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Ensuring Equity in California’s Energy Transition

Residential electricity prices in California are on an unsustainable path.

The year 2021 has already had its fair share of energy and climate news: a slew of executive orders in Washington, a hot mess in Texas, and superstar energy talent jumping into the new administration.

In local news, PG&E’s rates jumped around 5% this month. This price hike was approved by the California Public Utilities Commission back in December to fund additional wildfire mitigation. It is the most recent example of the high and rising residential electricity prices for customers of California’s investor-owned utilities (IOUs). As necessary as the expenditures may be, the rate hike comes at an unwelcome time for many struggling to cope with the pandemic and the economic and social turmoil it has created. And yet more price hikes are on the way.

Against that backdrop, Meredith, Severin and I released a new Energy Institute working paper, in conjunction with Next 10. In the report, we take a look at California’s residential electricity prices, ask how we got to where we are today, and consider some options for reform.

The status quo of recovering increasing system costs through high volumetric prices is unsustainable. High volumetric prices are both a headwind against action on climate change and a force exacerbating the affordability crisis. It is time for a rethink.

All is well at the start of the trip. Source: Flickr, available via Creative Commons

I liken the status quo to the low point of a family road trip with young kids, the point at which you regret having left home in the first place. You’ve exhausted the value of screen time as a distraction. The children are hangry, but they reject the snacks you packed. The toddler has decided she no longer believes in the merits of car seats, and is now sobbing. Then someone announces that they need to go potty, like, immediately.

At this point, you can’t just power through on the current course. You need to pull over and make some changes. California needs to do the same. The good news for the Golden State is that there are ways to simultaneously improve the equity of our electricity rate structure and put ourselves on a faster path to decarbonization.

Why are prices so high?

When you find yourself taking deep yoga breaths outside your car on the shoulder of some remote segment of I-5, while children inside the car scream like banshees, you inevitably ask yourself: How did I get here?

We ask the same in our report about California’s residential electricity prices. SDG&E’s customers now pay twice the national average per kilowatt-hour (kWh); PG&E’s customers pay 80% more; and SCE customers get a relative bargain, paying only 50% more than the national average. How did we get such high prices?

We know from prior work that these prices are too high from an efficiency point of view, but we wanted to understand the components that drive these prices. To do so, we broke down the cost of electricity into generation, transmission, distribution, pollution and other costs, separating each into components that represent marginal (avoidable) costs that scale with usage, and those that do not. We summarize our results in the “waterfall” figure below, which stack the pieces that represent marginal cost on the lower staircase, with the remaining costs that are recovered through rates on the upper staircase.

Only a modest portion of the total costs come from the marginal cost of providing more electricity to an existing customer, even after including transmission and distribution costs that scale with usage, as well as the cost of carbon permits. This is what we label private marginal cost (PMC in the figure). To get the social marginal cost (SMC in the figure), we add a bit more to represent the unpriced portion of carbon emissions, assuming a $50 per ton social cost of carbon. This social marginal cost runs around 8 cents per kWh, which is about a third to a half of current prices.

The gap between the volumetric rates that consumers pay and this social marginal cost is effectively an “electricity consumption tax” that we are using to pay for system costs. This tax pays for generation, transmission and especially distribution costs that don’t scale with usage, as well as many public purpose programs (like energy efficiency), and cross-subsidies to low-income discount (CARE) recipients and households with rooftop solar.

As Severin blogged about previously, any price above social marginal cost sends the wrong price signal to households thinking about installing an electric heat pump water heater or buying an electric car. High prices threaten to make electrification uneconomical for many.

And rates are only going to rise further. A large bill is coming due for necessary climate adaptation, in the form of wildfire mitigation, and climate mitigation, in the form of electrified transportation and heating. The CPUC released a white paper last month that forecasts annual rate increases of 3.5% to 4.7% across the three IOUs for the next decade, driven in large part by growing wildfire costs that are expected to constitute between 6.5% to 8.5% of total costs on residential bills in that time.

