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Equitable Decarbonization Requires Rate Reform

Electricity rates in California are a roadblock to decarbonization, but reform can help.

As a passionate fan of the Chicago Cubs, I grew up expecting to lose. Rays of hope and promise always gave way to defeat and disappointment. I long thought that this aspect of my youth was great preparation for a career studying US climate policy, which seemed to be defined by a similar inevitability of defeat.

But, sometimes things change. The Cubs won the World Series in 2016 (after a brief 108-year drought), and now climate policy is suddenly on a winning streak. In the last several weeks, the Inflation Reduction Act unexpectedly rose from the dead, and California passed a suite of new, aggressive climate bills. This momentum is encouraging, but several factors could derail the ability of legislative gains to produce real carbon mitigation.

Here in California, one of these obstacles is the high price of electricity. In a report released last week, Severin, Meredith and I take a close look at how residential electricity pricing in California is acting as a barrier to a lower carbon economy by artificially raising the cost of electrifying homes and vehicles. (We’ll be hosting a webinar to discuss the report on October 4, 11 am – noon Pacific.)

If you live in California, most of your electricity bill is a regressive electricity “tax”

Our new report, which was supported by Next 10, shows that households served by California’s three large investor-owned utilities (IOUs) pay an average of nearly $700 per year in what we call an “electricity tax.” For customers of Pacific Gas & Electric and San Diego Gas & Electric, this “tax” is about two-thirds of customer bills on average, and it is around half for Southern California Edison customers.

This cost to customers is not literally a tax. It’s the gap between the price customers pay per kWh and the cost to the utility of providing that power. When I turn on my lights, I have to pay about 25 cents per kWh, but it only costs PG&E about 8 cents per KWh to deliver that additional power, including the cost of pollution. The huge gap between price and cost, which we quantified in a companion report last year, exists because California’s IOUs need the extra revenue to cover system costs, and other residual costs for grid hardening, energy efficiency programs, rooftop solar incentives, low-income subsidies and other programs, entirely by raising per kWh prices above cost.

In the report, we label the gap between price and social marginal cost a “tax” on electricity because it represents a fee above cost used to collect revenue to pay for some good or service (in this case the costs of the electricity infrastructure, as well as other state priorities). The problem with recovering needed revenue via this “tax” is that it makes electric vehicles, heat pumps and other climate-friendly technologies more expensive. Turns out it’s also regressive.

In the report, we use anonymized billing data on more than 11 million customers of these IOUs to estimate annual, household-specific electricity tax burdens. Given growing concerns about affordability, we are particularly interested in how this electricity tax varies with income. We use data on income from the US Census as well as survey data from California in order to get the best available estimate of income for each household in the billing data.

Our results show that lower-income households pay a much larger share of their income via the electricity tax than do wealthier households. We label the total paid via the tax the annual “residual cost burden.” As shown in the figure below, the lowest-income customers in both PG&E and SDG&E pay 3% of their income to the electricity tax, and remember that the tax is just the portion of their bill over and above the incremental cost of providing their power.

ES1_income

High prices slow progress on electrification

Does the electricity tax really make a difference for decarbonization? We find that it does.

To think this through, we used survey data on vehicle mileage from California drivers to ask how much extra these drivers would pay per year if they got an electric vehicle as a result of the electricity tax. We call this the “electrification cost premium,” as it shows how much more expensive it is to electrify as a result of having electricity prices above social marginal cost. We used survey data on home energy consumption in the state to do the same calculation for the adoption of a heat pump for space heating.

In both cases, the annual cost premium averages around $600 per year. As shown in the figure below, the amounts vary considerably across IOUs because of differences in the electricity tax across utilities and due to differences in miles driven or heating used.

This cost premium works directly against tax credits that are being proposed as a lynchpin for spurring electrification. A $600 tax, at a 5% discount rate over 15 years, nets out to a present value of $6,500, which means that the electricity cost premium in California effectively undoes the vaunted $7,500 federal tax credit for buying an EV.

ES2_premium

Using recent estimates from our Energy Institute colleagues (see here and here), we estimate that lowering volumetric prices to social marginal cost would increase EV adoption by between 13 and 33 percent, and it would boost adoption of electric heating in new homes in the state by around one-third.

Put another way, pushing electrification in California with our current rate structure is like trying to zoom down the highway with your parking break on. If you find yourself in this situation, you should release the brake. Similarly, policymakers can reform rates so that they don’t stall progress on electrification.

What can be done?

The good news about California’s electricity pricing conundrum is that there are ways to foster decarbonization by lowering prices while at the same time making the system more equitable. In this case, equity and efficiency can go together.

There are two key paths to reform.

The first is to lower electricity prices by moving suitable costs onto the state budget that are currently funded through utility bills. This won’t reduce costs, but it allows the state to raise revenue through the state sales tax (which is more progressive than the electricity tax) or income tax (which is dramatically more progressive than the electricity tax). In the report, we discuss which line items might be “suitable” for a transfer, highlighting wildfire mitigation costs and public purpose programs as the most obvious.

