If You Like Your Time-invariant Electricity Price, You Can Keep It

Shouldn’t a 2000-square-foot house in San Francisco cost the same as in Omaha?  If you answered yes, then time-varying electricity pricing won’t make much sense to you either.   And you are probably puzzled, or outraged, at how much more expensive wrapping paper is on December 15 than on January 1.

But if you recognize that a house in San Francisco is fundamentally a different product than that same home dropped into Omaha, then you will have no problem understanding why electricity should cost more at some times than at others.  It’s the scarcity, of course.

If you are a reader of this blog then you already know that electricity is really costly to store, so a kilowatt-hour (kWh) in the middle of the night is fundamentally a different product than a kWh at 3pm on a hot weekday afternoon.  People want a lot more kWhs on hot weekday afternoons, just as a lot more people want that house in SF than in Omaha, at least compared to the much more constrained SF supply.

OptionalDynPrice1If you forced the price of a house in SF to be as low as in Omaha, then you’d have many more people demanding SF houses than there are homes to be had.   At Omaha prices, I know some people who would keep a place in SF just for weekends when they come into “the city” for culture (yes, here in the Bay Area we call San Francisco “the city”…apologies to New Yorkers and Londoners).   You’d have to use some sort of lottery system to allocate the houses, or you’d have to scrutinize each buyer’s “need” for a house in SF or, as often happens with rent control, buyers would have to make a little “side payment” to the seller to be the one who gets the place.

And if you forced the price of a house in Omaha to be as high as in SF, there would be a lot of nice, but empty, homes in Omaha.  Pure waste.  In the longer run, the good citizens of Omaha would just be crowded into smaller houses than they’d like — and should be able to afford — given the wide open plains of the Midwest.

As bad as a housing shortage is, nothing creates a political firestorm like a shortage of electricity and the blackouts that follow.  So, in electricity markets where all kWhs are priced the same, we avoid the blackouts by building scads of extra houses, uh, electricity generators.  Someone has to pay for all that extra capacity; it gets rolled into the price of all the kWhs that are sold.  And that too is a waste.

Smart MeterA smart meter. There’s probably one right outside your house.

For decades, economists have argued that electricity prices should vary over time the way house prices vary across cities.  With the smart meters that most residential customers in the U.S. now have – installed over the last decade — the technology is in place to do it.

But some people just hate, hate, hate time-varying pricing.  They want their electricity rate to be the same morning, noon and night, winter and summer, rain or shine or heat storm.  Some economists have fumbled this problem saying, “too bad, these prices reflect the real cost, so deal with it.”   A decade ago, I was one of them.

That’s not the right answer.  Prices vary for many things, but if you hate that volatility there is often an option to avoid it.  The cost of having a car to drive today depends on whether yours was stolen yesterday, but you can pay someone to make that cost variation go away.  Just as an insurance broker can offer you a product that eliminates (or greatly reduces) the cost variation caused by the risk of having your car stolen, a utility can offer you a product that eliminates the variation in your cost of electricity.

Insurance isn’t free and neither would be the option to buy electricity at a flat price.  If you want that time-invariant price, you’d be pooled with other people who want it.  Who would those people be?  Well, they’d disproportionately be people who consume a lot of electricity at expensive times, those hot summer afternoons.

Would that make the time-invariant pricing option unaffordable? No.  My own research has shown that even with a lot of this sort of “adverse selection” the flat price would increase by less than five percent.  And a not-quite-released study by my colleagues at the Energy Institute and at Lawrence Berkeley National Lab (LBNL), which Catherine previewed in a blog in 2013, showed that there might not be much adverse selection at all.

One key to a smooth transition would be to design rates that fairly reflect the cost of serving each type of customer, those who stick with flat rates and those who go with, and respond to, time-based variation.  It’s easy to do, but regulators would have to resist pressure from some “consumer groups” who fight time-varying pricing,  essentially arguing that we should continue screwing the majority of low-income customers in order to protect a few low-income customers whose bills would go up (and not by much, even for them).

From the study by Catherine et al, it’s clear that another key is making time-varying pricing the default: you can actively choose to be on the flat rate, but if you do nothing you default to time-varying pricing.  Defaults matter, because some people don’t pay attention and because some people who are unsure of which option to choose – whether it is retirement saving, electricity pricing, or getting a flu shot – go with the default option.  And the study by Catherine et al shows that customers who defaulted onto the time-varying pricing overwhelmingly stuck with it even though they had the option to leave at any time.

Time-varying electricity pricing has been a good idea for a long time, but it matters now more than ever.  That’s because transitioning to greater use of solar and wind power will mean that it won’t just be demand that fluctuates in ways that are difficult to predict, it will also be supply.  We can manage that uncertainty the old-fashioned way, by building more and more excess capacity, or the new techy but very expensive way, by investing in storage capacity, as Catherine discussed a couple years ago.


Or we can first take the common-sense approach of using prices to let customers know when there is plenty of electricity available or when there is a potential shortage.  We’ll still need some extra capacity and some electricity storage, but not as much.  The savings from sending price signals would likely be at least hundreds of millions of dollars each year in California.  One study from LBNL found time-varying pricing would dramatically increase the value of wind and solar power as penetration of those sources increased, a topic Meredith blogged about a year ago.

And, as electric vehicles roll out, the opportunity to respond to time-varying pricing will expand exponentially.  Cranking up your Tesla –uh, I mean Leaf or Fiat 500– charging when the wind is blowing, is technology that has already arrived.  There really is an app for that.  We just have to start using these technologies to save money and at the same time lower the cost of integrating renewable generation.

Most San Franciscans don’t want to live in Omaha, and I bet most Omahans don’t want to live in San Francisco.   The lower house prices in Omaha are one reward for not trying to be another tech worker in the city (…by the bay).  Charging your car or running your laundry at lower cost should be your reward for using electricity when the wind is blowing or sun is shining.

But if you don’t like that, no problem, there should be a flat-price option for you to choose instead.  Think of it as Topeka.

Note: After writing most of this blog, I found out that the California Public Utilities Commission will hold a forum to discuss time-varying pricing and other rate design issues tonight (Nov 16) in Stockton, CA.

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Historic Opportunity to Reduce Global Fuel Subsidies

With crude oil prices under $50 per barrel this is an historic opportunity for Saudi Arabia and other countries to eliminate energy subsidies.

Low crude oil prices are making the impossible possible. Back in August, the United Arab Emirates (UAE) rolled back gasoline and diesel subsidies, leading prices to increase by 25%. UAE’s energy minister, Suhail Al-Mazrouei, said the change was about “building a strong economy that is not dependent on government subsidies.”

This is a stunning change for one of the world’s largest crude oil producers. Cheap gasoline has long been a permanent fixture throughout much of the Middle East, so when the second-largest OPEC producer increases gasoline prices this is big news.

And it is not just UAE. The World Bank recently released new data on global gasoline prices and several major economies have increased gasoline prices since the last data release two years ago.


Indonesia, for example, increased gasoline prices by $1.75/gallon. These are even larger price increases than would initially appear because global spot prices decreased by $0.75/gallon during this period. So compared to the opportunity cost of gasoline, Indonesia’s $1.75 increase represents a whopping $2.50/gallon reduction in subsidies. The economic waste from fuel subsidies goes up with the square of the gap between the price at the pump and global spot prices, so even countries with small nominal increases like Iran implicitly took large steps to improve economic efficiency.

