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Is Distributed Generation the Answer to Regulatory Dysfunction?

One delightful aspect of teaching an MBA course in energy and environmental markets is getting together with my former students as they pursue careers in the industries I study.  I learn so much about the latest trends and ideas in these markets, and they frequently challenge the way I have been seeing the world.

This happened recently when I had coffee with a former student whom I will refer to as “Pat”.  Pat has worked for a successful alternative energy company and done well, but s/he is ready to think about new paths.  Like many cleantech mavens, Pat is excited about distributed generation (DG), particularly with improving storage technologies.  Pat explained to me a potential business model s/he has been exploring with rooftop solar photovoltaic (PV) panels and on-site storage.

As I’ve written in a previous blog, I’m skeptical that rooftop solar is the most cost effective way to utilize the fabulous breakthroughs in PV technology.  I proceeded to lay out my argument, addressing each of the claims for distributed generation, even though I know Pat is a regular reader of the Energy Institute blog and had surely heard my views before.

But Pat was a star student and continues to be one of the most insightful people I know in the business.  So I was not surprised, but still unsettled, when Pat put on the table an argument for DG that I hadn’t heard before, or maybe Pat just presented it much more clearly so that I finally actually got it.

DysfunctionalUtilities1Here’s my dramatic (if you are an energy geek) re-creation of what Pat said: “Yes, Severin, in theory grid scale generation and delivery of renewable electricity generation is probably more cost-effective.  And, yes, there are some fixed cost of distribution systems that utilities are recovering through volumetric charges, which drives up the retail price and gives an inefficient incentive to install DG.  And, yes, California’s extreme increasing-block residential price schedules mean many households are paying more than 30 cents per kWh for much of their consumption, way above cost.”

“But,” Pat continued with growing enthusiasm, “California’s investor-owned utilities currently charge average residential rates in the 21 to 24 cent range –more than 50% above national average–and the utilities themselves are forecasting those numbers will rise in the coming years.  [Actually those are average rates among customers who aren’t on the low-income tariff.  More on that below. –SB]  I don’t know if rates are so high because of utility incompetence, a dysfunctional regulatory process, or some other reason, but it’s not my job to figure it out.  In any other industry, if a company’s prices are too high we rely on pressure from competition to reign them in.  Why should electricity be any different?”

Pat concluded with, “Severin, ever since I took your class many years ago you’ve been saying that California has high electricity rates in part to pay for the mistakes of the past.  But those ‘mistakes’ keep happening and keep driving up our rates.  At some point, aren’t those ongoing mistakes just part of a broken regulatory process? DG is the competition that will either force repairs in the process or will replace it.”

DysfunctionalUtilities2Pat’s argument isn’t entirely general; there are plenty of states — and even some municipal utilities in California — with rates that rooftop solar can’t touch.  And, there’s not much evidence nationally or internationally that competition introduced by deregulating retail electricity markets has significantly lowered rates.   Plus, it’s worth remembering that most residential customers don’t have a single-family home with a south-facing roof and no shading to put solar panels on, so most of us have to get all our electricity from the grid.

Nonetheless, Pat raises an important point.  Before proponents of high fixed charges and special fees for solar customers get too far down that road, they need to confront the fact that average residential electricity rates in California (and New York, and some other locations where DG is gaining the most traction) are out of line with the rest of the country.

I’ve been asking around about the high, and rising, average residential rates in California, and been surprised at the lack of clarity for the reasons. This seems like a central question of rooftop solar policy (as opposed to rooftop solar politics).  If the rates really reflect high costs of providing electricity, Pat and other DG supporters have a more compelling case that they are providing efficient competition.  On the other hand, if they are driven by other regulatory or legislative policy objectives, then we have to recognize that funding them in this way may encourage inefficient DG installation.

Put differently, is DG the answer to regulatory dysfunction, or is it just regulatory arbitrage? By regulatory arbitrage, I mean taking advantage of the structure of pricing or other utility obligations by pursuing strategies that reap private rewards through cost shifts to other ratepayers.

The simplest cause of regulatory arbitrage is the fact that electricity prices are well above the marginal cost of delivering a kilowatt-hour to the customer in California and many other states. In California, this is in part because of the regulator’s longtime resistance to fixed monthly charges, and in part because of the increasing-block price structure that leaves many customers today paying over 30 cents for their incremental kilowatt-hour.

In addition, the many programs that policymakers have decided to finance through electricity charges also invite regulatory arbitrage. For instance, significant parts of electricity bills in California and many other states pay for energy efficiency programs, early investments in renewable technologies, and — especially large in California — reduced electricity rates for low-income customers. Among the three large investor-owned utilities in California about 30% of all residential customers are on low-income rates.  And, of course, for more than a decade, part of electricity rates in California have paid to subsidize rooftop solar, both directly through the California Solar Initiative (from 2007 to 2013) and indirectly through net metering policies.

