised 22 miles in all electric mode and after your battery is empty you drive a regular hybrid. That is right, 22 miles, without ever burning a molecule of evil climate changing, health destroying, liquid petroleum product. My pulse quickened. I felt like I was about to lease a halo. And then the dealer said: “This car is great. It saves me so much money. I never plug it in at home. I just charge it at work!” Cold sweat started forming. I thought to myself “I wonder if this guy used to siphon gasoline out of his boss’ gas tank before he got his new wheels?”

So let’s think about this for a second. 7.6 kWh for 22 miles comes out to 0.35 kWh per mile. What the heck are kWhs? They are the units that the electricity delivered to your outlet is measured in. What do they cost? Well, that depends on who your utility is. In my case, this utility is called PG&E and I pay for my electricity using block rate pricing. Here is what the price schedule I face looks like:

table rates
What this means for those of you living in the hotter parts of Contra Costa County is that if you use your air conditioner when it’s hot, you are probably paying 32.4 cents per kWh. This means a single battery charge of the C-Max hybrid energy would cost 7.2 * 0.32445 = $2.33. While I would be cruising down the road quietly like a puma, my card carrying economic soul is crying into its pillow. Why? If I would have not plugged in the C-Max and just used the hybrid feature using some evil gasoline, I would have gotten 44+ miles per gallon. At $3.35/gallon (best price on gasbuddy.com right now), the 22 miles would have cost me $1.68. A savings of 28%.

My greener than Al Gore mother would argue that if I were more saintly in my home electricity consumption and were on tier 1, the 22 miles would have cost me $1.09, which is 35% cheaper than the hybrid mode.

So I pulled my electricity consumption record using the green button and tried to figure out what getting the plug-in would do to my electricity consumption and how the cost would compare to the regular hybrid using our past 5 years of electricity consumption as data. I added a daily charge of the car to our electricity bill and calculated out bill totals with and without the plug-in. The plugin costs about 67 dollars a month to charge at home, which comes out to 10.25 cents per mile. If I had driven in hybrid mode I would have paid 7.39 cents per mile assuming the low gas price. But even at $4 a gallon, the hybrid mode wins. Now, since I am supposed to do what is socially optimal, I have to add in the damage carbon does. Assuming the less favorable $4 gas and a $40 Social Cost of Carbon, the hybrid still wins – just barely. I would save about $90 by going hybrid.

One thought that had occurred to me is to see whether my utility offers a tariff which accommodates my new usage pattern. And it does.

estimated rates

Their estimates suggest that I will be paying $260 more than I currently pay for existing uses and a back of the envelope calculation suggests that I lose compared to the current plan with my plug-in hybrid as well.

Now here comes the kicker. Because of the federal and state subsidies, the lease price of the plugin hybrid and the regular hybrid are almost exactly the same. And at my place of work there are outlets in the parking lot. So what is the privately optimal thing to do? Buy that American made electro stallion, plug it in at work and save some money. Which is roughly what the guy trying to sell me the car did.

But this is just plain wrong.

  • I would increase the university’s electricity bill and drive up my students’ tuition! (Severin has already written about why free charging is a bad idea.)
  • I would get a free ride in the car pool lane, because I bought myself a halo and increase congestion in these lanes.
  • I would rake in thousands of dollars in taxpayer-financed subsidies for the option to charge the car when it is cheaper for me to do so (at the movies and my mother-in-law’s house). These subsidies and stickers are pushing this technology and are hoping for it to become more efficient in the long run, which is sensible. But the gap is still several thousand dollars on the lot.
  • On the marginal cost side the plug-in is almost competitive with the existing hybrid technology even in my very expensive electricity neighborhood and after accounting for the external costs from carbon emissions. But my electricity is California oh so clean! Areas with cheaper electricity mostly rely on a higher mix of cheaper dirtier coal power, which will drive up the external costs per mile. A recent paper by some alumni and friends of EI suggest that electric vehicles aren’t greener — compared to a comparable hybrid if charged with coal fired power.

I might still get the plug-in, but I am charging it at home. Because my Dean reads this blog.

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The multibillion dollar question: How to spend carbon revenues?

Debates over carbon pricing policies tend to focus on the costs imposed on firms and households. When a carbon tax or cap and trade program is introduced, firms see energy-related operating costs rise, drivers pay (cents) more at the pump, households see the prices of energy – and energy-intensive goods – tick up.

On the flip side, in addition to reducing harmful emissions, these policies generate revenues.  Estimates of the total value of revenues from the auctioning of emissions allowances in the European Union’s Emission Trading Scheme are estimated to be around €10 billion annually. In California, lawmakers expect sales of greenhouse gas pollution permits to bring in $5 billion annually.