The two biggest movers were Egypt and Indonesia. Gasoline prices in Indonesia increased from $1.78 in November 2012 to $3.52 in November 2014, while prices in Egypt increased from $1.70 to $3.33.  Both countries made these reforms to curb rising budget deficits and both have pledged to use some of the fiscal savings from reforms to target health, education, and social protection measures (see here, here, here, and here).

Mexico took a slow but steady approach to rolling back subsidies. Gasoline and diesel prices in Mexico continue to be set by PEMEX, the state-owned petroleum monopoly.  But after holding pump prices well below global spot prices for more than a decade, the decision was made to steadily increase them during 2013 and 2014.  The monthly “gasolinazos” were each relatively small in magnitude, but cumulatively have now completely eliminated fuel subsidies in Mexico.


Cutting fuel subsidies is good for the economy. Why? Economic efficiency requires that prices be set equal to marginal cost. Cutting fuel subsidies eliminates “deadweight loss” (economist-speak for “waste”) and ensures that the benefits exceed the costs for all gasoline and diesel sales.

Cutting fuel subsidies is also good for the environment. We are less than 1 month away from the 2015 UN Climate Change Conference in Paris where participants will be discussing all types of creative approaches for reducing carbon dioxide emissions.  Few are as simple and effective, however, as increasing energy prices. Indonesia’s recent reforms, for example, could eventually reduce Indonesian oil consumption by 30%, or half a million barrels per day. This is equivalent to more than 75 million tons of carbon dioxide emissions annually, a significant part of Indonesia’s entire proposed commitment for COP 21.

Why is this subsidy reform happening now?  Low crude oil prices reduce government revenue in oil producing countries, increasing budget deficits and making fuel subsidies harder to afford.  This fiscal urgency was a major part of the motivation in most of the countries where subsidy reform has occurred. The situation was particularly desperate in Egypt and Indonesia, where the governments combined reforms with public-education campaigns aimed at explaining just how costly the subsidies had become from a fiscal perspective.

Low crude oil prices also reduce the size of the subsidy, making it an opportune time to allow prices to rise to international levels. Had UAE attempted to liberalize prices last year, it would have meant much larger price increases and more public backlash. When Yemen tried to liberalize prices in August 2014, it led to large protests and violence, in part because global spot prices were so much higher than they are today.

The true test is going to be whether countries like the UAE can maintain the reform in the future when global oil prices increase. Although the term “deregulation” is being used to describe the reforms in UAE, prices in UAE are not truly deregulated. They continue to be set by a “Fuels Prices Committee”, which meets on the 28th of each month. You have to worry when crude prices increase, this committee is going to come under huge political pressure to freeze retail rates.

dubai-256585_640The Dubai Marina at Night.

UAE’s reform nonetheless provides a clear roadmap for countries that continue to have large gasoline subsidies like Venezuela (where retail prices are $.06 per gallon), Saudi Arabia ($.61), Kuwait ($.83), Turkmenistan ($.83), and Qatar ($.87). The UAE reform suggests that there may be a changing culture around fuel subsidies.

The next big change may be in Saudi Arabia. Two weeks ago the Saudi oil minister Ali Al-Naimi made news when he said that Saudi Arabia was considering reducing fuel subsidies. One report even suggested that the Saudi government had asked the UAE government for advice. Ali Al-Naimi backed away from these suggestions last Wednesday, however, saying that such steps are only, “when you are in dire need, and fortunately Saudi Arabia isn’t today in such dire need.”  Given Saudi Arabia’s historic leadership in the Persian Gulf region and long tradition of steep subsidies, any reform there would be huge news and could lead the remaining countries that subsidize fuels to do the same, slashing economic waste and external costs.

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RIP Incandescent Light Bulbs?

fake tombstonePeople do strange things around Halloween. I swear – I usually do not walk into our house with 8 pounds of store-bought candy (Butterfingers and Heath Bars, of course). A couple days before Halloween, as I fumble around looking for our fake tombstones, I do something else unusual – I turn on the light in our basement.

If light bulbs were power plants, the bulb in our basement would be a peaker – used very rarely but providing high value when called on. In addition to its 10 minutes of use around Halloween, it gets another 10 minutes before Christmas as I run down to the basement to grab the tree stand while my kids and husband wait patiently with that year’s tree choice/victim on top of the car. Probably because it’s used so rarely, the bulb hasn’t burned out yet, so it’s one of the few incandescent light bulbs remaining in our house.

Seeing our trusty basement bulb reminded me of the news stories from a couple years ago about banning incandescent light bulbs. It made me wonder – are those bans really in effect? Should I preserve our basement specimen as some kind of energy-themed artifact?



The answer is not as straightforward as I anticipated. I started by doing a little empirical research and typed “incandescent light bulb” into Amazon’s search box. Lots of choices, and they’re still dirt cheap. So, no Antique Roadshow for our basement bulb – I can replace it for less than $1 online.

But, then what of all the news articles about the ban? Here’s where it gets interesting. In theory, the ban is in effect. In a nutshell, the Energy Independence and Security Act of 2007, which was signed by George W. Bush, set out a schedule that called for progressively tighter efficiency standards for light bulbs. Phase 1 called for slightly more efficient bulbs, which required about a 25 percent efficiency improvement for incandescent bulbs. It was phased in by bulb size, starting with 100-Watt bulbs in January 2012. For now, you can still buy a “halogen incandescent,” which I think surrounds the filament with a halogen gas instead of a vacuum. Phase 2, which is coming in 2020 (2018 for California), sets aggressive minimum lumens per watts, which is expected to outlaw all incandescents.

So – and this is not a completely rhetorical question – how is Amazon selling normal 100-Watt incandescent bulbs? I confirmed that I could in fact order them (Prime, even) and 4 are headed to my house today. My reading of the legalese is that it’s against the law to manufacture or sell these in the U.S., though not illegal to buy them. The law allowed amazonsellers to get rid of their existing stock, but the ban on 100-Watts has been in effect for almost 4 years, so it seems unlikely that Amazon’s sellers are still depleting their stock.

While there are a number of loopholes for the incandescent ban (e.g., for bug lamps or decorative bulbs), I don’t think the bulbs for sale on Amazon’s site fall into any of them. And, as a contact at the California Energy Commission pointed out, some of the comments on Amazon questioned why the bulbs are marked, “Do Not Sell or Use in the U.S.”

The best answer that I can find is that members of Congress opposed to the ban have prohibited the DOE from spending money to enforce it. So, maybe what Amazon is doing is technically illegal, but won’t be enforced. I should also note that all the examples I’ve seen are “sold by” someone else and “fulfilled by” Amazon. But, I would be unlikely to find these other retailers except through Amazon.

I have two reactions to Amazon’s scheme – one as a citizen of the U.S. and one as an economist. As a citizen of the U.S., I’m disheartened by the idea that we have a recent, bipartisan law on our books that is flagrantly violated. This isn’t some back-alley side deal. This is Amazon – the earth’s biggest retailer.

As an economist, I am also disheartened, but for a slightly more nuanced reason. Economists generally view standards to be poor substitutes for more direct regulations, like pollution taxes. One of the main motivations behind efficiency standards for light bulbs is to reduce the pollution created when electricity is generated to power the light bulbs. But, economists point out that it’s better to just tax the pollution coming out of the power plants. Because it’s such a blunt instrument, the standard is worse than the tax. Consider our basement bulb – it’s on for so few hours that its use emits very little pollution. So, forcing us to spend a couple dollars more to buy an LED – as the 2020 incandescent ban will do – is a waste of society’s resources.

