Electricity Prices Are a Lie

And lies cause waste

There’s a controversy right now in California. Fine, nothing new there, California whaddya gonna do. But this particular controversy raises some interesting points.

The topic is “net metering” for households with rooftop solar power. Net metering applies when a house is using a negative amount of electricity, because the rooftop panels are generating more than the household is using. This happens routinely at midday, and the extra power goes back into the grid, where it can be used by a nearby house. How should this affect your electric bill?

Under the current rules where I live, each unit of power you feed to the grid is subtracted from your electric bill, according to the retail price for electricity. Your ultimate bill is based on the electricity you pulled from the grid, minus (“net of”) the electricity you gave back; hence, “net” metering.

There is a lot to this topic, much of which I’m going to save for a later post. For the moment, just consider:

1. If a house on average generates as much as it uses, the electric bill will be zero. (In practice there’s a minimum monthly fee, but it’s pretty low.)

2. If everyone did that, the utility would get very little money.

3. But the utility would still need to maintain a ton of infrastructure to keep things running at night. Small revenue - big infrastructure = problem.

Clearly, there is a flaw somewhere.

The Price Is the Problem

Where I live, charges are based on the amount of electricity you use. There’s a small minimum fee, and the price per kWh (kilowatt-hour) goes up with higher usage (to encourage conservation), but basically it’s a price per kWh.

This has the advantage of being easy to understand: use more, pay more. However, it does not track with the actual cost of providing electricity. I did a quick bit of research, and found the following figures for operating expenses at my local utility (PG&E):

• Cost of electricity + cost of natural gas: $2.9B

• Operations, maintenance, depreciation, etc.: $9.5B

In other words, the direct cost of providing an additional unit of electricity or natural gas is only 23% of overall operating expenses. I’m oversimplifying horribly, so don’t quote these figures anywhere, but the basic idea is clear: utilities charge by usage, but their costs are mostly determined by other things, such as the amount of peak capacity they need to have available.

Traditionally, most households used a substantial amount of electricity each month, so we could ignore the disconnect between price and cost. Everyone who was tying up capacity (which utilities provide for free) was also using power (which they charge for), and it all kind of worked out.

Rooftop solar, especially when combined with net metering, breaks that model. A household might wind up not using any power at all, on net, but still rely on the utility for services that cost money. During the day, the utility’s distribution lines are carrying excess solar power to other customers. At night, the generation, transmission, and distribution equipment is providing the household with electricity. In effect, the utility is providing rooftop-solar customers with a gigantic battery, free of charge. It is also providing a backstop for times when the rooftop system can’t support the house’s needs – for instance, short winter days. The price for those services should not be $0.

Actually, Lots of Prices are Lies

Distorted prices aren’t unique to electricity. When clubs charge a high price for liquor, it’s not because the drinks cost a lot; the excess price covers the entertainment. The infamous “two-drink minimum” is there to make sure people don’t cheat the system.

Traditional retailers charge for purchases, but allow you to browse the merchandise for free. That worked fine until e-commerce enabled “showrooming”: “the practice of examining merchandise in a traditional brick-and-mortar retail store or other offline setting, and then buying it online, sometimes at a lower price” [Wikipedia]. It’s hard for Best Buy to make money if people visit their store to check out the TVs on display, but then buy on Amazon.

Videotapes and DVDs cost almost nothing to mass produce, but studios charge a lot for them, because they need to make up the cost of producing the movie. That was fine when you couldn’t watch the movie without buying the tape. This is why Hollywood fights piracy so hard.

Health care, airplane seats, cellphone roaming plans… there are lots of important markets where costs and prices are at least somewhat decoupled. When the people naturally use the system in a manner that keeps cost and price in alignment, this generally works out. When technology evolves in a way that exposes the gap – showrooming, rooftop solar, video piracy – problems arise.

Unrealistic Prices Create Waste

When prices don’t reflect costs, we incentivize wasteful decisions. Some examples are pretty colorful. For instance, the US Mail’s parcel-post rates sometimes lead to abuses like this (source):

ANCHORAGE, Alaska (AP) _ An Anchorage building-materials supplier is taking advantage of a loophole in postal regulations to mail 6,000 concrete blocks to a remote village 700 miles away.

