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California must fix its expensive and unfair electricity pricing

Uploaded: Jan 31, 2021
Back in the olden days, when we used to go places, I enjoyed travelling to visit my sister in Minneapolis. I would take lots of scenic pictures -- lakes! -- but inevitably I would take a photo like this:

Gas prices in Minneapolis on January 30 (Photo credit: Karen Listgarten)

It always amazed me how cheap gasoline was in Minnesota, and in fact pretty much anywhere outside of California. This data from the US Energy Information Administration backs that up. We pay about a 40% price premium for gasoline.

We pay about 40% more for gasoline. Source: US, CA, SF

What I didn’t realize on all of those trips is that the gasoline prices in California are nothing compared to the electricity prices we pay here. (It did not occur to me to look at my sister’s electric bills!)

Our electricity prices are high! Source: US and CA, PG&E (1)

We pay 47% more for electricity in California than in the US on average, and an eye-popping 72% more in the Bay Area. Ouch. I wonder if we would be doing things differently if electricity prices were posted on signs just like gas prices...

Our electricity is even pricier than our gasoline, compared with national averages.

I’ve been wondering about this because:

(a) Our electricity relies on cheap renewables and natural gas, so it’s not clear why the rates are so high; and

(b) High electricity prices make it harder for us to electrify and hit our emissions goals. Why are we trying to run a race (emissions!) while shooting ourselves in the foot (high prices!)?

To begin to answer this question, I looked at this chart from the California Public Utilities Commission’s annual report on electricity and natural gas costs. It shows a breakdown of our electricity rates. You can see that the cost of generating one additional kWh of electricity -- the generation cost -- is relatively small compared to the rate we pay. Much of the rest comes from transmission and distribution, which are largely fixed costs, along with a small amount for “public purpose” programs like energy efficiency, EV infrastructure, and discounts for low-income households. (Remember those heat pump water heater rebates from the last post? We pay for them via our utility bills.)

Electric rate components. Source: CPUC report for the year 2019.

This chart helps to explain why rates from Peninsula Clean Energy and Silicon Valley Clean Energy aren’t as low as you (or they) might hope. They have to pass along most of the PG&E costs as well as a supplementary “franchise” fee. They are able to save you money only on the blue “generation” component. (2) More generally, this chart shows that cheap renewables can only do so much for our prices if other costs like distribution and transmission are high. (3)

So are we stuck with high electricity bills? It seems unlikely that distribution and transmission will get much cheaper, especially with wildfire and other safety concerns. (4) But some researchers are asking whether these large, generally fixed costs belong on our bill to begin with.

Severin Borenstein, an economist at UC Berkeley who is an expert on electricity pricing, argues that by pricing our electricity using high “average costs” rather than the smaller incremental or “marginal” costs, we are causing a number of problems. The higher prices mean that customers are less likely to switch from gas to electricity, and wealthier homeowners are more likely to bypass the system with rooftop solar and home batteries. (5)

When electricity is nearly free, moving away from gas looks pretty appealing. As the solar households electrify their homes, paying neither gas nor electricity bills, lower-income households are left holding the bag, paying an increasing share of the fixed costs of both utilities.

The pricing incentives are pretty messed up when it comes to equitable electrification.

There is something inherently unfair about incorporating fixed costs into our electricity rates, but it may not be obvious. After all, it seems like a good way to pay for the poles and wires, vegetation management, and so on. Indeed, it’s pretty common to put fixed costs into product prices. A retail store will incorporate the costs of its buildings into the prices it charges. The price for a gallon of gasoline will include the costs of maintaining the distribution network. In this way, everyone pays for those costs in proportion to what they buy. It seems fair, right?

Well, not so much when it comes to electricity. The problem is that people of all income levels use similar amounts of electricity. (An economist would say that demand for electricity is relatively “inelastic”.) As a result, allocating fixed costs based on electricity usage hits lower-income households harder.

Borenstein shares this graph illustrating the concept:

It is less equitable to include fixed costs in electricity rates than it is to include them in gasoline prices or product prices more generally. Source: The Energy Institute Blog, 2020

The orange line at the bottom, showing what we spend on electricity relative to the lowest-income households, is pretty flat. Wealthier people do spend more on electricity, but not much more. In contrast, wealthier people spend a lot more than lower-income people on gasoline (the green line), and even more on stuff in general (the purple line). Because the orange line is so flat, bloating electricity rates with fixed costs disproportionately hurts low-income households, even more so than a gas tax or a sales tax. This gets even worse as higher-income households move to solar and stop paying these costs. (The orange line gets flatter and could even slope downwards.)