By now you may be wondering – where is all this money going?   The answer varies across the jurisdictions that are implementing carbon pricing policies. This week’s blog takes a look at how two very different revenue recycling policies are panning out.

How should we be spending carbon $$ (in theory)

Over the past decade, economists have been busy analyzing the implications of different uses of carbon revenues, paying particular attention to how carbon pricing policies interact with pre-existing taxes. The policy recommendations that emerge from these studies depend critically on what policy makers are trying to achieve.

Model 1: If minimizing the economic costs imposed by the carbon pricing policy is the primary concern, substituting carbon for distortionary taxes on capital produces the largest economic cost savings. Recent work by Dale Jorgensen and co-authors suggests that if carbon revenues are used to offset taxation of capital spending, the performance of the overall economy (in terms of GDP) could actually improve under a carbon tax.

Model 2: If policy makers are concerned about the equitable distribution of policy impacts across different income/demographic groups, there is a case to be made for reductions in payroll taxes, or even targeted transfers, to correct for the regressivity of a carbon tax (i.e. taking a larger percentage of a lower-income and a smaller percentage of a higher income) and/or meet re-distributional objectives.

Model 3: If policy makers are losing sleep over budget deficits, carbon revenues can be used to offset increases in capital, labor, or consumption taxes that would otherwise be needed to balance the budget.  Here again, offsets to capital tax increases provide the largest economic benefits, followed by labor taxes, consumption taxes, and lump-sum transfers.

Model 4: If concerns about global climate change are paramount, tax revenues can be used to support the research and development of clean energy research, development, and deployment that many see as essential inputs to meaningful climate change mitigation in the long run.

 How should we be spending carbon $$ (in public opinion)

Whereas economists see the costs and benefits of many options, public opinion on how revenues should be spent appears less equivocal.

A group of political scientists – including my former Michigan colleague Barry Rabe  – recently conducted a national survey to gauge public support for a carbon tax. The survey asked several questions about “support for a tax on carbon-based fuels such as coal, oil, and natural gas”.  They find that the level of support for the tax varies significantly with the choice of how to allocate revenues:

rabe

What is particularly striking about these results is the extent to which tying revenues to a particular use – renewable energy investment in particular – increases support for the carbon tax.

How are carbon $$ actually being spent  (in practice)

Carbon pricing is underway! Here on the west coast, between California and British Columbia, we are seeing some real live experimentation with hybrid-versions of the four models summarized above.

I was fortunate enough to spend some time recently in British Columbia, home to old growth forests, humpback whales, and a revenue neutral carbon tax.  I seized the opportunity to play carbon tax tourist and ask lots of questions.

The BC carbon tax is pegged at CDN $30/tonne  CO2e (approximately $27 US). To put this in some perspective, the tax adds about 25 cents per gallon. For a fascinating account of the mechanics and politics of the BC carbon tax, read this paper.

When the carbon tax was first introduced, the provincial government made a commitment to return carbon tax income to BC residents via tax reductions and lump-sum payments. The enacting legislation actually threatens to reduce the Finance Minister’s salary by 15% should he fail to deliver on this revenue neutrality promise.  To date, the finance minister is still getting paid; all tax revenues have been “recycled” through a number of tax channels. Initially two thirds of the tax cuts went to individuals (including a low income tax credit and reductions in personal income taxes) and one third to firms via corporate tax reductions. Over time, the share of tax cuts flowing to the business community has increased to more than half.

Of course, it is difficult to know for certain whether these tax cuts would have happened even without the carbon tax. What we do know is that distortionary taxes have been reduced as the carbon tax increased. A recent paper suggests these changes in the tax structure have been progressive. Moreover, my very unscientific polling of whoever would talk to me about carbon taxation suggests that the Canadian-on-the-street understands how carbon tax revenues are being spent and believes that this approach is working. Oh Canada!

Next stop, California

The politics of the California cap-and-trade-program, constraints imposed by the state’s constitution, and a host of other complicating factors have given rise to a very different allocation of carbon revenues in California as compared to BC. Currently, a majority of permits are allocated for free as a form of industrial assistance, allocated to utilities on behalf of ratepayers (Californians, look out for your lump sum climate credit this month) or set aside as a cost-containment reserve. The remainder are sold at auction to generate revenues.