Just as getting back in the car and making it to our family destination is a necessity not a choice, these expenditures have to be made. But, we can choose how to pay for them.

The status quo is not fair

We are effectively funding the state’s energy infrastructure through a tax on electricity, but like most taxes, many wealthy people find a way to avoid it. The well trod path for avoiding California’s electricity consumption tax is behind-the-meter (BTM) solar. It’s the offshore account for your utility bill.

Behind-the-meter solar now offsets more than 15% of total residential electricity use across the state’s IOUs. When customers avoid the electricity consumption tax by going solar, the utilities are allowed to recover the lost revenues by hiking rates for everyone else, as Lucas previously discussed here. Our estimate of how this cost shift shows up in rates is the brown box in the waterfall figure, which highlights that this is a substantial factor, especially for SDG&E. The bar chart below translates this cost shift into an annual cost increase for non-solar households, which ranges from nearly $100 to around $225 across the IOUs.

Source: Borenstein, Fowlie and Sallee (2021)

Households with solar are disproportionately wealthy, so this increasing cost shift is not only exacerbating inefficiencies by raising costs, it’s also inequitable.

This trend is particularly troublesome given economy-wide growth in inequality, highlighted in particular by socioeconomic and racial disparities in the impacts of the pandemic. And while it isn’t reasonable to try to use electricity rates to unwind economy-wide income inequality, it does seem reasonable to expect electricity rates to not make matters worse. But things will worsen if prices keep rising and more and more wealthy households make use of BTM solar, shifting more costs onto those who can least afford it.

Recalculating our Route Forward

If we want to achieve an equitable transition to a low carbon future, California will need to make some changes. The good news is that there are ways to simultaneously improve the efficiency and the equity of the system, either by establishing income-based fixed charges or by shifting some costs off of customer bills and onto the state’s general budget. Energy efficiency programs, subsidies for solar, and wildfire mitigation all represent pieces of the state’s climate adaptation and mitigation agenda that are good candidates for the general budget.

Instituting income-based fixed charges would require some effort and involve some trade-offs, as we discuss in some detail in the report. But we can do hard things. And the time for making tough choices is upon us because the rising chorus of complaints from the backseat is making the status quo untenable. If we want to reach our intended destination of an equitable low-carbon future, we need a course correction.

Let’s find the off ramp to a more equitable energy transition. Source: Navigon

Keep up with Energy Institute blogs, research, and events on Twitter @energyathaas.

Suggested citation: Sallee, James. “Ensuring Equity in California’s Energy Transition” Energy Institute Blog, UC Berkeley, March 8, 2021, https://energyathaas.wordpress.com/2021/03/08/ensuring-equity-in-californias-energy-transition/

James Sallee View All

James M. Sallee is an Associate Professor in the Department of Agricultural and Resource Economics at UC Berkeley, a Research Associate of the Energy Institute at Haas, and a Faculty Research Fellow of the National Bureau of Economic Research. He is a public economist who studies topics related to energy, the environment and taxation. Much of his work evaluates policies aimed at mitigating greenhouse gas emissions related to the use of automobiles.

13 thoughts on “Ensuring Equity in California’s Energy Transition Leave a comment

  1. On this issue of Social Inequity, that is all the rave in socially-inequitable circles: have any economists actually asked disadvantaged Californians what they want in return for that money bleeding from their bank accounts to their utility? Or are we making assumptions about what the impoverished need and want from our lofty perch, preferring to avoid venturing into that part of town?

    Seems presumptuous, that their priorities are probably different than ours. It seems that impoverished people in California might want something different than those in New York, or New Orleans.

    If asked, I would bet nearly all of respondents would rather put food on the table than contribute to the social cost of carbon, that they would prefer a flat per-kWh rate, than have to worry whether doing their laundry early in the evening means they can’t afford take-out that week. I would bet nearly all of them don’t give a damn about climate change, and would find a way to pay a bit more if it meant never having to worry about a cold snap (or an earthquake) taking away their power, and clean water to drink, for days or weeks; that they would want the choice of whether to pay for solar panels on their roofs, to determine for themselves whether it’s a good investment or not.