Then again, we’re talking about light bulbs. Most people aren’t paying attention to the economics of their light bulb purchases – even I, as an energy blogger, feel a little sheepish to be calculating the cost-benefits of an LED versus incandescent for our basement. And, people may be making mistakes or lack the information necessary to make the best choice for them. For example, they may wrongly extrapolate from the early, poor-performing CFLs to assume that all non-incandescent bulbs will be low quality.

A recent paper by Hunt Allcott and Dmitry Taubinsky goes through careful reasoning to show that if consumers aren’t paying attention, are making mistakes or lack good information, a light bulb ban, like the one under EISA, can make sense. The paper’s basic empirical results suggest that the ban can’t be justified on those grounds, but I’m willing to extrapolate those findings, as the authors indicate is possible, to suggest it would make sense for today’s LEDs, which are higher quality and more economical than the CFLs that Allcott and Taubinsky evaluate. Given that I think the chances of getting an optimal pollution tax are very low anytime soon, I’m even more comfortable with that extrapolation.

If my guess is correct – that the incandescent ban will be a good thing for society – then I really hope some regulatory agency finds the resources to crack down on Amazon and its sellers. But, this is mostly my speculation, and it would be useful to do more research like Allcott and Taubinsky’s to help quantify the potential impact of the ban. It seems that many members of Congress disagree with me.

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Leaking Coal to Asia

portofoaklandThe view from my window high up in the ivory tower is spectacular. Through my open window I breathe in the unpolluted air of knowledge and bask in the glow of theory. Recently I climbed down to attend a hearing at Oakland’s city council about the possible construction of a coal export terminal right here smack dab in the heart of the most liberal metropolis in North America.

Here’s what’s happening. A developer proposed a plan for a new export terminal on an old army base next to Oakland harbor. This is good news. Export terminals lead to lots of jobs and ancillary economic activity. West Oakland is a relatively low-income community with high rates of unemployment. I was excited when I heard about this initially. Recently, however, the proposal was modified to allow for the annual shipment of 4 to 5 million tons of Utah coal abroad, which amounts to roughly a 10% increase in US exports. Why should we care about what gets shipped through a terminal? Well, let me count the ways.

At this hearing, some very fancy lawyers testified that we should not worry about any local negative health consequences from this shift. I am not so sure. We could envision coal dust escaping from the rail cars would end up in kids’ lungs – no matter how covered the cars are. Plus, I would imagine that the ships and trains themselves would lead to increases in local air pollution. Ships are one of the main sources of air pollution in the Bay Area. And, ships that bring coal abroad are not the same high quality shiny new ships we use to bring containers and cars from here to there and back.

More globally, we (finally) have serious regulation at the federal level that address the negative externalities from climate change. Most significantly, the Clean Power Plan will lead to a significant decrease in demand for US coal. Coal, as even my seven year old knows, is the main culprit when talking about greenhouse gas emissions. This is of course bad news for the producers of coal. If demand shifts in, price drops and you sell less at a lower price. Unless you find new markets for your coal, this carbon stays in the ground. Which is the point of climate policy. Period. Well, if you get a shiny new export terminal and can ship coal abroad, that sort of fixes things for you as you now have access to a new market and the coal, whose combustion results in increased emissions of a global pollutant, gets burned anyway.

Countries throughout Asia are burning coal like it’s free (and in some cases it sort of is). Getting more coal of higher quality from the US is a great thing from the Chinese perspective. But from a global perspective it likely is a loser. Here is why I think so:

  • I am sure half the economists reading this blog would argue that this high quality coal would displace lower quality higher sulfur coal one for one in China and this would make the world better off. In theory, this might be the case. But over time, this new source of coal generates further incentives to structure your energy economy around coal. Better coal might lead to cleaner air in some parts, but from a climate change point of view, what you want is an energy sector less dependent on coal in the long run. More US coal, which drives down local prices, does not help this objective.
  • This proposal undermines the US federal government’s and California’s efforts to curb greenhouse gas emissions. Getting this coal to furnaces abroad guts part of the stated goals of the Clean Power Plan and undermines the point of California’s aggressive climate change goals. We would use the most progressive state in the world on this issue as a launching pad for coal to the rest of the world.

What baffles me about this is the political economy of what is happening. I understand that local leaders in West Oakland are pushing very strongly and convincingly for more jobs in their community. This project would likely lead to increased employment for youth, raise incomes and result in a variety of ancillary benefits that come along with these welfare improvements. I understand that the pushers of coal want a platform for their carbon. If you have something valuable, you want to sell it. The Oakland city council is trying to determine what the right thing is for their community, which is a tough thing to do since the global impacts are not part of their charge.

But where is the state? I would assume that Governor Brown, who has pushed hard for climate regulation and has even talked to the Pope about the issue, would be his usual vocal self in this case. He also has a war chest to come step in. Yes. I am talking about cap and trade revenue. We are currently using some of the early revenue to build a high-speed train project, which will initially connect the Metropolis of Merced with Bakersfield. There are the delta tunnels too. What we should do with cap and trade revenue is many things, but helping communities who are disadvantaged by climate policy is certainly one of them. This assistance could be in the form of job training programs or other job creating initiatives targeted at people disadvantaged by the veto of such a terminal.

At the very least it’s time for a strong signal from Sacramento against new construction of carbon export terminals in California. The existing ones might have some spare capacity, but building new ones undermines California’s environmental legacy and global climate leadership role.

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Could Microgrids Be Big in the US?

Three years ago this week, Hurricane Sandy began forming in the Caribbean Sea. It went on to wallop several Caribbean islands and the Eastern Seaboard. In the US the storm caused an estimated $75 billion in damage. The electricity system was hit especially hard. Over 8 million homes lost power.

Policymakers on the East Coast don’t want to experience Sandy-style outages again. That’s led them to microgrids, in turn popularizing the concept around the country.

So, what exactly is the benefit of a microgrid?


Enemies of the power grid gather. SOURCE: “Balloonsanimals” by RiseRover at English Wikipedia – Transferred from en.wikipedia to Commons.. Licensed under Public Domain via Commons.

To answer that, first we have to recognize that the electric distribution system is fragile. Harmless seeming trees, squirrels and Mylar balloons routinely cause widespread outages. Most grid incidents don’t just affect downstream customers, but also cause a ripple effect, knocking out upstream and adjacent circuits.

Other networks we deal with daily are more robust. If a tree falls on a road, traffic re-routes to adjacent roads. Global internet traffic is constantly rerouting around congestion and outages to get to its destination. Even a local internet problem can be mitigated by jumping on a cellular network or your neighbor’s wi-fi.

A microgrid, then, is intended to bring more resiliency to the electric grid. It ties together local distribution equipment and generators, and keeps them up and serving demand, even if the surrounding grid is down.

For example, San Diego Gas & Electric is developing a microgrid in Borrego Springs, California. The remote community is served by only one transmission line that runs through a fire-prone area. The microgrid, which combines energy storage and solar photovoltaics, is intended to keep the area energized when the transmission line goes down.

New Jersey’s public transit operator, NJ TRANSIT, is also investigating the feasibility of a microgrid to keep its rail system operating even when power outages hit certain parts of the grid.