By law, permit auction revenues are deposited into a Greenhouse Gas (GHG) Reduction Fund to be used to support projects and programs that reduce GHG emissions; 25 percent of all revenues must benefit disadvantaged communities.  Although this may sound straightforward in principle, implementing this in practice has been messy.  Facing major budgetary challenges , the 2013-14 Budget Act loaned $500 million in auction revenues to the General Fund.  In June, California passed a state budget that allocates a quarter of cap-and-trade revenues to help pay for a highly controversial high-speed rail project.

Critics of the carbon pricing policies look at this and see a gravy train… “a massive new scheme of general taxation to be used for the whims and wish lists of the politicians.”  The Legislative Analysts Office, in addition to several environmental groups,  have argued that it is very hard to justify devoting scarce climate funds toward a new high-speed rail system on the grounds that it’s the most effective way to reduce carbon emissions.

Regional experimentation with carbon pricing policies has the potential to successfully demonstrate proof of critical policy concepts, increasing the likelihood that other jurisdictions will follow suit.  Economists have demonstrated how the allocation of carbon revenues generated by carbon pricing can significantly affect the success of  the policy in theory. Political scientists are highlighting how the choice of how to allocate revenues significantly affects the political feasibility and durability of the policy. In sum, these spending choices are an important part of the larger policy picture.

British Columbia is successfully demonstrating a disciplined approach to ensuring that carbon tax revenues offset other tax distortions. In contrast, California is aiming to spend revenues on climate change mitigation programs and technologies. This approach resonates in principle with a majority of voters.  But in terms of demonstrating this model in practice, so far not so good.  California needs a more measured and less political system of allocating carbon revenues to meet important policy goals.

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A Common Energy-Saving Device that I’ve Never Seen in the US

I tend to think of the US as ahead of most of the rest of the world when it comes to energy efficiency. Maybe not in the Germany or Japan league, but at least above the median. After all, our utilities are spending billions of dollars per year encouraging energy efficiency and our policy makers talk about it a lot.

But, I’ve stayed in hotels in France, Singapore and Kenya over the past six months and seen an energy-saving device that I’ve never seen in the US. Maybe you’ve seen them. It’s a simple fixture, pictured below, where you insert your key to activate the electricity in the room.

2014-07-11 07.48.17This doesn’t mean that you get charged for the electricity you consume while at the hotel. The device is basically a master switch that turns everything off as you take your key out and leave the room. (In my Singapore hotel, this worked with a lag, giving me a couple seconds to get out with the lights still on.)

To me, the energy savings to the hotel are ancillary and the main benefit is that there’s a single, default spot to leave my key. No more hunting through my purse and looking on every flat surface in a room as I rush out the door. The key is right there, on the wall next to the door, ready to go. I would pay extra for a room that had such a pocket even if it had nothing to do with electricity.

This is a clear example of what the energy efficiency community labels a “non-energy benefit.”

So, why don’t we see these in US hotels? It’s not because I’m staying at fancy new hotels in city centers in the other countries. Both my recent hotels in Western Kenya had the devices – in Kisumu and overlooking the Ugandan border in the town of Busia (population 52,000), where I took the photograph above, and pictured below.

An aerial view of Busia, Kenya

An aerial view of downtown Busia, Kenya

But, maybe I stay at nicer hotels in the US than when I travel abroad? The device has a penny-pinching feel to it, and there are drawbacks. For example, you cannot leave your computer charging while you’re out of the room. I don’t think that’s the story, though, since at least the hotel in Singapore was quite nice, and I’ve stayed in some real dives in the US and still not seen a key pocket.

It’s also not the case that electricity is extraordinarily expensive in the countries where I’ve seen the key pockets. They all have commercial rates in the 14-20 cents per kWh range, which is higher than the US average, but no higher than California. So, the hotels outside the US are not facing larger monetary savings from installing the master switches. (See here for Singapore prices, and here for French prices. I got the Kenyan prices from a recent presentation I saw by a former regulator. Admittedly, the true costs in Kenya should average in the occasional cost of running the diesel generator when the grid goes out.)

We talk about an energy efficiency gap, meaning that consumers and firms may be failing to invest in energy efficient technologies even if the payback in terms of lower future energy bills clearly outweighs the upfront investment. The typical explanations for the energy efficiency gap are that there is a market failure at play, like a split-incentive problem or lack of information. Certainly, hotel guests do not think about the effects of their actions on the hotel owner’s energy bill, so there are elements of the split-incentive problem here. But, this device is explicitly designed to address that problem and force the guests to save energy for the owner.

I am also hard-pressed to see US hotels’ failure to adopt the key pockets as an example of the energy efficiency gap, since the devices have been adopted in other countries. I can’t see why market failures exist in the US that don’t in Singapore, France or Kenya.