Borenstein proposes that rather than allocate fixed costs based on electricity usage, we allocate them based on income. He outlines a few ways that could be done, including tax credits (ala the Earned Income Tax Credit). Borenstein’s blog post on this topic is worth reading, as well as this comment (“This is turning electricity supply into a public good on the same order as education and public health.”) and this one (“The problem is not so much rate design as it is the excessive revenue requirements of the California IOUs.”).

What impact would removing fixed costs from our bills have on prices? Borenstein and Bushnell model how rates across the country could evolve if our rates reflected only the incremental cost of adding new power. The map below shows today’s marginal price per kWh. You can see that prices are high here in California as well as in the northeast.

Price per kWh across the US. Source: Borenstein and Bushnell, 2019

If states were to remove the fixed costs from their rate structure, so that rates better reflected the cost of producing one more kWh, the rates might look like this. (This is referred to in the paper as the “private marginal cost”.)

Private marginal cost estimates. Source: Borenstein and Bushnell, 2019

California is no longer an outlier!

Borenstein and Bushnell also look at an alternative adjustment. What would happen if electricity rates reflected the costs of pollution emitted by power plants? They might look like this, reflecting dirty power in several areas of the country. (The paper refers to this as the “external marginal cost”.)

External marginal cost estimates. Source: Borenstein and Bushnell, 2019

If you combine these two changes -- removing fixed costs and incorporating pollution impacts -- the prices might look like those shown below, which the paper refers to as the “social marginal cost”.

Social marginal cost estimates. Source: Borenstein and Bushnell, 2019

That is the kind of electricity pricing I could get behind! (My sister in Minnesota, maybe not so much.)

The point is, prices have consequences and we have options. In California, and across the country, we should have energy prices that align with our policies. The high electricity prices and underlying rate structure in our state are hurting our ability to fuel switch and hitting low-income households with more of the fixed costs. Moreover, the high prices are encouraging homes to move to off-grid power. As generally high-income earners switch to rooftop solar and then electrify their homes, greatly reducing their utility bills, lower income households end up paying even more. That cannot be the future we seek. Our electricity pricing should be designed to turn us away from fossil fuels both quickly and equitably. We must do better.

Notes and References
1. I use the PG&E price quoted from EIA specifically because the other two prices come from there as well and I wanted the methodology to be consistent. (For example, they likely incorporate the CARE rates.)

2. Peninsula Clean Energy has a good description of its rates in the middle of this page, including how they compare with PG&E.

3. Palo Alto’s rates are significantly lower than PG&E, by about 30%. This is partly because the city has a very inexpensive hydropower contract, and partly because it is a municipal utility with other costs independent of PG&E. However, even Palo Alto found that its transmission costs went up 15% last year.

4. We should ask why our transmission and distribution costs are so high. My sister’s Minnesota electricity is cheap (11.4 cents/kWh) and her rates include both transmission (1.5 cents) and distribution (4 cents). That is much less than PG&E’s 4 cents and 10 cents, respectively. While we could move the costs off of our bill, we should also look into reducing them!

5. There is an argument to be made that rooftop solar is not priced properly, with power providers paying retail for rooftop solar power that they would otherwise pay wholesale for. I will write about that in a future post. Questions include how to value the added resilience and reduced load on the grid that rooftop solar provides.

6. In case you are wondering, our natural gas is also more expensive than the national average, but not by as much as electricity.

Price premiums for residential gas and electricity. Gas prices: US, CA, PG&E. Electricity prices: US and CA, PG&E (The local gas price shown here is sourced from PG&E, while the others are from EIA. It’s possible they are calculated differently.)

Our natural gas rates have a similar structure to our electricity rates, with distribution and public benefits included. According to this CPUC writeup from a few years ago, the cost of the gas is about 31% of the rate, transportation costs are twice that, and the public purpose charge is the remaining 7%. If only the wealthy are able to move away from gas, these fixed costs will hit the remaining lower-income gas users that much harder.

Current Climate Data (December 2020)
Global impacts, US impacts, CO2 metric, Climate dashboard (updated annually)

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Posted by KOhlson, a resident of Old Palo Alto,
on Jan 31, 2021 at 10:56 am

KOhlson is a registered user.

Thoughtful post - thanks, again.
CPAU seems to have many inputs as to how it should operate. One the one hand, deliver reliable utilities to the town, and make "extra" money doing it. This has been a stated goal for over a century.
Web Link
This seems somewhat at odds with the overall feeling that we should be moving to clean/renewable energy, and to conserve, too. For example, tiered electricity rate promote using less electricity, aka paying relatively more when you use more. An extreme scenario, where everyone has solar, so gas or electricity revenues to CPAU approach zero, would have significant consequences for PA's budget. It follows that every home that consumer less energy from the city is a step closer to that situation. It's hard to tell if the CPAU Strategic Plan speaks to any of this. Web Link

But it does not seem to be a Priority Focus Area.