The University of California, San Diego’s campus has developed a slightly different flavor of microgrid, one that goes beyond resiliency to market response. Consumption and generation on the campus can be optimized jointly in response to electricity prices. For example, the aggregate consumption can be reduced in response to high wholesale energy prices, or peaks can be shaved to avoid demand charges.

Additional companies and policymakers are considering whether investments into microgrids make sense. How should they assess the opportunity?

Reviewing the costs and benefits is a good place to start.

Costs include deploying distributed energy resources, installing advanced grid equipment such as automatic switches, and installing a microgrid controller to keep all the parts working harmoniously.

Distributed energy resources such as rooftop solar and energy storage face challenging economics, especially as regulators continue to reform retail pricing . Of course, that could change over time.

Meanwhile advanced grid equipment, like switches that automatically reconfigure the grid to avoid outages, are becoming more common and accepted by the industry.

Still, fundamental technological breakthroughs are also needed. The microgrid controller is a substantial challenge as explained in this Sandia National Lab report. The microgrid needs to recreate the functions of the bulk power grid in a highly local area. For example, microgrid supply and demand need to be kept in balance in real time. That’s tough on the bulk grid, but even more challenging on a small scale where there’s no room for error. Any entity pursuing a microgrid today will be taking on a research and development effort on these controllers.

On the benefits side, microgrids potentially offer improved reliability, lower costs and greater integration of distributed renewable energy.

I expect reliability is the most important benefit. Focusing on ways to improve electrical reliability in the US makes sense, especially given our poor reliability relative to other industrialized nations.

In a world full of microgrids, few customers would experience outages. Grid problems would be quickly isolated and distributed energy resources would supply customers who are cut off from the bulk grid.

However, utilities have many alternative tools available to enhance reliability. Burying overhead lines, building redundant connections and investing in automated switches are all tried-and-true solutions.

An honest evaluation of microgrids needs to consider these existing alternatives.

Microgrids could also lower costs in some instances. For example, a microgrid could manage peak demand served by a particular substation in order to avoid or delay an upgrade. Once again, alternatives need to be evaluated. The cost of upgrading the substation could be more or less than the cost of setting up and running the microgrid.

Using a microgrid to help integrate distributed renewable energy is another benefit supporters point to. The idea is that the intermittent generation from, say, distributed solar, could be matched to energy storage and consumer demand to keep a circuit from becoming overloaded. This approach would allow utilities to accommodate new distributed solar installations on a crowded circuit, instead of prohibiting them, as recently happened in Hawai’i triggering widespread protests.

Even faced with multiple hurdles and cheaper alternatives, investments in microgrids could still make sense.

Government R&D funders need to consider whether microgrids should be prioritized above other R&D objectives. I suspect that microgrids R&D would make the cut in the US given our sorry electrical reliability. We need to do something different on the grid. Microgrids could be part of the answer.

For private companies, the case is tougher. A company would need to believe that it can capture the R&D spillovers by patenting new technologies that are developed and selling them to others. That’s a risky proposition given the immaturity of microgrid technology.

In the near-term, the dominant model is government and private sector partnerships. Companies invest an amount that makes sense given their likely private gains, and government R&D pays the rest. That approach makes sense.


The microgrid of my childhood. SOURCE: By KMJ at de.wikipedia (Uploaded by Nordelch) [GFDL or CC-BY-SA-3.0], via Wikimedia Commons

Of course there’s also the “cool” factor.

Growing up in Houston, I remember getting excited as hurricanes approached. I enjoyed pulling out the candles and flashlights to prepare for the inevitable power outage. Perhaps the children of 2030 will get just as excited about the activation of their microgrid to get them through the storm.

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How Can Zero (net energy) be a Hero?

I am frequently asked why people seem to dislike economists so much. It’s a complicated question to answer. There are lots of reasons, many represented in the comments section of this blog. One could be economists’ stubborn insistence on evidence-based analysis of programs we would all like to see succeed.  Another reason is the propensity of economists to complain like curmudgeons about popular ideas that seem to be embraced by everyone but make little economic sense.

I’m taking this latter path to unpopularity. This week the target is zero, or more specifically the calls and efforts to lead a zero net (insert bad thing here) lifestyle.


My Hero Zero from Schoolhouse Rock

Zero abounds throughout the UC system. A team at UCLA is working on zero net-energy building materials. My campus at Davis is the site of what the campus calls the “largest planned zero net energy community in the United States.”    Not to be outdone, UC Merced has a Triple Zero target by 2020. And there is a systemwide carbon neutrality initiative with a goal of making the UCs as a whole zero-net carbon by 2025.     Zero has also moved into official policy-making. The California Public Utilities Commission has spearheaded an effort to make all new California homes zero-net energy by 2020, and all commercial buildings ZNE by 2030. Fundamentally, the allure of such initiatives is to start making headway in reducing the consumption of something we may run out of (e.g., water or oil) or reducing the output of something that is doing us harm (e.g., greenhouse gasses).   But we have to ask ourselves whether it’s the best way to make progress.

It’s not that I’m opposed to the concept of zero net-carbon, it’s a matter of scale. I travel a lot and meet quite a few folks who still don’t believe in climate change (Americans mostly, but also a cab driver in Canada, a barrista in Australia – the common thread seems to be a dislike of Al Gore). In an attempt to convert such people I point out the fact that we are putting more GHG into the atmosphere than the earth can absorb, and if we continue on that path we eventually get to a REALLY high concentration of GHG. Even folks who may not, for some reason, be persuaded by today’s state of the art climate models should recognize that infinite carbon dioxide would be a bad thing. So sooner or later the earth is going to have to get back to at least zero net GHG.

The problem, from an economist’s perspective is therefore one of geographic scope. The only meaningful scale on which to pursue zero net carbon is a global one. One way to get to global balance would be for every house, every person, every store, to lead a zero-net carbon existence. But this is almost certainly not the best, or even a realistic, way to get the globe into balance. One of the basic insights provided by economic philosophy has been the concept of comparative advantage, which produces gains from trade.   The ability to specialize on the things we do well is one of the fundamental drivers of increased productivity and economic growth.


What is the harm of a zero-net (bad things) framework? I see a few serious concerns. One is that it distorts the way these self-contained communities view the costs and benefits of their own resources. This has been captured in discussions of how to price energy in zero-net energy communities. For example, if you’ve got enough solar panels and batteries, the marginal cost of producing renewable power is zero, and there is a temptation to simply charge a monthly fixed fee for power. That’s what’s done in West Village.

This highlights one of the distortions of zero. Namely, why stop at zero? If there are ample renewable resources on hand, wouldn’t it make sense to push some back out to the grid and displace someone else’s power. In other words, even though the marginal cost of generating power may be zero, the opportunity cost of that power is whatever you can sell it for.   Again, if there are potential gains from trade, don’t let zero stand in the way.

A second concern with the zero framework is an overemphasis on hitting zero. The zero framework implies that there is great reward when you reach zero, but if you get down to 10%, you are a failure. Witness the handwringing that is playing out over the “failure” of West Village, which is stuck at about 85% self supply. Much of climate policy is treating targets as all or nothing goals. Economists focus on the marginal (incremental) benefit of each successive MW produced or GHG ton saved and compare it to the costs of those savings. It could be that it’s pretty cheap to get down to 50% or 80%, and ridiculously expensive to get the last 10% to get down to “zero.”