If all of these programs were eliminated, would average residential rates among California’s IOUs still be well above national average?   Of course, there are other factors that a cost analysis has to account for, such as the mix of generation, the density of residential consumers and the average consumption per customer.

I think that answering this question is critical to making good energy policy in California.  But after asking a number of regulators, utilities and other policy analysts in the state, I have not turned up any studies that put together all the numbers one needs.

That wouldn’t be the complete answer to Pat’s argument. It has to be paired with a credible analysis of the value and costs DG brings to the grid. But next time I see Pat, I’m hoping to have a better response than “good question. I should write a blog about that.”

 

I’m still tweeting energy news and research articles @BorensteinS

Severin Borenstein View All

Severin Borenstein is E.T. Grether Professor of Business Administration and Public Policy at the Haas School of Business. He has published extensively on the oil and gasoline industries, electricity markets and pricing greenhouse gases. His current research projects include the economics of renewable energy, economic policies for reducing greenhouse gases, and alternative models of retail electricity pricing. In 2012-13, he served on the Emissions Market Assessment Committee that advised the California Air Resources Board on the operation of California’s Cap and Trade market for greenhouse gases. Currently, he chairs the California Energy Commission's Petroleum Market Advisory Committee and is a member of the Bay Area Air Quality Management District's Advisory Council.

31 thoughts on “Is Distributed Generation the Answer to Regulatory Dysfunction? Leave a comment

  1. Hi, I’ll just comment on the California low-bill-from-efficiency claim, which BTW the New York Times promoted in an October 2015 article, “California Leads a Quiet Revolution,” http://www.nytimes.com/2015/10/06/business/energy-environment/california-leads-a-quiet-revolution.html.

    The reality is that the average residential electric bill is relatively low in California principally because of California’s temperate climate, below-average households using electricity for space heating, and below-average residential household square footage. These three factors are clear from a handy EIA two-pager. http://www.eia.gov/consumption/residential/reports/2009/state_briefs/pdf/ca.pdf. EIA: “Average site electricity consumption in California homes is among the lowest in the nation, as the mild climate in much of the state leads to less reliance on electricity for air conditioning and heating.” EIA shows use of electricity for space heating as 21% in California and 34% in the U.S. overall. And EIA shows household average square footage as 1,583 for California and 1,971 for the U.S.

    Two other factors are worth mentioning for the utility bill in California. California has relatively high residential self-generation, principally solar PV (half of all such installations nationwide – the NYT got that right), driven in part by California’s high utility rates, along with other factors ably discussed in this blog previously, https://energyathaas.wordpress.com/2015/05/26/what-put-california-at-the-top-of-residential-solar/. The cost of self-generation doesn’t get included in the utility bill (neither do tax and other subsidies paid by others). And California has relatively high industrial rates (average industrial rate is 60% above the national average, http://www.eia.gov/electricity/sales_revenue_price/pdf/table5_c.pdf, versus average residential rate “only” 32% above the national average, http://www.eia.gov/electricity/sales_revenue_price/pdf/table5_a.pdf), suggesting a disproportionate shift of utility costs from residential customers to industrial customers.

    If California’s energy efficiency measures, including higher rates, have contributed anything to a lower monthly bill it isn’t apparent from history. In 1997 average monthly electric consumption California was 542 kwh and the U.S. was 838 kwh, http://www.eia.gov/electricity/sales_revenue_price/archive/054097.pdf. Flash forward to 2013 and it’s California at 557 kwh (not counting self-generation) and the U.S. at 909 kwh, http://www.eia.gov/electricity/sales_revenue_price/pdf/table5_a.pdf. There is no material difference in absolute or relative terms that could be attributed to California energy efficiency measures.

    The real lesson of California for other states and countries is: You can have high-cost policies without high residential utility bills as long as you transplant California’s weather, replace electric heat with natural gas, and reduce living space. And incent self-generation that doesn’t appear on the utility bill, and shift utility costs to industrial customers.

    This is not to judge whether California’s policies are worth their costs, only to point out that you can’t eat your cake and have it too.

  2. Also, don’t get too caught up on electricity rates by themselves. Californians’ utility bills are actually lower than average partly b/c we have higher rates in that higher rates, among other factors, lead to lower energy use. So we’re far more efficient in CA than most states and the net result is ratepayer benefits even with higher rates.

  3. You could probably quickly figure out the average cost of service by dividing PG&E’s revenue requirement on the electricity side by its sales. I just poked around and couldn’t find the revenue requirement disaggregated btwn electricity and gas — but maybe another reader can!