The shipments across Alaska could end up costing the U.S. Postal Service $500,000, and even the air carrier that stands to profit thinks the mail system is being abused.

I won’t even try to detail the strange things people do with airline tickets, sometimes traveling hundreds of miles out of their way or booking extra wasted legs to take advantage of convoluted pricing rules.

Infamously, in the Soviet Union, the price of bread was kept so artificially low that farmers would sometimes buy fresh loaves from bakeries to use as pig feed.

The artificially low “ePacket” rate that makes it cheaper to ship goods from China to the US than from one US city to another is a hot topic nowadays, making it hard for online retailers based in the US to compete.

These are mostly examples of waste due to artificially low prices, but artificially high prices create waste, too. For instance, pricey CDs prevented lots of people from listening to music. More seriously, in the US, many medical procedures have wildly inflated “list” prices, pushing some people away from basic preventative care.

Hidden Subsidies Promote Muddled Thinking

There are many reasons a business might charge prices that don’t line up with costs. Sometimes, it is simply too difficult to make prices track costs precisely. (Imagine if a hardware store tried to charge by the minute for advice from a clerk – and increased the fee when the store is busy.) Sometimes it’s a marketing move (“free” entry lures people into a nightclub). I won’t attempt to list all of the reasons.

In a regulated market, prices are often distorted by a desire to subsidize some behavior or group. For instance, electricity prices are designed to:

• Encourage energy conservation

• Promote adoption of solar power

• Ensure low-income households can afford electricity

Sometimes this is overt; the programs to reduce electric bills for low-income households are quite explicit. But sometimes the distortion is hidden. The current net metering system in California is pretty favorable to customers with rooftop solar; in effect, it’s a subsidy. But rhetorically, proponents can argue that it’s simply the fair way to handle negative usage.

To be clear, subsidies are a perfectly legitimate tool. But hidden subsidies confuse the political conversation. In an ideal world, the conversation around electricity rates would look something like this:

• How large a role should rooftop solar play in the green transition?

• As solar prices come down, how much subsidy is required to fulfill that role?

• Where and how should rooftop systems be placed? Is one big system as valuable as two small ones? Should we focus on sites that are favorably situated (roof angle, tree cover, etc.)? What other considerations should come into play?

• What form of subsidy would best meet these goals?

In practice, it’s often politically difficult to argue for overt subsidies, and we resort to workarounds like net metering. This creates misaligned incentives (we may be feeding some bread to pigs), and it makes it hard to calibrate our efforts (maybe we’re providing too much support for solar, and not enough for heat pumps).

If there are lessons here for the climate movement, I think they might be:

• When lobbying for a policy, try to make it as “honest” as possible – minimize the gap between the policy and the actual goal.

• Don’t cling to a subsidy longer and harder than necessary. Net metering is not the goal; rooftop solar installations are only an intermediate goal; decarbonization is the goal.

Maybe Some Lies Are Necessary?

I don’t know how to feel about this. In an ideal world, when we need to subsidize something, we’d be upfront about it. In the real world, the politics don’t always work. That’s probably why we can’t just institute a carbon tax and have done; instead, we dance around with net metering, and automotive mileage standards, and building efficiency codes, and other measures whose actual purpose at this point is primarily to reduce carbon emissions, but are dressed up with other motives.

In a sense, all of these lies are there to combat an even bigger lie, the root-of-all-evil lie when it comes to climate change: “unpriced externalities”. As I noted in an earlier post:

Markets have huge blind spots, known as “externalities”. Wikipedia defines an externality as “a cost or benefit for a third party who did not agree to it”.

When the person causing an externality does not have to pay for it, we say that it is “unpriced”. Greenhouse gas emissions are a classic instance: polluters don’t pay for the carbon they emit. This is the ultimate distorted price: emissions have a high cost, but the price we charge polluters is $0. That price is a colossal lie.

(My friend Jean-Claude points out that in California, this is not true! We have a cap-and-trade system that sets a price on carbon emissions for a large swath of emitters. It doesn’t cover everything, and the price is still too low, but it’s a good start.)