Electricity is replacing on-site fossil fuel consumption for U.S. home heating, and energy prices explain why.
Berkeley was the first, but now more than thirty municipalities in California have enacted measures limiting or prohibiting natural gas in new homes. The list includes San Francisco, San Jose, and most recently, Oakland.
Proponents argue that electrifying buildings is critical if the U.S. is to sharply reduce carbon dioxide emissions from the building sector. Critics argue that electric heat costs more per unit of heating, so electrification mandates are expensive.
Mostly missing from this discussion, is that home electrification is nothing new. In a new Energy Institute working paper, I document dramatic growth in residential electric heating over the last seven decades and ask two questions: (1) What explains this increase? and (2) How much would U.S. households be willing to pay to avoid an electrification mandate?
Growth in Electric Heating
Only 1% of U.S. homes in 1950 used electricity as their primary heating fuel. Electric heating has increased steadily since that time, reaching 8% in 1970, 26% in 1990, and 39% in 2018. Electricity is today the dominant form of heating in the Southeast and widely used throughout the West and Midwest.
What explains this increase? The paper proposes and tests five hypotheses. To distinguish between the different explanations, a statistical model is constructed using data on heating choices from millions of U.S. households over the period 1950-2018. There is considerable inertia with home heating decisions, so the model is focused on the initial heating choice at the time each home is constructed.
Prices, Prices, Prices
The five explanations are shown to collectively explain 90% of the increase in electrification since 1950. But by far the most important single factor is energy prices. U.S. residential electricity prices have fallen over 50% in real terms during this time period, while residential natural gas and heating oil prices have both increased.
Residential Electricity Prices By State
The statistical model reveals a pronounced negative and statistically significant relationship between electricity prices and electrification. The effect is large in magnitude. Everything else equal, going from 21.6 cents per kWh (the current price in Massachusetts) to 9.6 cents per kWh (the current price in Louisiana) implies a 32 percentage point increase in electric heating.
Changing energy prices explains 70% of the increase in electrification since 1950. This is a large share; much more than I would have guessed, frankly. Changes in other factors like where new homes are built, housing characteristics, and climate also matter, but collectively can explain only about 20% of the increase in electrification since 1950.
Changes in household income have had almost zero impact. Electric heating is convenient and has no on-site emissions, so I had hypothesized that rising incomes since 1950 would help explain the shift. I was wrong. Turns out that higher income households are actually slightly less likely to choose electric heating, but the effect is so tiny that rising incomes over this period can explain essentially none of the increase in electrification since 1950.
So the big policy takeaway is that energy prices matter for electrification choices. This finding underscores the importance of pricing energy efficiently, a central theme in energy economics and a favorite topic at the Energy Institute blog.
California is an illustrative example. At the same time dozens of municipalities are banning natural gas in new homes, the state is also continuing to make policy and retail rate design choices resulting in some of the highest electricity prices in the country.
Energy Institute researchers Severin Borenstein and Jim Bushnell find that the price per kWh in California is two or more times higher than the actual incremental cost of providing electricity. These high prices mean that California households have too little incentive to electrify, and it is no coincidence that electric heating is much less common here than in neighboring states.
Regulators can mandate and ban natural gas for new buildings. However, without additional policy and rate reform, California’s high electricity prices mean that electrification mandates will raise costs for households.
Willingness to Pay
How much would U.S. households be willing to pay to avoid an electrification mandate? The working paper next uses a discrete choice model to calculate willingness-to-pay. Households weigh energy prices, climate, geography, housing characteristics, and other factors when making heating system choices and willingness-to-pay is inferred based on revealed preference.
Willingness-to-Pay to Avoid an Electrification Mandate
Households in warm states are close to indifferent between electricity and natural gas, so a mandate would cost them less than $600 annually, on average. In Florida, for example, most households prefer electricity anyway so a mandate would impose low economic costs.
However, households in cold states tend to strongly prefer natural gas so would be made worse off by $2500+ annually, on average. Households in New Hampshire, for example, use a lot of heating, and by revealed preference would be willing to pay a significant amount to continue having access to natural gas.
The model also reveals considerable variation within states. For example, households in multi-unit homes have lower demand for heating and thus lower willingness-to-pay to avoid mandates. These households thus represent a potential opportunity for electrification.
An important caveat is that the model is estimated using historical data, and thus cannot speak to how the impact on households will be affected in the future by technological change. Probably most importantly, electric heat pumps are expected to continue becoming more energy-efficient over the next several decades. This will increase acceptance of electrification and decrease the costs of a mandate.
One broader implication of the research is that, nationally, it may be a lot easier than is generally believed to encourage electrification. The steady historical trend over the last seven decades means that 50 million U.S. households have already electrified. Moreover, the analysis identifies large numbers of additional households for whom adopting electric heating would impose relatively modest costs.
An important goal for future research is to ask whether electrification mandates pass a societal cost-benefit test. These willingness-to-pay estimates provide a starting point, but they are calculated based on current residential energy prices and thus reflect private, not social, costs. These costs would then need to be compared to the benefits from reduced fossil fuel emissions. At a high enough social cost of carbon, electricity could make sense from a societal perspective even in places where it imposes large private costs.
Of course the generation mix matters too. U.S. electricity generation has become much cleaner, but emissions vary regionally and there are large parts of the country that continue to rely heavily on coal. The economic case for electrification is strongest in places where electricity generation is relatively green.
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For more details see Lucas W. Davis, “What Matters for Electrification? Evidence from 70 Years of U.S. Home Heating Choices”, Energy Institute Working Paper.
Suggested citation: Davis, Lucas. “What Matters for Electrification?” Energy Institute Blog, UC Berkeley, January 4, 2021, https://energyathaas.wordpress.com/2021/01/04/what-matters-for-electrification/
Lucas Davis is the Jeffrey A. Jacobs Distinguished Professor in Business and Technology at the Haas School of Business at the University of California, Berkeley. He is a Faculty Affiliate at the Energy Institute at Haas, a coeditor at the American Economic Journal: Economic Policy, and a Faculty Research Fellow at the National Bureau of Economic Research. He received a BA from Amherst College and a PhD in Economics from the University of Wisconsin. Prior to joining Haas in 2009, he was an assistant professor of Economics at the University of Michigan. His research focuses on energy and environmental markets, and in particular, on electricity and natural gas regulation, pricing in competitive and non-competitive markets, and the economic and business impacts of environmental policy.