Electricity prices in California are not fair and not good for incentivising electrification, says James Sallee at the Energy Institute at Haas, because of the way people are being billed. There is no doubt that electrification (grid upgrades, etc.) and climate mitigation (including controlling California’s wildfires caused by power cable failures) must add to the cost of transition. But Californians can now find themselves paying up to twice the national average per kilowatt-hour. Sallee stresses two main points. Firstly, wealthy households with their own behind-the-meter rooftop solar are avoiding costs. Secondly, high prices work against the consumer purchase of heat pumps and EVs. Sallee summaries their paper “Designing Electricity Rates for An Equitable Energy Transition”. He ends with proposed solutions, such as establishing income-based fixed charges and shifting some costs off of customer bills and onto the state’s general budget.

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

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

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

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

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

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

Why are prices so high in California?

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

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

We know from prior work that these prices are too high from an efficiency point of view, but we wanted to understand the components that drive these prices. To do so, we broke down the cost of electricity into generation, transmission, distribution, pollution and other costs, separating each into components that represent marginal (avoidable) costs that scale with usage, and those that do not.

We summarise our results in the “waterfall” figure below, which stack the pieces that represent marginal cost on the lower staircase, with the remaining costs that are recovered through rates on the upper staircase.

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

“Electricity consumption tax”

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

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

Necessary costs

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

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

Wealthy households with rooftop solar are avoiding costs

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

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

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

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

Recalculating our route forward

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

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

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James Sallee is Assistant Professor, Department of Agricultural and Resource Economics, University of California, Berkeley, and a Research Associate of the Energy Institute at Haas

This article is published with permission.

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