So, is it possible that Hilton contemplated installing these in their US hotels, and decided that their guests would be turned off, meaning that lost business would outweigh any energy savings? I suspect that’s the case. Even Starwood’s new Element hotels, which are branded as green and use low-VOC paints and carpets made from recycled materials, opted not to use the “master switch.”

This article quotes an Element executive describing how they surveyed customers before deciding whether or not to use the switches.  “’Some,’ he recalled, `said they would suffer discomfort because they would get back to their room and it would be extremely hot.’”

hotel ac

Always on?

One lesson is that I am not a typical US hotel customer. I like having a place to keep my key, and I don’t like walking into what feels like a 65-degree hotel room, even if it’s 95 degrees outside. But, other US consumers apparently like a lot of AC.

This example highlights that saving energy can come at an economic cost. Sure, there may be energy-saving technologies – simple ones installed in remote Kenyan hotels – but if people like walking into 65-degree hotel rooms, businesses will be unwilling to adopt them. And, if a utility program or government standard pushed the hotels to adopt them, all those hotel guests with polar bear tastes would be less satisfied customers.

I am curious. Have you seen these devices in the US? If so, in which hotels? Where? If not, why is the US so different from other parts of the world? Do you agree that US consumers’ love of AC is part if the explanation? I, for one, would love to get to the bottom of this!

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Rationalizing California’s Residential Electricity Rates

California is finally talking seriously about changing the way utilities price electricity for residential customers.  In particular, as a result of recent legislative actions, the CPUC now has some flexibility to modify the extreme increasing-block pricing (IBP) schedules that were adopted after California’s 2000-01 electricity crisis.  IBP means charging more for additional kilowatt-hours as a household consumes more over the billing period.  Pacific Gas & Electric’s current residential rate schedule, shown in the figure below, illustrates how IBP can charge drastically different prices for an additional kilowatt-hour (kWh) depending on how much the customer is consuming. (The rates of Southern California Edison and San Diego Gas & Electric look pretty similar.)

PGErates2014August

 PG&E’s current increasing-block residential electricity rate structure

This extreme form of IBP violates one of the basic tenets of utility price setting: cost causation. Prices should reflect the cost of serving a customer.  The cost of providing electricity does vary over time, an issue that I will return to below, but it does not vary with how much a household uses over the billing period.  That kilowatt-hour (kWh) for which PG&E charges one customer $0.32 costs the utility the same to provide as a kWh for which PG&E charges another (or the same) customer $0.15.

The implementation of IBP in California is both unfair and inefficient, a holdover from policy made during the darkest days of the electricity crisis without careful analysis of the impact.  While California’s IBP schedules are more extreme than in other states, the lessons from the Left Coast have much to teach in other locations as well.

To remind the young or forgetful (or the less-obsessed with electricity tariff history), prior to the electricity crisis, the regulated electric utilities in California had two-tier IBP rates with the second tier 15%-20% higher than the first tier.  The majority of customers consumed more than their first-tier baseline quantity for their region, paying the first-tier price up to the baseline and the second-tier price for any additional electricity beyond that.  But more than a third of customers only experienced first-tier rates.

After the crisis, utilities needed to raise revenues, but politicians said they wanted to protect the poor, so regulators instituted a 5-tier system, with rates on the first two tiers – designed to go up to 130% of baseline quantity, which is about the median household’s consumption – frozen at pre-crisis levels.  As a result, any revenue increase had to come on tiers 3, 4, and 5, which constituted only about one-third of the residential electricity sold. (Tiers 4 and 5 were merged into one tier a couple of years ago.)  To get the needed revenue, the price on those high-tier kWhs had to go up a lot.

SCEtiers1999-2009

            Southern California Edison’s tiered rates from 1999 to 2009 (Source Ito (2014))

That is how we got to the IBP schedules we have today where the highest-tier rates are more than twice as high as the low-tier rates (though the high tiers change frequently, so the exact ratio is a moving target).  This ratio is far out of line with other retail rate structures.  The majority of utilities in the U.S. don’t have IBP; they sell all electricity to residential customers at the same cost per kWh.  In the one-third or so that do have IBP, the rate structure typically looks more like pre-crisis California, with two tiers and only a small difference between them.