A third problem is that zero promotes a fiction of self sufficiency and isolation that might become a reality. The wonders of smart-grid technology hold the promise of a more integrated system where refrigerators in Sacramento can be cycled to offset intermittent renewable generation in Fresno. Or technology could be deployed to create pockets of zero-net consumption that end up having to balance their own supply variation internally. Why is a zero community better than a zero State? Or a zero multi-state grid?

Some of these risks may be washed out in implementation of “zero.” After all, many definitions of net zero allow buildings or communities to credit energy or GHG reductions made elsewhere. This is just getting to zero by checking the boxes in a certain order, but it makes you wonder what the point is. If I can call my house net zero because it’s paying some money to a solar panel somewhere else, isn’t that just a form of retail choice?   If that’s what it takes to reap gains from trade in GHG reductions, I guess it’s better than nothing. But from where I sit, it would make more sense to work for an aggregate goal and spread the burdens proportional to the costs.

If these zero (bad things) targets are just aspirational and serve as a way to get people excited and mobilized about reducing (bad things),  they are not necessarily a bad thing.  However,  a narrow focus on a local zero fails to account for the big picture and can cause us to overlook more meaningful global solutions.   After all, the best way to a sustainable climate may have zero zero.

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Are the Benefits to the Weatherization Assistance Program’s Energy Efficiency Investments Four Times the Costs?

Today’s post is co-authored by Michael Greenstone (University of Chicago) and Catherine Wolfram (UC Berkeley) Faculty Directors of The E2e Project.

As featured in the New York Times For Government That Works, Call In the Auditors

The urgency of climate change demands solutions that work. And so, a clear-eyed assessment of how well existing policies and programs are performing is critical, no matter the results. Using rigorous evidence to inform policy design and implementation is the only way to ensure that we effectively confront climate change. The need for objective evidence is particularly important in the case of energy efficiency investments because they play a central role in virtually every single climate change mitigation plan.

Recently, we conducted a first-of-its-kind, randomized controlled trial of the nation’s largest residential energy efficiency program, the federal Weatherization Assistance Program (WAP). The trial consisted of a sample of more than 30,000 WAP-eligible households in the state of Michigan. Our research revealed that investments in residential energy efficiency upgrades among weatherized households in our study cost about double what these households will save on their energy bills (efficiency retrofits cost about $4,600 per household and estimated energy savings are only $2,400). You can read more about our results here.

These findings contradicted commonly held beliefs about the benefits of energy efficiency investments and generated a heated debate. Our previous blog post responded to some of the key concerns.

The Department of Energy (DOE) has since released 36 documents (here and here), totaling 4,446 pages, evaluating WAP. The boldly stated conclusion of the evaluation is that the benefits of the investments are four times the costs.

We have spent many hours poring over these opaque documents. Our judgment is that many of the DOE’s conclusions are based on dubious assumptions, invalid extrapolations, the invention of a new formula to measure benefits that does not produce meaningful results, and no effort to evaluate statistical significance. Using the DOE’s findings, we show below that costs exceed energy savings by a significant margin. We also document major problems with the valuation of non-energy benefits, which comprise the vast majority of estimated program benefits.

Overall, the poor quality of the DOE’s analysis fails to provide a credible basis for the conclusion that the benefits of energy efficiency investments conducted under WAP substantially outweigh the costs. This blog summarizes our assessment of the DOE’s analysis for a general audience. We provide a more technical discussion, using the important example of benefits relating to thermal stress, here.

I.  Energy Efficiency Investment Costs Exceed Energy Savings by a Significant Margin.

The typical approach to assessing energy efficiency investments is to test whether the energy savings exceed upfront costs. Using standard economic assumptions, our study and the DOE study agree that costs incurred under the Weatherization Assistance Program significantly exceed energy savings. Here we focus on the ARRA period, but the basic conclusions from outside of ARRA are similar (we explain this here).

What does the DOE find? They collect energy consumption data from approximately 16,000 households. They then compare energy consumption at weatherized households before and after weatherization with energy consumption in a comparison group. Using this basic approach, the DOE finds that the average annual savings for households is $223 per year during the ARRA period. This is the primary result on energy savings.

For most, if not all, households, the decision to pursue weatherization assistance is purposeful. Households may choose to invest the effort of applying for weatherization following – or in anticipation of – a change in energy consumption or their ability to pay energy bills. In other words, there could be important differences in energy consumption patterns across groups of households receiving weatherization in different time periods. The report provides little evidence that the comparison group provides a credible estimate of the energy consumption patterns that would have been observed among weatherized households had they not received weatherization retrofits. The consequence is that we cannot know whether the measured differences in energy consumption are due to the energy efficiency investments or the pre-existing differences between weatherized households and the comparison group.

In contrast, our study is based on a randomized controlled trial (RCT) precisely because we wanted to improve the quality of evidence on the returns to energy efficiency investments. The power of RCTs is that they deliver the true effects, obviating concerns about differences in the types of households that get weatherized and the timing of those decisions. Indeed, this is precisely why society has relied on RCTs to test the efficacy of new drugs for decades and is increasingly using them to evaluate social policy.

Setting aside concerns about the estimation strategy, it is straightforward to convert the estimate of average annual energy savings reported in the evaluation, $223 per year, into a present value of energy savings over the lifetimes of the measures installed by making several assumptions. The following table describes the present value of lifetime savings under different assumptions about the discount rate and the lifespans of the measures. Notably, the table follows the standard assumption in the economics literature and assumes energy prices will remain constant, after adjustment for inflation. It also generously assumes that there is no depreciation in the savings created by the measures.

Net Present Value of Energy Savings from DOE Study of ARRA Period
Time Horizon                                      Discount Rate
3 Percent 6 Percent 10 Percent
10 years $2,003 $1,641 $1,370
16 years $3,028 $2,254 $1,745
20 years $3,646 $2,558 $1,899
Note: The table reports the net present value of energy savings (in dollars) implied by the DOE’s household-level energy savings estimates ($223) using a range of discount rates and assumed time horizons. Reductions in energy bills associated with the estimates are assumed to accrue over the life of the measure.

These “present value” energy savings can be compared against the average cost per weatherized household. The DOE reports a wide variety of costs, and it is difficult to judge which should be compared to the savings. The most straightforward is the average total expenditure per weatherized household: $6,812 during the ARRA period. The DOE reports incurring costs per household of $5,926. When comparing household benefits and costs, the DOE evaluation uses a much lower $3,745 per household, although it is unclear what cost components are omitted to arrive at this low number.

Using a 6 percent discount rate that seems a reasonable approximation of households’ borrowing costs, a 16-year time horizon (the average projected lifespan of efficiency measures in our data), and assuming no depreciation in annual energy savings (likely generous), the DOE estimate of annual energy savings implies a present value of $2,254 per household. This is less than half of the DOE expenditures per household. It also falls significantly below the lowest reported costs of $3,777.

To compute the average discounted value of energy savings, the DOE uses a longer time horizon, a lower discount rate, and assumes that energy prices will increase in real terms over time – all assumptions that make the savings look larger. These assumptions imply a higher present value of $3,190 per household. This higher value notwithstanding, WAP program costs still exceed estimated savings by a significant margin.

The conclusion that the program is remarkably cost effective cannot be justified on energy savings alone. The DOE’s claims rely heavily on the possibility of substantial non-energy benefits. We explore the credibility of these estimated benefits next.

