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The Current System of Electric Billing No Longer Makes Sense

Dan Seif
August 14, 2020
Corporations, Customers

Let’s stop pretending that we’re paying for “energy” in our home power bills and understand we’re mainly paying for infrastructure.

Home electric bills have long been priced volumetrically (per unit of electric energy consumed; per kWh), with only some small additional fixed charges like a meter charge and/or local fixed surcharges. Yet, this legacy charge structure does not reflect the paydown on our grid’s sunk capital costs, or much incentive customer load changes that reduce the needs for more grid infrastructure. Also, this charge structure is no longer the most advantageous economic structure for many homeowners and renters in light of a myriad of new home technologies.

Instead, we should allow all consumer classes – but most impactfully the residential class – to opt-in to billing based on a three-part structure that relate to how their energy use actually impacts the system.

  1. Energy Use (per kWh): This is the amount of electricity you use each month measured in kilowatt-hours (kWh). You are paying for the ongoing cost of generating the power that reaches your residence. In electric industry-speak this rate structure is “volumetric.”
  2. Distribution (per kWNCP): This is your kW overall peak power use in any given billing month. You are paying for your burden on the local distribution wires system. Paying down the capital costs of the distribution line on your street is much more closely associated with the maximum amount of power it must handle in a given month or year than the amount of energy it’s carrying at any given moment. In electric industry speak this rate structure is based on non-coincident peak (NCP). Your residential load performance on an NCP basis also affects the need for future upgrades of your local distribution system.
  3. Transmission (per kWCP): This is your annual or semi-annual energy use when the regional transmission grid is at its coincident peak (CP). Here you are paying for your burden on the regional transmission system. The cost of paying down the sunk cost of your region’s high voltage transmission system is much more closely associated with the moment, or top few moments, of maximum power provision in a given year than the amount of energy it’s carrying at any given moment. Your residential load performance on a CP basis also affects the need for future upgrades of your regional grid.  Similar considerations apply to generation capacity system costs, where certain generators and sometimes demand response are paid for being available at grid load peak moments, and thus those should be combined into this CP-based cost.
Three-Part Rates Background: there’s nothing new here

A billing system based on volumetric consumption alone mainly incentivizes one energy action by the end-user — efficiency measures with year-round impact, like procuring a more efficient refrigerator or lightbulb.

But more substantial efficiency actions, that are seasonally effective, could save the homeowner more on a three-part bill. For most of the U.S., electric heating and, in particular, cooling, dwarf other power consumptions in the home, even on a year-round analysis basis.

Heating or cooling efficiency actions that reduce your residence’s peak load, like a more efficient air conditioner, would pay out handsomely against both NCP- and CP-based rates.  Furthermore, predictive-intelligence driven smart thermostats and home energy storage systems should pay out way better against CP-based rates than current volumetric-only ones.

The three-part rate structure described above is already common for large commercial buildings in several states. So it’s hard to argue that providing this structure to another class of customers, residential, would be a wild idea.

It’s also effectively what many distribution-level utilities already face: they are exposed to the volumetric wholesale energy costs and CP-based transmission charges.

Where NCP and CP-based rates are in effect, they are the result of long-standing political compromises between different consumer groups, utilities, and their regulators. Any one of these groups can point out the very real technoeconomic and fairness imperfections in these rate structures. But these NCP- and CP-based rates structures have been the prevailing structures for decades and create price signals generally agreed to be more indicative of both sunk and future infrastructure costs than volumetric rates.

The rise of wire costs

Some large build-outs in transmission and distribution more than pay for themselves, such as very high voltage lines from strong renewable resource areas to high load areas. Universal resistance against T&D infrastructure buildout is foolish.

But the overall level of increase in T&D spending and annual rate-base payback versus flat U.S. load is suspect and unsustainable – and would still be high even without these prominent high-voltage buildouts. For instance, in ERCOT the transmission cost recovery tariff increased by about 5 percent per year (~3x inflation) over 10 of the past13 years, with the 3 years excluded being those in which ERCOT’s prominent high voltage buildout (“CREZ”) were added to the ERCOT rate base.

For more than 100 years, the majority of residential power bills was linked to wholesale energy costs. This made volumetric-only residential bills pretty reasonable. Now, however, three-quarters of residential power bills are composed of “other costs” (see Exhibit 1 below). These other costs are primarily tied to payback on transmission and distribution sunk costs — wires, towers, poles, and substations.

Exhibit 1: Cost and Cost Share of Average US Residential Power Bill

Source Data: CAISO, ERCOT, SPP, MISO, PJM, NYISO, ISO-NE, DOE EIA, ABB Ventyx Note 1: Average RTO/ISO wholesale energy costs used as proxy for full US wholesale energy costs Note 2: Wires/Other costs include T&D, ancillary services, additional grid operator charges (e.g. uplift & admin), energy capacity, retail profit, taxes, and surcharge

In fact, nationally these other costs have risen on average by nearly five times the U.S. inflationary rate (~8 percent per year) since 2007 with no increase in national load to dilute down the cost increases in power bill rates. Only a few states (most notably California and New York) have taken material action to manage these escalating costs with new regulatory structures to better allow for demand response, storage, and other new technology solutions. And even where action is being taken, wires cost escalation is a train running downhill.  When the emergency brake is pulled, it still takes a long time to stop the momentum, not to mention reverse it.

Having NCP- and CP-responsive technologies will be critical to lowering costs to the consumer, as the vast majority of value in the system going forward will be dominated by NCP- and CP-associated T&D infrastructure costs.

Who Needs to Act?

The reality is, smart home control systems, batteries and electric hot water heaters, will never reach their sales potential under the current way of calculating residential power bills.

It’s time for those companies, particularly large balance sheet entrants (Amazon Echo? Google Home?), to start thinking about their relationship with state public utility commissions and their billions of dollars of unrealized revenue because of a lack of three-part rates. CP-based rates, in particular, can pay out extremely well, with the chance to push a homeowner’s $/kWCP cost to near $0.

Instead of advocating for CP-based rates for none (such as removing these rates from large commercial and industrial), consumer advocacy groups should be pushing for CP-based rates for all. Many citizens will prefer the simplicity of volumetric rates and not be ready to adopt some technologies that lower bills based on three-part rates. That’s fine, and it’s why any new billing options should be just that – optional. Consumers should be able to choose between options for how their power bill is structured and not be forever affixed to one or the other.

Allowing for price signals to, more clearly, reflect the costs of the power grid will help to lower present residential energy bills for those who procure the right in-home technologies. It will also reduce the need for future grid upgrades, and thus provide the double benefit of also reducing the cost of future residential energy bills for all.

The Takeaway

The need to offer opt-in three-part rates to electricity consumers has never been more pressing. Transmission and distribution costs now dramatically outweigh wholesale energy costs, at nearly 3 to 1, and are relentlessly increasing. Meanwhile, the technological solutions now available to us to manage and respond to these costs on three-part rates are smarter, cheaper, and more readily implementable than ever before.

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