Lots of claims get lobbed into the political heat of the discussion about IBP, generally with little empirical basis, so it is worth reviewing the best evidence we have.  Increasing-block pricing proponents make three cases for IBP:

First, some proponents argue that high-usage customers are more expensive to serve on a per-kWh basis because they on average consume a higher share of their electricity at peak times.  It is ironic that some of the same organizations that make this argument also are the adamant foes of time-varying pricing that would reflect time-varying costs directly.  In any case, my own research (published in Review of Industrial Organization in 2013) shows that there is a tiny bit of truth to this claim, but the operative word is tiny.  That study shows that for PG&E and Southern California Edison, the different time-patterns of consumption between large and small residential consumers could justify at most about a few percent price difference. That would be less than a one cent per kWh average price differential, far smaller than would result even if we returned to the pre-crisis IBP structure, and vanishingly small compared to what we have today.

My study shows that the true incremental cost per kWh of serving large and small residential customers is virtually the same.  And that cost is much lower than the upper-tier prices under the IBP used by the California regulated utilities.  Even if you added the carbon cost of the emissions and priced those emissions at $37/ton (the latest estimate of the social cost of greenhouse gas emissions from the Obama administration), that would raise the appropriate price by less than two cents per kWh.

The second argument for IBP is the one that drove the political debate in 2001, that IBP is a way to raise rates while protecting the poor.  Implicit in this claim is that poor people consume less electricity than rich people do, which makes intuitive sense, but at the time the legislation was rushed through during the crisis there was just a sense, not a measure of the real difference.  A paper that I published in 2012 (in American Economic Journal: Economic Policy) shows that using the steep post-crisis IBP does help low-income customers relative to a flat rate, but by much less than you might think.  The reason is that the CARE program that is explicitly designed to give lower rates to low-income consumers – those up to 200% of poverty or $47,700/year for a family of 4 – has already taken most of the low-income customers out of the standard IBP tariff and put them on a separate low-income tariff.

Overall, I estimate that moving to a flat-rate tariff would raise the average bill of a customer making about $50,000/year or less (in today’s dollars) by about $5/month.  That’s not nothing, but it’s also not a huge effect to get in exchange for an increasing-block rate structure that greatly distorts prices away from real costs – which are essentially the same for the low-tier and high-tier kWh.  Furthermore, moving from IBP to a flat rate would likely incent more truly needy households to sign up for CARE.  If the goal is to help the poor, a program targeted directly at the poor makes more sense than one targeted at consumption level, which has a weak correlation with how wealthy a household is.

Using IBP to help low-income households has another problem.  It arbitrarily harms many low-income households that are heavy users for completely understandable reasons.  Household baselines are based on climate regions (PG&E has 10 regions, SCE has 6) and…well…nothing else.  They don’t adjust for how many people live in the house, how old those people are, how much time they spend at home (rather than using electricity somewhere else), or any other reason that we would expect even an energy-conscious household to consume more.  Instead, IBP rewards people who live alone and don’t spend much time at home.  Does that make sense?

The third case made for IBP is that it leads to conservation, because it raises the price of marginal consumption.  In theory, this could be right, but in practice it doesn’t work out that way.  The idea is that it raises price for the heavier uses and lowers price for the lighter users, compared to a single flat rate, but the response of heavy users is proportionately larger.

But path-breaking research that our former grad student Koichiro Ito published this year in the economics profession’s top journal (American Economic Review) shows that most customers don’t pay attention to the marginal price they face, but instead respond to the average price or total bill.  This isn’t surprising given that the vast majority of customers don’t even know we have tiered pricing and even for the electricity-obsessed it’s very hard to know what marginal price you will face at the end of the month.  Ito demonstrates that when customers respond to average price, IBP results in virtually no change in total consumption.[1]

Solar_panels_on_house_roof_winter_view

Residential Solar PV has been a big beneficiary of increasing-block pricing  (Source:http://256.com/solar/images/)

But what has become apparent in the last few years is that one small set of customers is very aware of IBP and the high marginal prices for heavy consumers: solar PV households, or actually the solar PV vendors who explain IBP to them.  While evidence that IBP incents energy efficiency is absent, the evidence is clear that IBP is a key driver behind the distributed solar PV movement in California.

In fact, solar PV installers “work with” customers to optimally design systems so they just shave off the high-tier usage without touching the low-tier usage where the price is way too low for PV to save customers money.  With federal subsidies that pay nearly half the cost of PV — and net metering that pays the residential customer for electricity supplied to the grid at the retail rate rather than the wholesale rate that other renewable generation sources receive – solar PV can beat the high-tier prices of IBP.  That’s why solar PV installers are the most vocal opponents of rational rate reform that would call a kilowatt-hour a kilowatt-hour regardless of how many other kilowatt-hours you consume during the month.