    It’s safe to assume 100% would prefer getting by without any electricity at all, if it meant they couldn’t be surprised by a $9,000 electricity bill that would wipe out their savings and put them on the street. It’s safe to assume none of them give a damn about “market design”, or what we think is best for them, although it would probably make them angry that we’re allowed to decide.

    These are my assumptions – I haven’t asked them either. But it’s not up to me.

  2. What do you think about using CARE subsidies to fund solar for low-income ratepayers? Maybe something like the Green Tariff Shared Renewables program, but with a lower cost?

  3. The proposal for income-based fixed charges seems to be an academic idea from people with no political experience.

    First, electric consumers are not interested in sharing their income levels with their electric utilities. I suspect many of us would sooner share the video of our colonoscopy with them.

    Second, it would be very cumbersome and expensive to implement and enforce such a requirement. Utilities have relied on social service agency qualifications criteria for access to low-income assistance programs, specifically to AVOID the cost and hassle of collecting (and verifying!) income data. We already have a system to collect money from people based on their income; it’s called an income tax. Perhaps this discussion can be simplified by proposing that income taxes be used to pay the electricity system costs that exceed marginal cost. That would simplify collection, avoid easy evasion, and have the same net impact (reducing the costs to be recovered through electricity bills).

    Third, Richard McCann is correct: much of the excessive level of California electric rates is within the control of the CPUC. The municipal electric utilities in California have much lower prices. Much of the difference is a very high allowed ROE, a very high allowed equity capitalization ratio, very high executive compensation, and recovery (with a return, in many cases) of investments that have proven uneconomic or non-viable).

    Fourth, a big chunk of the excess power supply cost in California is the above-market prices of earlier renewable energy contracts — the very “infant industry” investments that helped build the wind and solar businesses to where they are now cost-competitive. These may be good costs to socialize, since people all over the world are benefiting from the low cost of new wind and solar.

    Fifth, a big chuck of the excess of retail rates in California over those in other states is the cost of the CARES program, a relatively generous low-income assistance program. These costs are ideal costs to recover though taxes, rather than through electricity prices.

    Finally, I strongly disagree with the calculation of “societal marginal cost” in the Next10 report. Their inclusion of certain externalities is a good component of the analysis, but the practice of ignoring most T&D costs is not. The authors and I have long disagreed on whether electricity prices should reflect short run marginal costs (their position, which I learned in my Economics classes) or long-run marginal costs (my position, which I learned in my Finance classes, taught by the Business Administration faculty). Simply stated, in the real world, companies must recover their long-run marginal costs in prices in order to stay in business. Airlines do not offer the last seats on a plane for the cost of fuel, and hotels do not offer the last room in a hotel at the price of a bar of soap and clean linens. The basic rule is that you BUILD things that will pay for themselves and produce a return if expected prices will cover LRMC, but you OPERATE those things whenever the market clearing price exceeds SRMC. In my opinion, the Total Service Long Run Incremental Cost (TSLRIC), or the cost of building and operating a new T&D system, should be the foundation of T&D rate design. That would put the cost of off-peak distribution (the cost of a basic low-capacity distribution infrastructure) at perhaps 3 cents/kWh, and the on-peak distribution (the additional cost of bigger wires and transformers) at perhaps 6 cents/kwh.

    Net out the generous ROE and other costs allowed by the CPUC, the above-market infant-industry subsidies, and the CARES program costs, and then add in the long-run marginal costs of replacing the T&D system, and the gap between rates and marginal costs that they are concerned about becomes very small. Yes, a fixed charge should reflect the full costs of billing and collection, and California fixed charges do not do that. And customers should pay the cost of their connection to the grid (service drop and line transformers) in a capacity-based subscription charge. But all shared T&D costs and power supply costs belong in per-kWh rates.