The second is to introduce fixed charges that vary by income on electricity bills, an “income-based fixed charge” (IBFC). Earlier this year, the state legislature passed, and the governor signed, a bill requiring the California Public Utility Commission to introduce such a charge by 2024.

In our latest report, we present an example of an IBFC, one designed to be as progressive as the state sales tax. The figure below shows one possible schedule of fixed charges for PG&E, where monthly charges would range from 0 for the lowest income households to $141 for households making more than $200,000 per year (roughly the top one-sixth of households in PG&E territory).

In exchange for adding these fixed charges, the volumetric price would drop dramatically, so the fixed charge is not simply a bill increase. PG&E households making more than $200,000 would, for example, see their monthly bills rise by only $35 per month on average, despite having a $141 monthly fixed charge. Conversely, lower-income households would see savings on average. A household, at any income level, that starts driving an electric vehicle or electrifies their home will see a much smaller bill increase than under the current system.

Bill impacts will vary across households depending upon factors such as their current consumption patterns, CARE participation, and service territory, as shown in the lower part of the figure.

This is but one example plan. Regulators seeking to implement an IBFC will need to consider how many tiers to create, how progressive to make the system, and whether or not to put measures in place to manage the big changes in bills that some might face, such as phasing an IBFC in over time. We hope that our calculations can help kickstart that conversation.

Figure9_PGE

Minimum bills have minimal merit

Minimum bills, which increase bill amounts for households with sufficiently low consumption, are sometimes suggested as an alternative way to raise revenue without raising prices further or adding fixed charges.

We used the billing data to take a look at minimum bills and concluded that they are simultaneously ineffective and highly inequitable. Minimum bills of $30 per month (a dollar a day) raise a trivial amount of additional revenue. At $60 per month, minimum bills can increase revenue by modest amounts, but the burdens are quite regressive. About 40 cents of every dollar raised by minimum bills of $60 per month would come from households making less than $50,000 per year. This is even more regressive than the status quo.

Severin had previously demonstrated that minimum bills were inefficient because they create a zero price for consumption at quantities below the minimum. Now we know they complete the trifecta: they are inefficient, ineffective and inequitable. Minimum bills should be a non-starter.

Conclusion

Having been forged in fires of futility as a kid, I can rest content if the Cubs are lovable losers who resurface to win a title every 50 years or so.

Not so the climate. We need to be greedy about winning. We need to win so much that we get sick and tired of it.

So it is imperative that we remove obvious obstacles that threaten our pursuit of an equitable low-carbon future. The current electricity pricing system in California is one such hazard. We can see it clearly. We know it is unhelpful. We know how to change it. So let’s get to it.

For more information:

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

Suggested citation: Sallee, James, “Equitable Decarbonization Requires Rate Reform,” Energy Institute Blog,  UC Berkeley, September 26, 2022, https://energyathaas.wordpress.com/2022/09/26/equitable-decarbonization-requires-rate-reform/

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.

45 thoughts on “Equitable Decarbonization Requires Rate Reform Leave a comment

  1. What we really need is Real Time Electricity Pricing (RTEP). The utilities should be posting a 24 hr look ahead for hour by hour electricity price and that should be based on supply and demand, especially taking into account electricity conveyed long distances. Prof Sallee’s proposal would be a blow to roof-top solar, which has lots of advantages over any other way of generating electricity. RTEP would incentivize anyone and everyone to do their own Demand Side Management (DSM) which is even more beneficial than electricity storage. RTEP would also incentivize electricity storage. A combination of wider use of rooftop solar, DSM, and electricity storage (by any means, not necessarily lithium ion) would be extremely beneficial to just about everyone in the state. Most, bu certainly not all, people charging EV’s would naturally do it when the rates are lowest. Utilities pumping water (East Bay MUD is the largest in California) would shift their water pumping to low rate hours. In fact, EBMUD already does this and has been doing it for more than 20 years. There is a lot of storage built into the design of their water systems. I would rather see the Energy Institute at Haas focusing on RTEP. The 24 hr look ahead should be either imbedded in the electrical system itself, or if necessary, could come over the Internet.

  2. Great research. Does pricing negative externalities on necessary, inelastic goods such as electricity make sense in general?

    Seems like doing so wouldn’t change demand for the necessary, externality-causing goods, but instead would lower demand for whatever non-necessary goods people would’ve bought if they would not have had to pay more for the necessary, externality-causing goods.

  3. As usual, an interesting and provocative blog. Thank you, James.

    When the price of a good or service (in this case electricity) strays far from its underlying marginal cost, there are all sorts of unintended consequences, as Perhaps one of the reasons that Net Energy Metering of Roof-Top Solar has become such a contentious policy in California is that the “basis” for electricity costs started far too high. I also can’t help but think that there is regulatory reform required which provides a more equitable sharing of risk and rewards between ratepayers and IOU shareholders. The IOU rush to electrification and rate-basing the associated costs of same is more than a bit self-serving. Is grid hardening advancing new technology or catching up on overdue homework?