So, increasing-block pricing isn’t cost based.  It is a very indirect way to lower the average bills of low-income customers, while arbitrarily harming many of them and benefitting many wealthy people who live alone or don’t spend much time at home (or own a second home). And it’s only effect on conservation is to create incentives to install solar that just skims off the highest tiers of the IBP structure, an activity that is pursued overwhelmingly by the richest households (and which raises the bills of all other ratepayers).  The first step to rationalizing California’s electricity rates is to greatly reduce or eliminate increasing-block pricing.

Then we need to talk about time-varying pricing.  We should be transitioning to opt-in time-varying pricing immediately and to opt-out in the near future.  I’ve explained an efficient and equitable way to do this in a recent paper, but that will have to wait for another blog.

 

[1] Paul Chernick recently filed testimony on behalf of NRDC that mischaracterizes Ito’s finding, saying Ito claims consumers don’t respond to IBP.  That’s not at all what Ito finds, as I explain here.   A study by Energy & Environmental Economics argues that in British Columbia IBP does lower total consumption.  But the study looks only at whether high-consuming households consume less under IBP – which they do, not surprisingly—and ignores that low-consuming households consume more, because their price is lower than under a single flat rate.  What matters, of course, in the change in total consumption, on which the E3 study is silent.

I’m still tweeting interesting energy news articles most days @EnergyClippings

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Remember back when everybody hated electricity deregulation?

Today we take a break from our regularly scheduled blogging about environmental topics to provide a brief message concerning electricity restructuring.  Severin Borenstein and I are finishing up a draft paper for the Annual Review of Economics (available as a working paper here) that looks back over the last 20 years of electricity restructuring and it has given us a chance to update some data sets and revisit some topics that really haven’t gotten a lot of attention since around 2008.

Around that time I started giving a talk titled “If electricity restructuring is so great, why does everybody hate it?” Back then, several states like Illinois and Maryland were actively pursuing options to “re-regulate” markets that they had at least partially restructured.  The New York Times ran a series of articles that pointed to studies showing that rates had increased more rapidly in states that had restructured compared to those that did not.    The gist of my talk was that this could very well be true, but did not necessarily signal that restructuring was a failure.

Back in 2000, Severin and I had written a paper arguing that the motivations for restructuring were driven more by a desire by some groups to avoid paying for stranded assets (like nuclear and coal plants which looked like white elephants in the late 1990s) than by a belief that restructuring would reap massive efficiency gains.  In economic terms, customers preferred to pay market-based prices — which were based upon marginal cost in competitive markets — rather than regulated rates — which were based upon average production costs. During this period of relatively large capacity margins and low natural gas prices, market-based pricing appealed to customers and terrified utility shareholders whose assets would become stranded absent other compensation.  However, despite the allure of market-based pricing,  the regulatory and political process allowed utilities to recover the bulk of what appeared at the time to be stranded costs. So customers ended up paying for most of these costs anyway.

The great irony of this period is that a half decade after transition arrangements largely compensated utilities for the losses incurred in selling or transferring these assets, the market value of those same assets had fully recovered. By the mid-2000s the relationship between average and marginal cost had largely reversed, and states like Illinois and Maryland expressed a great deal of regret about the decision to restructure. However, since the formerly regulated generation assets were now largely held by private, deregulated firms, there was no clear path to dramatically “re-regulate” the industry without paying full market value for those assets. Looked at this way, one can view the disappointment with restructuring as being driven by magnificently poor market timing.  Utilities sold off their assets at the nadir of their value, and as natural gas prices climbed throughout the 2000s, those assets became quite valuable under market-based pricing.  Therefore, my take on this topic circa 2008 was that, with hindsight certain states would have been better off restructuring, but that was due to external shocks like natural gas price increases and changes in technologies.

ippStates by Percentage of Generation from IPP sources

Then a funny thing happened.  Since 2009, this story has largely reversed yet again.  Natural gas prices have declined sharply, nearly to the levels seen at the dawn of the restructuring movement. The attention of policymakers has now been consumed by environmental priorities, particularly the implications of coal generation decline and renewable generation growth for costs and greenhouse gas emissions.  A surge of subsidized renewable generation, combined with low natural gas prices, has driven wholesale prices steadily lower.  As one would expect, in the short run this has benefited consumers in market-based states disproportionately more than those in regulated states.  This figure plots the average prices of electricity and natural gas in “restructured” states (defined as a state with more than 40% of its energy produced from IPP sources – the states that are not blue in the figure above) and “regulated” states. The dashed line shows the difference between the two groups.  One can see the gap between the states growing as natural gas prices climb, and then following the natural gas prices right down again.

retail_rates_by_yearElectricity and Gas Prices

The table below summarizes the changes in rates using two different definitions of restructured that are explained in the paper. All together if you look at the changes in between the two groups now, restructured states actually come out a little better than the regulated states.  Rates kept rising at a consistent trend in regulated states, while they have declined slightly in the restructured ones.