    The end-effect of the proposed rate design would be relatively rapid departure from grid services by solar customers assessed a hefty surcharge. The cost of off-grid technology and storage is no longer a large premium over typical retail utility prices, and it is getting smaller. The proposed rate design would accelerate the utility death spiral in many areas, by alienating the very (higher-income) consumers who can afford this technology. Including not only solar and storage, but even the polluting whole-house propane-fired generator many will choose to assure uninterrupted service. The end result would be more pollution and financially weaker electric utilities.

    Refer for Smart Rate Design for a Smart Future for the details on efficient electric rate design. https://www.raponline.org/knowledge-center/smart-rate-design-for-a-smart-future/

  4. I really appreciate all this work you are doing on electricity prices and solar. It’s a big problem.

    Just as a “flight to solar” by the wealthy is a problem for fixed costs of electricity, so is a “flight to electrification” by the wealthy a problem for fixed costs of natural gas. Electrification is very expensive and only the wealthy can afford to leave the gas “grid”. Are people looking at this problem in the same way that you are looking at rooftop solar? Building electrification will help to reduce volumetric electricity prices, but it will also leave non-electrified building owners (and renters) holding the gas bag, so to speak…

    • First, electrification for new housing is no more expensive than installing natural gas. The cost effectiveness studies show this that you can find here: https://localenergycodes.com/

      As for recovering the legacy costs of the natural gas system, several concepts have been put forward, including this one from EDF: https://www.edf.org/sites/default/files/documents/Managing_the_Transition_new.pdf

      The bottom line is that once we install natural gas infrastructure, we’re stuck with gas use at that location for up to a century. The amount of biogas that might be available can meet only 5% of our current demand, so it can’t be used for low value residential applications. The big hurdle is figuring out to retrofit electrification into low income housing. It’s not insurmountable, but it likely will require income transfers of some type to finance this.

      • Richard, thanks, the EDF report is exactly the type of thing I was looking for. I will read it over. BTW, I should have clarified that I was talking about retrofits. Agreed that all-electric pencils out for new construction. And agreed that it seems a stretch to imagine that either biogas or clean synthetic gas will be affordable and plentiful enough for these applications.

  5. First, I have a different take on what has led to these high rates. It’s been created by a layering on of poor management decisions by the utilities in response to state policy directives. I wrote about this in a blog post here in response to the report release just before the CPUC en banc: (The blog has other links that won’t work here.)
    https://mcubedecon.com/2021/02/24/what-is-driving-californias-high-electricity-prices/

    One item I left out of that list is the allowed return on equity, which appears to be as much as 50% higher than the current market for similar equities: https://mcubedecon.com/2019/11/13/utilities-returns-are-too-high-part-2/

    An important issue is how will investments by BTM solar customers be treated going forward. The two primary source of PG&E’s high generation rates are prematurely signing most of its RPS requirements to terms that average $100/MWH for 30 years, and paying AGAIN for 50% of Diablo Canyon based on an ill conceived 1995 settlement. (Diablo Canyon was fully paid off by 1998.) If we’re going to address high rates, rather than going after the customers, we should start at source that we can so clearly identify. Why is no one talking about forcing investors to share a portion of these costs (and this can be done in more painless ways such as replacing equity with debt and/or extending the recovery period beyond 30 years.)? Until those other investors are asked to make similar sacrifices, e.g., repricing RPS PPAs to current renewable market values, we can’t ask these customers to pay higher rates.

    In 2002 we let the second largest long distance company in the US go bankrupt. This was viewed as a natural consequence of technological change as customers switched to other communication means. Sounds pretty similar.
    https://money.cnn.com/2002/07/19/news/worldcom_bankruptcy/

    PG&E has gone bankrupt twice in that period with almost no consequences for shareholders. (And SCE has used PG&E’s perils to leverage good deals for itself.) Instead of hammering everyone else, we need to have a serious discussion about having the utilities concede their errors and putting forward their offers on what they will contribute to mitigate the rates.

