New Energy Institute paper asks what the “electrify everything” movement could mean for natural gas customers who are left behind.
(Today’s post is co-authored by Catherine Hausman, an associate professor at the University of Michigan.)
The growing “electrify everything” movement aims to reduce carbon dioxide emissions by transitioning households and firms away from natural gas toward electricity. Already many cities in California and beyond have implemented electric-preferred building codes, heat pump subsidies, and other programs aimed at building electrification.
Our new Energy Institute working paper asks what this energy transition means for the customers who are left behind. Reports have noted that remaining gas customers during the transition could see higher bills. We dig into this in depth.
Growing and Shrinking Utilities
The current push for building electrification is still in its early stages, so it is too soon for an empirical analysis of how utility behavior responds to this policy push. Instead, we use historical evidence from growing and shrinking utilities as a proxy. Although mostly driven by population change, not building electrification, this evidence is a valuable opportunity to learn what happens when large numbers of customers enter and exit.
The figure below shows residential customer counts for a random set of U.S. natural gas distribution utilities during the period 1997-2019. The utility business is often thought of as stable and predictable, but we show that utilities have experienced a surprisingly large amount of recent change. We observe, for example, 320 utilities that experienced five or more consecutive years of customer growth, and 250 utilities that experienced five or more consecutive years of customer loss.
The shrinking utilities may seem surprising. But even though the total number of U.S. natural gas customers has increased 25% over this time period, many specific regions have lost population. Many utilities have lost customers, especially in rural areas, parts of the Southeast, Rust Belt, and Appalachia. Customer loss is particularly pronounced for small municipal utilities, but we also see it in cities like Philadelphia, PA and Birmingham, AL.
In the paper we use evidence from these growing and shrinking utilities to understand how utility operations and finances change with customer entry and exit. The single largest asset for these utilities is the pipeline infrastructure. Accordingly, we compile data on the total number of pipeline miles operated by each utility, and we examine how this responds to changes in the customer base.
As the figure below illustrates, we find that when utilities are growing, they add pipelines. A 10% increase in the number of residential customers on average leads to a 4% increase in pipeline miles. However, when utilities are shrinking, they do not remove pipelines. A 10% decrease in the number of residential customers has a precisely estimated 0% effect on pipeline miles.
Thus, utilities *expand* the distribution network during years of customer growth, but rarely *shrink* the network during years of customer loss. This makes sense. When a gas utility loses a customer, it generally doesn’t retire gas mains because other customers are still on that pipeline.
We next perform a similar analysis using data on utility revenues. Utilities collect revenue from customers to pay for capital and operating costs, and we want to understand how these revenues respond to changes in the customer base. Part of our motivation for the paper is that many categories of utility expenditures are likely to be “legacy costs” that don’t necessarily disappear as customers leave the system.
This is exactly what we find. Similar to the pattern for pipeline miles, we find an asymmetric relationship between utility revenue and the size of the customer base. A 10% increase in residential customers leads to 10% increase in revenues. However, a 10% decrease in customers leads to only a 5% decrease in revenues. This pattern implies that some costs do stick around after customer exit and that remaining customers make up half the lost revenue through increased rates.
This same dynamic is likely to play out in response to increased building electrification. During such a transition, it won’t be easy to retire pipelines until everyone in the network has discontinued service. Moreover, in addition to maintaining pipelines, the utility will still need to pay for legacy costs including past capital expenditures, pensions, and ongoing operations and maintenance.
Finally, we use our empirical estimates to simulate future bill impacts for different levels of building electrification.
Recent studies assume roughly a 15% reduction in natural gas residential customers by 2030; 40% by 2040; and 90% reduction by 2050. Our estimates imply that customer losses of this magnitude would mean annual bill increases of $30, $120, and $1,600 per remaining residential customer, respectively.
The figure below summarizes our results. The cost shift starts out modest but then increases sharply as legacy costs become concentrated on an increasingly small number of remaining customers.
Did Somebody Say Utility Death Spiral?
Higher retail prices for natural gas will also accelerate the transition away from natural gas, prompting further customer exits, and thus additional price increases. While these dynamics will not last forever, an energy transition of this magnitude affects a large number of U.S. households and businesses, so it is critical to trace out the implications for both efficiency and equity. Figuring out the right set of policies to provide a path for decarbonization without hurting low-income households or pipeline safety will be challenging, and our paper provides some suggestions for policymakers.
We also see similarities between natural gas and electricity. There is a similar dynamic with electricity in that rooftop solar lowers utility revenues and can push fixed cost recovery onto low-income customers. However, buildings with rooftop solar generally don’t completely leave the grid. The mechanism in natural gas is different — customers depart entirely. Thus the standard rate reforms that are frequently suggested for rooftop solar, which assume that customers stay connected, would not address the fixed cost recovery and equity issues that arise with natural gas.
Fundamentally, cost recovery and natural gas utility operations and investment will need to be rethought so that the electrify everything movement is equitable.
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Suggested citation: Davis, Lucas and Catherine Hausman. “Who Will Pay for Legacy Utility Costs?” Energy Institute Blog, UC Berkeley, July 7, 2021, https://energyathaas.wordpress.com/2021/07/06/who-will-pay-for-legacy-utility-costs/
For more details see Davis, Lucas and Catherine Hausman. “Who Will Pay for Legacy Utility Costs?” Energy Institute Working Paper 317.
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.