This is not meant to be a comprehensive study of rate differences.  For example, we suspect that Renewable Portfolio Standards requirements in some states, like California, are keeping rates from declining faster.  But I do find it fascinating that the situation has reversed so dramatically over the last 5 or 6 years.  Not surprisingly, there isn’t much clamoring for re-regulation these days.

You also don’t see much clamoring for more restructuring either, however, which is equally interesting. The relationship between average costs and marginal costs appears again to be turning in favor of marginal costs, but today the resulting pressure is being manifested in the arena of distributed generation, rather than retail choice. Although rooftop solar and retail competition are not usually equated, from a consumer perspective the economics of each can be very similar.  Both have been pushed forward in large part by a desire to avoid paying for sunk costs – generation in the case of retail competition and distribution costs in the case of distributed generation.

However, looked at from a societal perspective, such motivations can be disheartening. Consider the prospect, hinted at in this article, of a future where homes install batteries and distributed generation in order to avoid paying for fixed distribution charges.  Even if this becomes economically viable from a household perspective, this is a potentially appalling waste of resources.  We would be talking about thousands of dollars of investment per household to avoid paying for assets that are already there.  Who pays for these wires? Either utility shareholders or those households that don’t leave the grid.

There are real and important technological and efficiency advances happening, and competition is providing some of the impetus for that. But much of the economics and politics of this industry have been and still are dominated by the not-very-noble desire to stick someone else with existing infrastructure costs.

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The Big Stick: Cap and Trade in the Peoples Republic of Carbon

Many of us have argued that a patchwork of national or subnational climate policies is a largely pointless undertaking unless the big two (United States and China) are part of that patchwork. The US has taken some steps towards national regulation recently and there are noises coming out of China that the next five-year plan will contain a significant piece of mitigation policy.

The sooner, the better. The averaged annual growth rate of Chinese emissions over the past decade was 9.1%, which implies a doubling of emissions every eight years.

In order to get emissions under control, there are inflexible standards or price-based mechanisms like cap and trade (CAT) and carbon taxes. The US lacks a national CAT, yet has functioning markets in California and on the East Coast. The EU has the super-national emissions trading system (ETS) supplemented by a significant portfolio of energy efficiency and renewable energy policies.

China has, in the recent past, started a few experimental cap and trade systems, which may well be regarded as blueprints for a larger national market. While trade volumes on these exchanges are relatively thin, the figure below shows that prices vary between 4 and 13 dollars per ton (which is not too far from the price on the California system and the ETS).

Daily permit prices on six Chinese regional exchanges (Dollars per ton)

The big stick CDW-2

The National Development and Reform Commission, which is the arm of the Chinese government responsible for economic planning, has provided coarse outlines of a national market starting in 2016, which will cover 3-4 billion tons of CO2 with a volume of roughly 65 billion US Dollars by 2020. This is twice the volume of the European market. And some simple algebra suggests that the planners expect permits to trade at just below $20, which is higher than anywhere else in the world currently or in any of the regional markets in China. This is exciting news and will surely provide some significant momentum in the upcoming climate talks.

I am somewhat puzzled by the apparent choice of a national cap and trade system over the other price based alternative to a CAT: a carbon tax. The reason I am puzzled is deeply rooted in some simple political economy. Cap and trade generates valuable assets (permits), which are frequently handed out to carbon intensive industries, which would otherwise fight the regulation and possibly prevent it from being implemented. If the government hands out permits, it gets no revenues from these permits.

A carbon tax, on the other hand, is charged on each carbon atom and most likely charged fairly far upstream the carbon river. It generates revenues for the government (especially at ~$20 a ton). My (limited) understanding of how environmental policy works in China is that industry gets much less say in what regulations will be implemented and how.

Here are a few simple advantages of a carbon tax over cap and trade in an economy that currently does not come close to collecting a universal income tax:

  • It is relatively simple to collect far upstream.
  • It provides carbon price certainty.
  • It does not suffer from the significant design issues involved in setting up a market in one of the most highly regulated economies in the world.
  • It generates significant revenue, which may prevent one from having to set up or ramp up income taxation schedules, which are distortionary.
  • It provides the regulator with direct control of the rates.
  • China has extensive experience at the regional level with collecting effluent fees (which are essentially emissions taxes of criteria pollutants).