I want to be clear that I am not promoting more energy consumption, nor a less green future. But I believe that CPAU, and CA energy pricing is out of alignment with stated goals. And it's pretty clear they currently do not have the incentives to recalibrate to a renewable future - as you say!

Posted by John Sack, a resident of Barron Park,
on Jan 31, 2021 at 11:00 am

John Sack is a registered user.

Interesting! When I first moved into Palo Alto, people told me that our electricity was so cheap relative to PGE, and I never looked to see whether and by how much that was true (and why). It would be interesting to learn more about this -- especially if something could change that significantly (e.g., new power contracts).

One weird effect of Palo Alto's electric pricing that I noticed when we were first installing solar is that our "payback period" was longer than in nearby areas, precisely because our power cost less. Perhaps this explains why solar is less adopted in other parts of the country (though I had naively thought that was just because the weather wasn't as conducive as ours).

Posted by Jennifer, a resident of another community,
on Jan 31, 2021 at 11:10 am

Jennifer is a registered user.

Everything is higher (including wages) in California. Per capita, California residents use less electricity than any other state except Hawaii. Our gas/electric bills are nothing compared to people back east and the mid west. I remember my cousin in the mid west complaining that her gas/electric bill was several hundred dollars in the winter in the 90s. At the time, my bill was less than 100 dollars.

Posted by Sherry Listgarten, a blogger,
on Feb 1, 2021 at 1:32 pm

Sherry Listgarten is a registered user.

Great comments!

@KOhlson, that's right. Palo Alto is already worried about gas prices going up as homes abandon gas. (They assume they solve the budget problem by raising rates for the remaining customers.) They specifically want to see electrification of whole blocks to avoid that. Look at the Utilities Advisory Committee presentation at the end of this link. I'm not sure if they are worried about solar adoption as well, which could have a similar effect.

@John: Yes, it's harder for solar to be profitable in Palo Alto than if you have PG&E (for example). There are two reasons for that. One is that Palo Alto's electricity rates are cheaper, so you save less. But the other is that Palo Alto doesn't credit customers full retail for their solar, unlike the PG&E and other big utilities. It credits around ten cents instead. This change was made a few years ago, so not sure if it applies to you.

The state is also looking to revisit net metering, since it's generally understood it serves as a transfer of wealth from lower-income to higher-income families. Palo Alto's lower compensation rates are "better" in this regard, in that it tries to reimburse based on its avoided costs.

Georgia Power is another example of a utility that credits based on wholesale rates: "Unlike many utilities, Georgia Power does not offer credits worth the full retail rate of electricity for excess solar power sent back to the grid. Instead, the utility compensates customers at the “avoided energy” rate, which is equivalent to the amount that the utility would otherwise pay to buy the power on the open market." I'm sure customers are less likely to adopt rooftop solar there.

Lots of states are trying to figure this out.

@Jennifer: Yes, our climate helps to keep our bills down. But I wonder to the extent that our policies keep bills down as well, who those policies are helping. A few weeks ago a friend put it this way: "Our rates may be higher, but our bills are lower." My question is, whose bills are lower? If bills are lower because of great building codes, who is living in those newer homes? If bills are lower because of all the rooftop solar, who has it? And if we are lowering bills for the wealthy, what does that mean for everyone else, when the utility infrastructure isn't getting any cheaper to operate or maintain?

Posted by Rich, a resident of Another Palo Alto neighborhood,
on Feb 2, 2021 at 1:24 pm

Rich is a registered user.

The theme of this article is to say that higher-income folks should pay more for electricity because that is the more equitable way to do things. So why not just levy a tax on higher income rather than going through these very indirect ways to achieve the same purpose? This is effectively a tax on the higher income, without stating that it is a tax on higher income, so why be so shy?

Posted by Dan Waylonis, a resident of Jackson Park,
on Feb 2, 2021 at 3:04 pm

Dan Waylonis is a registered user.

Thanks for doing the research! I've really wondered about this as well. Unfortunately, the biggest anomaly is #4 in your notes "We should ask why our transmission and distribution costs are so high." And it's the one that's the least clearly defined. My cynical side says that electricity is expensive in CA/SF and NY/NYC because we can afford to pay. However, for a "utility" that should have it's price carefully measured and analyzed, I'd say that the CA PUC has really dropped the ball.

Posted by Dave Smith, a resident of Old Mountain View,
on Feb 3, 2021 at 1:15 am

Dave Smith is a registered user.

Missing facts:
1) Mandates solar and wind power is not cheap. It cost 2x of Nat gas
2) Everyone Liberal like the author likes to blame PG&E, but California only forced power generation to be separate yet MV forces me to buy from a more expensive power collective in the name of green energy. Yet forced PG & E to keep power transmission because no money, no growth and no taxable income for CA or cities
3 ) Tesla got subsidized to sell in CA with higher power bill taxes.. and only Elon musk made money out of it
4)CA is a socialist state and we tax everything and siphon to the pay for programs that incentivize lack of effort and to illegal immigrants support.