II. Unreliable Approaches to Exploring Whether there are Non-Energy Benefits.

The DOE evaluation reports a program-wide benefit to cost ratio of 4 to 1. To arrive at this conclusion, the report points to a long list of “non-energy” benefits. They include health-related benefits such as reductions in thermal stress and asthma (valued at $6,870 per household) and improved productivity at home and at work due to improved sleep (valued at $3,142 per household), safety-related benefits such as reduced fire risk and reduced carbon monoxide levels (valued at $985 per household), and other benefits such as reduced reliance on food and energy assistance programs (valued at $1,641 per household). The rationale for relating energy efficiency investments to some of these outcomes (e.g., improved productivity due to better sleep) is not well articulated, but nevertheless we examined the basis for the claims.

A close look at these claimed benefits uncovers significant problems with the methods used and assumptions invoked. We highlight three general concerns here.

  1. Non-energy outcomes are not directly measured. And the path from imputed impacts to benefits estimates is generally dubious.

In contrast to energy consumption, which is measured directly using household energy bills, most of the non-energy benefit estimates are based on survey responses from program participants. Connecting the dots between survey responses and non-energy benefits involves many steps. The resulting benefit values are extraordinarily sensitive to many key assumptions, several of which are not well explained or substantiated.

The significant benefits attributed to reduced hospitalization rates after weatherization provide one example. DOE surveyors asked a select set of households the following question: “In the past 12 months, has anyone in the household needed medical attention because your home was too cold (hot)?” Using a formula they invented that has never appeared in any textbook (more on this below), the DOE deduced from the survey responses that weatherization assistance reduced the share of households needing medical attention by 1.4 percent.

The path from the response to this survey question to monetized benefits is long and winding. The nearly $5,000 per household of mortality reduction benefits are particularly illuminating. Since no data on mortality was collected, the path to claimed reductions in death begins with the above question about medical attention. Of course, not all instances of medical attention lead to death, so the DOE analysis assumes that some proportion of these instances lead to hospitalizations, doctor visits, or emergency room visits. The next step in this circuitous path is to assume that some fraction of the assumed hospitalizations lead to death. Consequently, responses to a survey question about “medical attention” turn into $5,000 worth of benefits per weatherized household.

This approach to calculating benefits is applied throughout the analysis of non-energy benefits. For example, responses to questions about sleepless nights are converted into productivity benefits that exceed $3,000 per household. The general point is that the failure to directly measure the outcomes of interest leads down a long and winding road that seems far removed from solid footing.

There are three other noteworthy points about the imputation of health-related benefits

  • It is natural to assume that the starting point of benefits associated with reduced thermal stress would be a substantial change in indoor temperatures, making it warmer in the winter and cooler in the summer.In the only report where indoor temperature is directly measured, DOE finds that average indoor temperature increased by 0.3 F in weatherized homes as compared to a control group. This very small change calls into question the basis for the claimed health effects due to reductions in thermal stress.
  • Notably, in cases where DOE analysts were able to directly measure outcomes with a documented connection to health, these data were not systematically used in the benefits valuation exercise. For example, DOE researchers conducted a field study of indoor air quality parameters in weatherized homes, including carbon monoxide (CO), radon, formaldehyde, and temperature. This study found no significant changes in carbon monoxide following weatherization. Yet, the claimed benefits include reductions in CO poisoning.
  • In contrast, weatherization was found to increase radon and formaldehyde levels. In the accounting of costs and benefits, however, no effort was made to quantify the potential health costs from the increase in these potential health risks. Thus, at least in the case of the direct indicators of air quality, the DOE study assigns benefits in cases when direct measures do not change and fails to evaluate costs when the indicators worsened. This selective accounting is a cause for concern.
  1. The invention of a new statistical technique to estimate benefits.

A very standard approach to estimating the impacts of an intervention (such as weatherization assistance) on an outcome, absent a randomized controlled trial, involves taking the difference in the pre-post change in outcomes in the treated group and then subtracting the pre-post difference in a comparison group. This is the basic approach that the DOE used to calculate energy savings summarized above. If outcomes observed in the comparison group provide a good proxy of what would have been observed in the treated group absent the treatment, this approach can provide a credible estimate of the effect of a program.

To estimate impacts on key non-energy outcomes (such as health and productivity), the DOE introduces a very non-standard and non-intuitive approach. Specifically, DOE analysts compute the average of the observed pre-to-post change in outcomes in the treated group and the observed difference in outcomes between the control group and the treatment group in the pre-period. This approach takes an average of two differences, rather than subtracting one from the other. In doing so, it undermines the entire rationale for the difference-in-difference approach (namely to control for the effect of potentially confounding changes over time that are not caused by the weatherization).

To the best of our knowledge, this approach has never been used in any textbook or research paper previously. Additionally, DOE researchers provide no rationale. While the DOE’s analysis of energy savings requires some non-trivial assumptions that are not required for randomized controlled trials, it is at least a recognizable approach to estimating the impacts of the program. In contrast, the approach to estimating non-energy benefits is unrecognizable, and we believe the resulting estimates have no meaningful interpretation.

  1. No attempt to separate a signal from the noise.

People’s lives change from day to day for many reasons. For example, the number of work days missed, or prescriptions filled, can vary over time for a variety of reasons most of which cannot be measured. The standard practice is to test whether a program’s impacts are statistically significant or just due to random chance. The evaluation does not follow this important convention. Indeed, the little information that is provided in footnotes about the variability of outcomes in treatment and comparison groups suggests that many of the key differences documented could well be due to random chance versus a causal impact of weatherization.

In summary, non-energy benefits comprise a very significant share of the estimated benefits of the energy efficiency investments that were made through the WAP program. The process of assigning dollar values to non-energy costs and benefits is inevitably complicated. Estimated values can be highly sensitive to underlying assumptions and measurement choices.

We find the DOE’s evaluation of non-energy benefits is flawed in several respects. While it is certainly possible that the people who received weatherization improvements benefitted in other ways, our judgment is that the DOE analysis fails to provide evidence that can credibly confirm or contradict this possibility.


The DOE has gone to great lengths to collect data on what happened to households after they received weatherization assistance. For this, they should be commended. However, the data were not analyzed in transparent and standard ways; this undermines the credibility of the results.

A seriousness of purpose in achieving policy goals requires finding out what works. A commitment to independent evaluation is the critical first step, and that requires high-level political support. The Obama Administration has supported evidence-based policy making in other realms; there are great opportunities to extend these efforts.

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Why are California’s Gasoline Prices So High?

“What?” you may be saying “Gas prices are lower than they have been in a long time.”   That’s true, even in California, but that just reflects the collapse of world oil prices.  And only partially.  You see, while oil prices have been falling across the country, the gap between California gas prices and the rest of the U.S. has climbed to higher levels for a longer stretch than at any time in the last 20 years.

CAvsUSRetailGasPriceWhy? I don’t know, but some people claim to, from consumer advocates arguing it’s collusion to industry representatives saying that it’s just a shortage of supply for California’s special cleaner-burning blend, known as CARB gasoline.

The figure above shows the difference between California’s average gas price and the U.S. average going back to 1995 when the state started requiring CARB gas.  For the decade from 2005 to the end of 2014, California’s retail price averaged about 31 cents above the national average.  That differential lines up well with the fact that our gas taxes were about 20 cents above the nationwide average during that time and making CARB gasoline adds about 10 cents a gallon to the cost.