One argument, which is often used against a carbon tax is that it does not guarantee what emissions reductions will be in any given period, as the marginal abatement costs are not known by the regulator. While this is certainly true, Lucas Davis points out from across the hall that with GHGs we care about cumulative emissions. When the marginal benefit of abatement curve is relatively flat, you want the flexibility afforded by taxes.  If costs end up being higher than expected, emission sources can abate less. One clear disadvantage of a tax is that it is somewhat harder to exempt individual sectors/firms from the tax. What this might mean in the Chinese context is that it puts smaller (already inefficient) coal mines at a further competitive disadvantage and risks significant local employment impacts.

The problem with almost all environmental regulation of course is that there will be some winners and some losers, but overall we make the pie bigger. I am thrilled to see the Chinese government get serious about climate regulation, but would hope that serious consideration is given to a tax instead of a cap and trade system. China has significant experience with taxes and the main institutions required to put a new one in place are, well, in place. Setting up a market is hard and the devil is in the details. Just ask California.

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Want to Schedule Your Electricity Use to Reduce Pollution? Here’s How

Some of us occasionally feel the urge to turn off the kitchen/porch/office light as our small step towards addressing global climate change. A Berkeley PhD student – Gavin McCormick – has started a nonprofit to provide information on exactly how our actions impact pollution.

Gavin’s organization, WattTime, is analyzing data from around the US to provide information like the map below. You can hover over an area to get almost live information on CO2 emissions.

WattTime

It turns out that it’s not straightforward to generate the information behind maps like this – far from it.

Consider two different scenarios. In both, I’m assuming that you’re doing something that you don’t usually do – turning off the porch light earlier, for instance – and that other consumers do not change what they do.

To understand what Gavin is doing, we first need a basic understanding of electricity grid operations. Many readers no doubt understand this better than I do, and this is a highly stylized description, but it works for these purposes.

Wherever you live, there’s a grid operator charged with balancing the electricity system and ensuring that there’s enough power generated at any given time to meet demand. The operator also needs to ensure that the plants are not generating too much as that could damage equipment.

GridOperator

The grid operator communicates with power plant operators in the region about how much they’re producing and with the grid operators in adjacent areas about imports and exports. Much of the communication is automated and, for instance, the grid operator’s “request” for less electricity when you turn off your light would likely be communicated through something called Automatic Generation Control (AGC).

Go back to turning off the porch light. If you live in Ohio and it’s a regular night, it’s possible that the AGC system will instruct a coal plant to reduce production. That’s great if you’re trying to reduce GHGs or other pollutants, as coal plants are as dirty as they come.

Turning off your light in West Texas may not be as helpful for reducing greenhouse gas emissions, especially if it’s windy. In this case, you well might be asking the grid operator to back off on the output from wind plants.

In fact, many wind producers receive subsidies from the federal government that increase in the amount of electricity they produce. This is called the production tax credit, and it was recently $23/MWh. So, wind producers actually want you to keep your lights on in the middle of a windy night. In fact, prices can be negative (though rarely below -$23/MWh), meaning that the wind turbine producers are willing to pay consumers to take their power at that point in time.

West Texas Market Clearing Prices for 2010

One thing that’s great about Gavin’s site is that he’s striving to use a better methodology than what’s out there now. There are other sites that simply report the average emissions in a given hour. So, for the Ohioan turning off the light, the other sites are averaging across zero-GHG-emissions nuclear power plants and the coal plants.

This calculation will provide a misleadingly low estimate of the impact of your actions, though, since the nuclear power plants won’t change their output when you turn off your light. They are not marginal, in the language of economists. So, it doesn’t make sense to account for their emissions, as your actions don’t affect them. While average GHG emissions vary by a small amount throughout the day, the marginal plant can vary a lot – from particularly dirty coal to emissions-free wind. The map above still reflects averages, but WattTime maps reflecting marginal emissions are coming very soon.

My example about a single porch light is actually below WattTime’s aim, as a 100W porch light is 1/5,000,000th of the output of a typical 500 MW plant. They’re really targeting the larger decisions by, for example, designing smart plugs for electric cars and industrial load controllers.

If Gavin’s company takes off, which we’re all cheering for, the calculations get a lot more complicated. If his company accounts for a large and predictable share of electricity demand, grid operators might anticipate that fewer people will turn on their porch lights when polluting plants are marginal, and adjust their decisions about which plants to turn on for the day. Ultimately, planners might anticipate this reaction and adjust the type of power plants they build. Gavin and crew are working on incorporating longer run decisions, so stay tuned for Version 2.0 of their site.

Information will help us make better decisions, and I’m delighted that there are innovators like Gavin out there who are perfecting the information that consumers get, and designing cool websites and apps to put the information in front of us.

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