  4. The best thing wealthy Californians could do is simply disconnect from the grid. That’s what I’d do. Even better, get out of that ‘equity’place.

  5. James: I submitted this around 12:30, but perhaps it didn’t go through. (I didn’t get the email notice about it awaiting moderation.) If you already received it but just haven’t gotten to posting it yet, please ignore. KS

    ***
    Good post on a problem that really needs to be addressed, and thanks to James, et al., for suggesting ways to do so.

    As for the suggestion to “move suitable costs to the state budget,” obviously that is much easier said than done. First, the state legislature already has the option of raising the state sales and income taxes by a 2/3s vote in both houses, which is a very tough task even with Democrats holding super-majorities in those chambers. The added hurdle in this scenario is that, to get any additional tax revenue dedicated to “suitable costs” from the “electricity tax,” it would have to come with a continuous appropriation for each specific program — that is, for X number of years each program will get Y amount of funding. There would be a lot of pushback on that, with perhaps the exception of low-income subsidies (such as the CARE program) which one could strongly argue is a “suitable” cost.

    Frankly, while I am ambivalent about raising the state income tax on the wealthy yet again — realistically, how many more times can we do this? — as proposed by Prop 30, we’d get a much better bang for the buck if we applied that revenue to electricity cost mitigation as opposed to the Prop 30 allocations, as important as they are.

  6. The average price to install heat pump space heating in California is $17,287.
    https://carbonswitch.com/heat-pump-costs/

    With 13.1 million homes in California, that comes to a grand total of $225 billion, or roughly California’s annual budget – not counting conversion to electric water heaters, ovens, and stoves. Are we not simply transferring the utility “system tax” to a consumer “conversion tax”, one that would grossly outweigh the burden of the former for low-income homeowners?

    A preferable alternative would be installing 10 more Diablo Canyon-scale nuclear power plants. Then, we’d have plenty of clean power for charging electric cars and diverting extra power to desalination. It would put 100% clean electricity by 2040 within reach.

    But that depends on our goal. Is it to reduce carbon emissions, or to soothe the irrational fears of anti-nuclear activists?

    • We’re going to reach near 100% no-GHG power before we could build 10 nukes. The problem is using that electricity which requires electrifying space conditioning. (And are you admitting that a new Diablo Canyon would cost $22 billion a piece? That’s a lot of solar+storage….)

      BTW, what’s the average cost to install a gas furnace + AC? My system cost >$10K 5 years ago. Don’t forget to net out the replacement cost alternative.

      • “We’re going to reach near 100% no-GHG power before we could build 10 nukes…”

        Uh-huh. Ask Germany how progress on their dream is proceeding. And France, which built nuclear capacity at a rate of over 2GW/yr in the 1980s.



        “Are you admitting that a new Diablo Canyon would cost $22 billion a piece? That’s a lot of solar+storage….”
        $225 billion is a drop in the bucket of what it would cost to provide 80% of California’s electricity from solar+storage. Again, ask Germany.

        

“Don’t forget to net out the replacement cost alternative.”

        OK, so $7,287 more for the switch. Everybody has an extra $7G laying around to spend on HVAC, right?


        • $225B will get you between 75 and 225 GW of RE at current costs, well beyond 10 GW. Residential microgrids with solar+storage cost $5,000/kW now. We can build 45GW of MGs for $225B, 4 times more than nukes. (Community scale MGs cost about 40% less.) That’s 86% of the most recent CAISO peak load record.

          France’s nuclear fleet is doing so well that it had to cut output during the European heat wave due to degradation of the plants. Capacity factors has declined from 90% to 77%. https://www.bloomberg.com/news/articles/2022-08-03/edf-to-curb-nuclear-output-as-french-energy-crisis-worsens

          The HVAC upgrade pays for itself in lower energy costs.

          • Richard, I don’t envy the position in which you’ve found yourself, but it’s time to face facts: renewable energy is a failure. Intermittent, unreliable electricity is in no one’s best interest, and never has been – it’s expensive, it has a horrendous land-use and wildlife impact, and it remains entirely dependent on natural gas and coal for backup power. Notwithstanding mythical “storage”, which has yet to offer a suitable replacement for natural gas on any grid worldwide.

            Germany is the poster child for the energy insecurity reliance on natural gas, and wind and solar by extension, make inevitable. Its carbon emissions reductions are flatlining at exactly where analysts predicted they would years ago, and after three decades and hundreds of €billions spent on its Energiewende, the country has finally resigned itself to energy realities. President Scholz won’t close all of his country’s nuclear plants by 2021, or 2022, or 2023. He has committed to keeping two of Germany’s last three plants open, at least through this winter.

            We repeat Germany’s mistakes at our peril – both environmental, and geopolitical.

  7. I suggest shifting all utility fixed costs to the gas bill. This will not change the overall bill but will make electricity the cheaper fuel.

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