On January 1, 2015 transportation fuels came under California’s Cap-and-Trade (CaT) program for greenhouse gas (GHG) emissions, as I discussed before.   It is now widely accepted that the CaT program should have, and has, increased gas prices by about ten cents a gallon.  Add that in, and we’d expect the differential between California and the rest of the country (where GHG emissions are still free) to average around 40 cents per gallon.

That’s about where things were for the first month and a half of 2015, but then on February 18 a fire at Exxon’s Torrance refinery near LA shut down the plant’s gasoline production.   That refinery normally produces about 10% of the state’s CARB gasoline.  Since then, California’s gas price has averaged about 82 cents per gallon higher than the national average.  The extra 42 cent premium since February 17 totals up to nearly $4 billion in extra payments – more than $150 for every licensed driver in the state – and still growing.   As of yesterday, the average California price was 71 cents above the US, according to AAA.

NoCAvsSoCARetailGasPriceThe problem is worst in Southern California, where prices since mid-February have averaged 26 cents higher than in the North.   In the previous decade, the North-South differential averaged around one cent.

High prices don’t necessarily mean that anyone is profiting unfairly or doing anything illegal.  Scarcity of a product drives up prices even in the most competitive markets.[1]

Events like the Torrance fire have caused price spikes in California before, but they generally have disappeared within 4-6 weeks, because that’s how long it takes to import CARB-specification gasoline from the many other refineries in the world that can produce it.  In 2012, when the Chevron refinery in Richmond had a major fire, prices jumped 50 cents for a couple weeks, but within a month that excess differential was gone.   As the figure above shows, previous spikes have never before lasted nearly as long as the current one.

So, this spike does suggest that something is amiss in this market.   Why is this spike so long lasting?  And what, if anything, should the state do about it?

Chevron+Posts+Best+Quarterly+Earnings+Record+Svo93DoV961l$4 gas was common in Southern California this May

Some consumer advocates point to increased concentration among in-state producers of CARB gasoline in the last few years and allege these firms are now colluding to reduce competition.  But the evidence presented so far is thin, mainly just that refineries are making a boatload of money.   That could indeed be due to producers restricting the quantity they sell in order to boost prices, but it could instead just reflect refineries having insufficient capacity to replace the lost production capacity when one of the largest producers shuts down unexpectedly.  Either could cause the price to jump.  In a 2004 paper that Jim Bushnell, Matt Lewis and I wrote, we discussed competitive and non-competitive causes of high gasoline prices, how difficult it is to tell them apart, and policies that might address them.

Critics also point to the fact that California refineries have been exporting gasoline despite the high prices at home.  But not all of the gasoline made in our refineries can meet the strict specification for in-state sales.  Non-qualifying gasoline is regularly shipped from California to Nevada, Arizona, Mexico and other places with lower standards.   So, exporting gasoline doesn’t seal the deal on anti-competitive behavior.  Now if California refiners were exporting CARB-specification gasoline since February – or making a choice to produce less CARB gasoline — that would be much more difficult to reconcile with competitive behavior.

Nonetheless, while consumer advocates have not proven their case, their suspicions have merit.  With prices very sensitive to even a slight shortage, and with two companies producing about half the state’s CARB gasoline supply, it seems quite possible that firms might be able to make more money by making less CARB gasoline.  This could be particularly true when a supply shock like a large refinery fire has already tightened the market.  That doesn’t prove they are doing it, but it does – as the lawyers say – go to motive.

In the past, one response from the industry has been that such output restriction would just create an opening for imports of CARB gasoline that would steal their market share.  But that leads us to perhaps the biggest puzzle of the current price shock: where are the imports?  With California’s prices this high – regardless of whether due to real scarcity or insufficient competition among in-state producers — it seems there is ample money to be made bringing in CARB gasoline from afar, as has happened during past spikes.  Why isn’t that happening this time, or happening in sufficient quantity to bring California’s prices back in line with the rest of the country?

More than one of my environmentalist friends has responded to my concerns by asking what’s so bad about high gas prices.  After all, we need to move away from gasoline and this will help.  I think there are a couple reasons that this isn’t the way we want to get off gasoline.

First, high gas prices hurt lower-income working families, so if we were imposing high prices with, say, a carbon tax policy, I at least would want to pair it with some other tax relief for that group to help offset the higher cost of fuel.  This isn’t a government tax policy, just higher profits flowing to private companies, and there is no offsetting tax reduction.

Second, because California is a leader in all things enviro, our energy policies are scrutinized worldwide.  If our fuels policy is viewed as causing inexplicably high gasoline prices, that will undermine political support for similar policies in other jurisdictions.

A year ago, I was named a member of the California Energy Commission’s new Petroleum Market Advisory Committee, five industry experts charged with examining the state’s high and volatile gas prices, and suggesting policy responses.  Three weeks ago, I was appointed chair of the committee.  Working with CEC staff, I hope very soon to hold a workshop at which we can hear the views of all stakeholders – refiners, importers, retailers, consumer groups and others — and ask them detailed questions.   Such an open discussion will, I hope, bring more insight and common understanding than we have gotten from the media-targeted rhetoric that usually accompanies discussions of gas prices.

[1] If you buy a house just before the market rebounds and then sell it a few years later at a tidy profit, is that unfair?

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VW’s Deepwater Horizon?

Last week one of the biggest environmental scandals since the Deepwater Horizon disaster made its way to somewhere near the bottom of page 11 of most major newspapers. VW admitted to systematically cheating on emissions tests of its Diesel vehicles. This might sound snoozy, until you read up on the details.

Vehicles across the US must satisfy emissions standards for criteria air pollutants (e.g., NOx, SOx, CO2). California, of course, has the most stringent of these standards and enforces them for new and used vehicles. If you have an older car, you need to go get your car smog checked every few years to make sure your clunker is still clean enough to be allowed on California roads. It is for this reason that until recently the share of Diesel cars in California was extremely low, since almost no vehicles satisfied these stringent standards. In come the “clean Diesels”, pushed mainly by German manufacturers of normal people (e.g., VW) and luxury (e.g., Mercedes and BMW) vehicles. Diesel was finally salon worthy! Look! It’s fuel efficient and clean! Many of my Birkenstock-wearing, dog-owning, El Capitan-summiting colleagues and graduate students ran out and traded in their Prii for the VW TDI wagon. So much space! So much torque! So much fuel efficiency! So much clean! Well, it turns out what sounded too good to be true was.

In a Lance Armstrongian feat of deception, VW has now admitted to having installed a piece of software called a “defeat device” that turns on the full suite of pollution control gadgets when cars are being smog tested. As soon as you leave the testing station and head out for your Yosemite adventure with Fluffy barking in the back, your car emits 10-40 times (!!!!!!!!!!!) the amount of NOx you just reported on your smog check card. Just to put this in perspective – this is like that 215 calorie Snickers bar having 2150-8600 calories instead. The EPA will almost certainly sue VW. The penalties involved here are significant. The EPA can ask for $37,500 per incident, which amounts to roughly $18 billion in fines. Plus there will likely be criminal charges filed against VW executives. Further, depending on whether these vehicles will continue to be sold in the US after everything is said and done, this is a disaster for VW as they rely heavily on the high fuel efficiency ratings of Diesels to satisfy CAFE.