  6. In talking with environmentalists who are more knowledgeable on these issues they raised the point that increase in building and other types of efficiency have been driven by the relatively high costs of electricity and that the accounting for when an efficiency measure is warranted is based on reducing costs. If electricity prices fall than there could be efficiency measures that don’t “price out”. Maybe using energy or GHG accounting rather than cost accounting will be necessary to include in proposals such as this. Again, I think I have this right but am a lay person so may have it wrong.

  7. While California rates are higher than than the national average that is due to a lot of the progressive politics that has been embodied into the utlity system. It is certainly true that we need to rethink the whole structure, but using rates as a subrosa income redistrictuion policy is going the wrong way even faster.

    “Behind The Meter” anything is just another name for demand. We should encourage demand reductions through efficiency, conservation and BTM generation all the same way. A kWh saved through increased insulation or generated from rooftop solar is still a kWh less the grid need to supply.

    “Income based fixed charges” is not a utlity policy at all really, it is an income tax. We probably do need to subsidize certain heretofore utility-related functions out of the general fund, but we don’t need to do that by establishing a parallel income tax structure.

    The orginal sin was larding up the regulated utlity structure with public goods functionality. It seemed like a good idea back in the day to treat effiicency improvements as avoided generation and thus shoehorn them into the rate structure. It was not and ultimately led to the problems we have now.

    Back then it was deemed that having a higher marginal price for electricity was a good thing because it would encourage investment in efficiency and demand reduction. It worked; people with resources responded to the price signals that they were given. We got what we asked for: high rates and high investment in BTM technologies. To change the system now to both reduce the benefit that those investors were to receive and at the same time tax them with “income-based fixed charges” is unethical to say the least.

    Yes, there are many things that need to be rethought. If we are going to an all electric future then everyone in the State is dependent on grid reliability. The cost of having such a reliable system should be spread out accross the population just like any other infrastucture. That leaves the variable costs to be paid by the users, which can be done much more reasonably and farily.

  8. [disclosure: i am not an economist or energy expert]
    1: why are there not others who can setup a distribution system to compete with PGE.
    2: btm solar is one way of reducing usage charges; pge-CPUC should raise the connection charge significantly based on peak usage. This should be based on usage drop for a ‘similar’ residence.
    3: every time an upgrade is needed ratepayers are charged more. Where did the depreciation charges pge took go? another tax break?
    4: the cost of undergrounding should be borne by the pge investors – with ROI coming from lower future fire expenses, and insurance premiums.
    5: build more storage for night time ‘non-use’

  9. James:

    I watched your online discussion of the Next10 report, and I read your blog…. the blog does a really good job of explaining the issue, and fills in some of my questions!!

    I’m an engineer, not an economist…. but I have been around economists enough to understand the concept of getting the right market signals, and market penetration when marginal prices actually reflect marginal costs … I think I got that!

    But, as a consumer who has already invested in rooftop solar, and who currently enjoys a low fixed price in my utility bill, I am not going to be very inclined to be willing to pay something like the monthly fixed charges that I think you say are appropriate …. for me, it looks like some would have to pay $180/month vs maybe $20/month…. gasp!!!

    Anyway, what might be more workable would be a hybrid system, where a portion of the true fixed costs are paid by the ratepayer and the remainder is paid through some sort of state program… maybe even with a rebate for those least able to pay fixed charges. I didn’t see any discussion of a hybrid approach…

    I think you did a really good job of explaining the “waterfall graphs”….

    • Agree on two fronts. First, there can be a hybrid of costs paid through different mechanisms. Second, the proposal we start with in the report definitely creates winners and losers relative to the status quo. We plan to focus on this in our follow on report later this year, and will work to quantify the impacts of possible reforms across the income distribution and for folks with solar today.

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