Everyone loves rebates. But the uncomfortable truth is that while utility rebates and government tax credits can lower the capital cost of electrification, the price of electricity continues to rise.
This week’s guest – economist and analyst Ahmad Faruqui — helps us understand why lowering the cost of electricity is critical for residential electrification to grow.
The following has been edited for brevity from a forthcoming article with permission of the author.
Everyone loves rebates. But here’s the uncomfortable truth: utility rebates and government tax credits lower the capital cost of electrification — in some cases by as much as $10,000 — but they do little to lower its operating costs. And high operating costs pose a substantial barrier to electrification in high-cost regions in the US and Canada.
Existing rate designs, such as time-of-use rates, higher fixed charges and demand charges, can lower operating costs but usually not enough to accelerate adoption of electrification equipment.
Let’s talk about how shifting the paradigm for designing rates can substantially lower operating costs without adversely affecting the revenue requirements of utilities.
While heat pumps are not being adopted by customers as fast as policy makers had hoped they would, EV sales continue to grow despite high electric rates in certain regions because gasoline prices are equally high. In my case, during the past 12 months, I spent $1,095 to charge my Model 3 Tesla and saved $578 by not driving a comparable gasoline car. But as electric rates continue to climb, the driving cost advantages of an EV over gasoline vehicles will eventually diminish, slowing the rate of adoption of EVs.
There is no easy way to lower the rate level overnight, because that will erode utility revenues and create financial turbulence. We need a new rate design paradigm that satisfies three conditions:
1. Makes electrification affordable
2. Recovers the utility's revenue requirement
3. Does not unleash a public outcry
It’s a time-honored principle in public utility economics to price energy services at marginal costs. In theory, electrification can be encouraged by setting the energy charge equal to the marginal cost of energy in cases where marginal cost is lower than average cost. But that will create a significant deficiency in revenues for public utilities. Thus, some have suggested recovering the revenue deficiency through a fixed charge. However, in states and provinces with high electric rates, this will yield really high values for the fixed charge when the energy charge is dropped to the marginal cost of energy, which will be a lot lower than the average cost.
To deal with that adverse effect, some have suggested that the fixed charge should vary based on income, being lower for low-income customers and higher for all other customers. But this rate design (really a shell game between fixed rates and energy charges) will also not accelerate electrification.
A new rate design paradigm
Today, a few utilities allow customers with EV to be charged a rate that is specific to that vehicle if they install a separate meter. Other utilities are examining the use of telematics to bill EV customers for charging their vehicles at home, which would eliminate the need for separate metering.
As for heat pumps, under the traditional metering and pricing paradigm, this would have required end-use metering, which can be very expensive. That’s no longer necessary. Artificial Intelligence (AI) may be able to infer the incremental load associated with electrification to which marginal cost pricing would be applied.
If there is some hesitation in using AI, an alternative would be to initially apply marginal cost pricing to all incremental changes in load shape. Georgia Power has implemented marginal cost pricing in this fashion since the 1990s for commercial and industrial customers. The pricing design they offer is real-time pricing. Both day-ahead and hour-head versions are provided, depending on the size of the load.
Consider the case of Pacific Gas & Electric Company, which serves more than 5 million customers in northern California. Using the E-1 tiered rate as a point of reference, the price of electricity has doubled over the past seven years, far exceeding the rate of inflation. As a point of reference, in 2008 the rate stood at 16.4 cents/kWh. More increases are expected to occur at year end, with the average rate possibly reaching 50 cents/kWh.
One of the popular rates being used by its EV customers is EV2-A. The rate features three pricing periods. During the summer, the off-peak rate is 31 cents/kWh. If EV load is priced at the marginal cost of electricity, the price may drop to 10 cents/kWh.
A typical household whose EV load is 3,000 kWh a year would see their annual EV driving costs drop substantially from $930 to $300. This would substantially enhance the appeal of EVs to drivers who are in the market for a new car, and probably accelerate the EV adoption rate.
It's imperative to change the existing rate design paradigm, which argues that rates should only be applied at the whole house level and extend the rate design paradigm to allow marginal cost pricing to be applied at the technology level.
Technology-based marginal cost pricing can lower the operating cost of electrification without triggering a redistribution of wealth among customers, which would precipitate a public backlash. Rates for existing load shapes would remain unchanged. Utilities will still recover their revenue.
Society as a whole will benefit through the reduction of carbon emissions that will accompany electrification. Climate change will be mitigated. Customers who electrify will see lower bills compared to what they would be paying with gas furnaces and ICE vehicles. There will be no losers. No one will see higher bills.
Ahmad Faruqui has 45 years of consulting, teaching and research experience in the efficient use of energy. He has worked for over 150 clients across the globe and appeared nearly 100 times before public agencies.
He has authored more than 100 papers and co-edited books on electricity pricing, customer choice and industrial structural change. He has appeared on NPR and Fox Business News and his work has been cited widely in several newspapers and magazines.
He has taught economics at San Jose State, UC Davis and the University of Karachi. He holds a doctorate in Economics from UC Davis.