In my eyes there are two interesting economic points to be made here. The first, maybe more headline worthy, is trying to determine the optimal fine in order to deter other manufacturers from engaging in such behavior. An economist would argue that what we have here is the classic case of an externality. By selling the dirtier vehicles, VW exposed kids, adults and dogs to massive quantities of local air pollutants. VW is responsible and should be liable for this. Hence VW should correct this market failure by paying the full external costs it caused. This calculation would involve estimating the economic damages from this additional air pollution and passing the bill on to VW. My back of the envelope calculation suggests that for the NOx portion this is about $232 per vehicle over three years (far from $37,500).

But, there is a large law and economics literature on determining the fines to achieve the optimal and efficient amount of deterrence. The problem with just passing on the external damages is that VW was not going to be caught with certainty. If the executives thought there was a 1% chance of getting caught, it might have been more worthwhile to cheat than if they thought that they were going to get caught with certainty. In this case, the penalty should be approximated by the external costs divided by the probability of getting caught. This, of course, would be significantly larger than the external costs alone. Getting the external costs right is hard to do (e.g., you need more pollutants and the damages vary across space), but can be done with standard tools in the talented economists’ empirical toolkit.

The broader question is how did this happen? This is not one student cheating on an intermediate microeconomics exam and thinking (s)he would get away with it. This is the world’s largest car manufacturer intentionally deceiving the federal and state governments by gaming their enforcement strategy. While some cynic might remark that folks will always cheat when there’s a dollar to be made, I think we can rethink how we design regulations by building in evaluation from the get go.

Michael Greenstone, who spends his summers two doors down the hall, has thought a lot about this recently. In the US, we pass many of our major regulations based on ex ante cost benefit analyses. Testifying on Capitol Hill, he recently made two suggestions that would significantly improve things. First, he argues that we should institutionalize the ex post review of economically significant rules “in a public way so that these reviews are automatic in nature”. He also argues that rules already in effect should start being reviewed using retrospective analysis. The relevant agencies should commit to changing or abandoning rules based on these evaluations, or possibly create new rules based on these evaluations.

The big issue here is of course, who should review these policies? He argues in favor of the creation of a regulatory analysis division within the Congressional Budget Office. This division would conduct the regularly scheduled reviews and conduct reviews at the request of lawmakers. I would go one step further and argue that these reviews should not only be staffed with government employees, but require the review and participation by independent academics. There is precedent for this model.

The certainty of independent review of policies and enforcement strategies significantly drives up the probability of detection, which would diminish the expected profits from cheating. By firms large and small. Plus, we are spending scarce public funds on environmental regulation. We should spend it on what works. And we need to figure out what that is.

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Are We Too Fixated on Rural Electrification?

“Rural electrification” and “energy access” are catchphrases in many energy and development circles. Multilateral lending agencies, many NGOs and the UN are highlighting the 1.3 billion people who currently do not have electricity in their homes. For example, of the UN’s 17 Sustainable Development Goals, number 7 is to “Ensure access to affordable, reliable, sustainable and modern energy for all.” Similarly, the UN and the World Bank launched the Sustainable Energy For All initiative in 2011, whose name basically defines their vision.

Building out the grid in Kenya

Building out the grid in Kenya

Electricity is certainly a vital part of modern life. Without it, people can’t watch TV, refrigerate food and medicine, charge a cell phone, protect themselves from extreme heat, or do many of the things those of us in the developed world take for granted.

I’m concerned, however, that development efforts may be misdirected because of the near singular focus in the energy sphere on this particular goal. I’m worried about two potential outcomes – that we’ll stop short or that we’ll go too far. My concerns may seem contradictory, but I fear that both are made more likely by focusing too exclusively on one binary measurement. (I’ll leave for another blog post the messy ethics of focusing on sustainable energy access – achieving energy access with green sources.)

Perils of Stopping Short

Here’s the potential problem with stopping short. I worry that once a household has a small solar home system, the data collectors will declare it “electrified” and policy makers will put a checkmark in the electricity box and declare victory. But, solar home systems provide very limited services at high per kWh prices and don’t allow people to do many of the things we associate with modern energy access.

For example, mKopa, the leading solar provider in Kenya, sells a tiny 8 Watt system that comes with 3 LED bulbs, a radio and a cell phone charging station. (Unfortunately, this very system was championed in a New York Times op-ed last week.)

The world’s chief energy data collectors at the International Energy Agency recognize that “[a]ccess to electricity involves more than a first supply to the household,” and claim that an appropriate definition of electricity access would include a minimum annual kWh usage level. But, they conclude that:

[t]his definition cannot be applied to the measurement of actual data simply because the level of data required does not exist in a large number of cases. As a result, our energy access databases focus on a simpler binary measure of those that do not have access to electricity…

I am part of a working group at the Center for Global Development that’s advocating for better data and reporting on energy access. A report is due out soon.

Perils of Going Too Far

The dangers associated with going too far are subtler, and may not be empirically relevant, but let me describe my concerns. As the chart below demonstrates, there is clearly a strong positive relationship across countries between GDP per capita and electricity consumption per capita. (The figure plots the natural log of both variables, so you can think of the relationship reflecting percent changes.) The same pattern holds for lots of other development indicators besides GDP per capita.GDPVKWH

Let’s assume that we know the relationship in the above figure is causal, meaning that driving up electricity consumption in a country will cause its per capita GDP to grow. What the chart misses is that not all kWh are created equally. A kWh that replaces a kerosene lamp with a CFL for a month may not be the same as a kWh that helps power a factory that employs 10 people for an hour, and one may have a larger impact on development than the other.

What if governments are less likely to electrify schools if they’re focusing on homes? Or, what if utilities that spend more money on building out their electricity systems to reach homes can spend less money on ensuring factories or hospitals get reliable electricity?

None of the Sustainable Development Goals are targeting the number of schools with electricity or the number of industries with reliable electricity supply, and, to my knowledge, we don’t have a firm analytical grasp on whether spending money on rural versus industrial or health sector electrification helps improves people’s lives by more.

I am not denying that rural electrification brings benefits. Nonetheless, any expenditure of public, World Bank or NGO money has an opportunity cost, so spending money on rural electrification means we can’t spend money somewhere else.

This struck me seeing the juxtaposition of a sleek new electricity meter on a Kenyan woman’s mud wall. She liked replacing her kerosene lamp with an electric light bulb and her neighbor liked having TV, but connecting her to the grid is not cheap. What else could the government have done with that money that may have helped this woman more than the electricity connection?IMG_3397

We asked another woman in the compound whether she would prefer her electricity connection or a new motorbike. She said electricity. But when we gave her the choice between better health services or electricity and better education for her kids or electricity, she chose both of those over electricity. If this woman is representative, electrification in rural households is not yet the right priority.

That said, there are reasons to believe I don’t need to worry about going too far. It is entirely possible that building out the electricity grid to reach homes will make countries more likely to connect health centers and schools, and not less likely. Also, there could be a lot of benefits that come from rural electrification that wouldn’t be captured if the kWh were directed at factories – what economists call spillovers. For example, one person interviewed in an NPR story (which features my co-author TedIMG_2757 Miguel) described how getting an electricity connection made him feel, “part of Kenya.” Similarly, introducing this young boy to engineers installing electricity at his home may incite an interest in engineering and make him more likely to go to university. These indirect effects are difficult to measure, but they may be very important.

Governments and NGOs need to figure out how to get the biggest bang for their buck. So, we need more data and more analysis to figure out the best way to improve people’s lives and how big a role there is for rural electrification. It may turn out that rural electrification has high payoffs relative to alternatives, but there are risks to forging ahead without a richer understanding of how electricity drives economic growth, improved quality of life, and other development goals.

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