  4. I hate to be “that guy” but it seems to be there is a huge assumption in this piece: that the prices we pay for electricity in California are due (primarily) to dysfunction. I think that’s a pretty complex case to make. We all have this notion that if the technocrats were just more technocratic and impervious to politics, they would arrive at some optimal solution, but can we please bury that idea in a deep hole. In reality, electric regulation is a political and highly normative process. Building an almost all-gas system was a choice. Hastening the decommissioning of OTC units was a choice. Making it difficult to build new transmission and site new projects is a choice. Forcing the utilities to get into substantial renewables and to do so early was a choice. Rolling out smart meters but not dropping customers into TOU tariffs is a choice. Setting tariffs between rural / urban, residential / industrial / commercial, heavy user / light user, etc that result in interesting cross-subsidies are all choices. It goes on and on. Were these all bad choices? Moreover, even if you believe they were, are they somehow so obviously bad choices that an honest broker technocrat would have chosen otherwise at the time? Maybe.

    That said, I’ll say this for Pat’s business plan: if they can make it work without NEM or even off-grid, all the more power to them. That would be thrilling new competition to the utility model. If they need NEM, then welcome to the “dysfunctional” regulatory scrum, my friend!

  5. I would have to conjecture that California as well as NY has extremely high rates because of the social requirements placed on utilities to address a wide array of social objectives. In California this has been going on for decades. Even the generation mix has surely been affected by these public policy objectives. One should not therefore be surprised that rates in California are so much higher than rates in the other states (with the exception of Hawaii). California, in my opinion, has made the choice of requiring electricity customers to pay dearly for public policy programs to advance the agenda of certain stakeholders and others. If that’s what California wants, then I guess that its preference. I find “Pat’s” logic pretty feeble. If anything, continuing to promote DG through subsidies will just aggravate the price increases that California has seen. I concur with Severin that what has caused high electricity prices in California is an empirical matter. But would the findings change public policy in California? I doubt it as California would likely continue on the same path that it has taken for years: Let electricity consumers fund those programs that are allegedly in the best interest of the state. There may be a tipping point where Californians say “enough is enough.” But it’s anyone’s guess when that will occur.

    • California electric rates seem very high. I just looked at my Davis bill for about 580 kWh, and it worked out to about 23 cents a kWh! Surely we are not still paying for the Legislature’s deregulation/ Enron, etc., boondoggle! For the first time I saw that we got a Climate Credit! That must be from the Carbon Tax?
      I had my brother-in-law living in Chicago send me a copy of his bill from ComEd. He pays 5.8 cents for supply [no tiers that I could see], 4.2 cents for transmission and distribution. I tried to see what the power sources were? One piece said northern Illinois was nearly 50% nuclear. Possibly most of these plants have been amortized so their power is fairly cheap. There seem to be renewable mandates but no clear picture on that was given. Coal and NG are also fairly large sources, it appeared.
      At his lake place in WI he pays 11 cents/kWh.

  6. Severin, it seems that what you’re getting at is the “value of solar” debate because the various VOS studies compare the cost of power from new solar systems to the cost of grid power. Most studies have found a net benefit from DG solar, as a recent summary by the Frontier Institute and Environment America found: http://www.environmentamerica.org/reports/amc/shining-rewards. This is just a summary so you’ll have to dig a bit deeper for the primary studies. Here’s CA’s 2013 effort to quantify the real costs/benefits of DG solar: http://www.cpuc.ca.gov/WorkArea/DownloadAsset.aspx?id=4292. And of course you’re aware of the current efforts in the Distribution Resources Plan proceeding (R.14-08-013) pursuant to AB 327 at the CPUC to quantify the Locational Net Benefits of DER? Preliminary studies have found substantial additional value from DG at certain points where it can avoid grid upgrades.

  7. There also used to be some transition charges related to restructuring in California. Are those still a factor in California’s higher prices? There’s also the question of how rates are made for all sectors–choices made on commercial and industrial rates may also be reflected in the residential rates, because the sum total has to add to the total cost for the utility plus reasonable profit.

  8. Its not just California, similar arguments apply in places like Australia, where the utilities expanded the grid substantially even as demand was falling. In a non-regulated industry, the shareholders would have had to eat the cost of that incompetence, but in a regulated market they are charging network tariffs high enough to make DG attractive. As they move from monopoly to competition, is it likely that utilities will need to pass on some of those sunk costs of mistakes onto consumers, and charge at closer to their current marginal costs in order to compete with DG ?
    This argument is even more true in developing countries, where the growth in small Solar Home Systems is in part driven by the regulatory nightmare of setting up mini-grids (e.g. government imposed tariffs below the cost of production) , along with the uncertainties of when subsidized power from a utility grid will leave the mini-grid provider with subsidized assets. This is especially true in countries like India where political pressures and corruption mean the grid is frequently present but mostly not energized.

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