Yeah I know my facts are unpopular but it is true and glossed over cause we CA Democrats control everything including the media

Posted by Asher Waldfogel, a resident of Old Palo Alto,
on Feb 3, 2021 at 6:58 am

Asher Waldfogel is a registered user.

Interesting post. An important caveat: we need policies that are somewhat neutral about utility system architectures until we figure this out. On-site generation is already close to utility generation and distribution cost. On site battery costs are higher than the remaining utility costs but falling fast. I wouldn't have argued this when I was on the UAC ten years ago, but today I suspect neighborhood level micro grids with local storage will soon pencil out. Rather than spending money on an additional PG&E high voltage interconnect, perhaps PAU can lead out with more innovative grid design. If we can't do that, then I seriously question the value of running a local utility in the post cheap hydro power world we now live in

Posted by Sherry Listgarten, a blogger,
on Feb 3, 2021 at 10:37 am

Sherry Listgarten is a registered user.

Thanks for the insightful comments. A few thoughts below…

@Rich: This post was more about the existence of the problem than the mechanism for fixing it, but to your point, Borenstein is certainly recommending a tax in the blog I linked to. However, he has suggested other mechanisms, including using cap-and-trade funds. I’m sure some readers might consider using proceeds from a carbon tax to fund electricity infrastructure. I think it’s a great topic for a blog post, but I didn’t intend to cover it here. All that said, I think we have to be very careful to ensure that electrification is available to and feasible for all and that prices for essential utilities remain accessible. When you are transforming a whole economy, you have to expect prices and price structures to change. I expect that a tax to pay for transmission is better than what we have now (increasingly regressive utility payments), but I don’t know that it’s the best mechanism.

@Dan: I agree, we should understand why transmission prices are high and increasing. Our municipal utility mentions this often. I will consider it for a future post.

@Dave: You are right about the price of various sources of electricity. Here is a graph from the EIA showing that.

I would love to understand what is beneath the costs better. Re PG&E, I do not intend to blame them, since I haven’t gone into why the costs are why they are. I would say that some of the big utilities *want* to transition to “poles and wires” companies. This evolution of the CCAs has been difficult not only wrt revenue but also when it comes to managing risk and having a fallback in case a CCA goes bust. The IOUs are in a difficult place. To your third point, I agree that a few people are making a lot of money from California policies to encourage cleaner tech. I talked with a CEO of one of those companies once, and he insisted that it was appropriate because people like him wouldn’t take the risk without a big payout. But I wonder about that and the size of the payout. FWIW, I wouldn’t call of this socialist (your fourth point), I would call it capitalist, to a fault. Just look at the inequality in CA. Anyway, thanks for taking the time to spell out your thoughts. A few links next time would be bueno.

@Asher: Microgrids are interesting, especially in the power-shutoff areas. It will be interesting to see how their costs evolve and how we value the resilience and lower transmission costs they provide. I think land costs here would be an issue.

Posted by CyberVoter, a resident of Atherton: other,
on Feb 3, 2021 at 1:10 pm

CyberVoter is a registered user.

If you would like an alternative view, look at the latest 5 min video at Web Link In short CA's Electricity & Natural Gas costs are so high & will be much much higher because the PUC is a Political organization of Zealots that are not trained technically, or in business/economics. There is no real reason that CA must have such higher rates. Things "Cost more in CA" because we allow it to happen! Solar & Wind require very long transmission & distribution line from their massive acreage to the end user. This wiring is both enormously expensive to build & maintain, and also suffers massive power losses over the distance & is a source of fallen wires to ignite fires!
We need to replace the current Political appointees at the CA PUC with people that understand the realities of the working class in CA and work for them. Otherwise "Green Investors" will get richer & the average Californian will get much poorer. There is no "Silver Bullet"as the Zealots claim.

Posted by Mark, a resident of Shoreline West,
on Feb 3, 2021 at 5:47 pm

Mark is a registered user.

We have an elderly person that we care for in our home. There are 2 medical devices that run 24/7. They have to be on and running. I am assuming it was the State of California that set the regulations on how to determine what size each household is, and can use before going into Tier 2, then Tier 3. Each higher tier has ever higher electric rates. We never get below $450 a month in the winter. During the summer it runs $600. We have a small room A/C that runs on those hot days to prevent another heat stroke. We did apply for the medical necessity form that PG&E has,it was filled out and signed by the physician, but the rates did not change.

How I wish we could go back to how the rates used to be, before our politicians in Sacramento started to regulate them, PG&E, to death. We are paying the price for it.

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