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The Practical Equity Implications of Advanced Metering Infrastructure
The Practical Equity Implications of Advanced Metering Infrastructure Reductions in advanced metering costs and the efficiency benefits of dynamic pricing make a compelling case to adopt both, particularly for industrial and commercial facilities. Regulators should seriously consider such policies for residential households as well. Regulators can take meaningful steps to mitigate, if not entirely offset, the possibility that some low-income ratepayers may have higher electricity bills with AM and DP. Frank A. Felder
Frank A. Felder is Director of the Center for Energy, Economic and Environmental Policy (CEEEP) at the Edward J. Bloustein School of Planning and Public Policy, Rutgers University. He benefited tremendously from the discussion during a one-day meeting on the Ethics and Dynamic Pricing sponsored by the Rutgers Initiative on Climate Policy and CEEEP.
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I. Introduction For more than 35 years, research has documented the efficiency benefits of having electricity retail prices fluctuate over relatively short time periods to reflect changing marginal costs.1 The concept of advanced meters (AM) has re-invigorated the debate concerning whether to implement dynamic pricing (DP) because AM lowers the implementation costs.
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he question of whether to implement AM raises a tangle of efficiency and equity policy issues, and it is helpful to clarify some important items at the outset. AM is not needed to implement DP, although it lowers the cost of doing so and facilitates more DP variations, such as realtime pricing. The benefits of AM are not limited to DP, although the ability to implement DP is often identified as one, if not the major, AM benefit. DP does not
1040-6190/$–see front matter # 2010 Elsevier Inc. All rights reserved., doi:/10.1016/j.tej.2010.06.002
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require having wholesale electricity markets with locational marginal pricing, although having such prices, if competitive, could be extremely useful in determining the dynamic retail prices used in DP. Without wholesale locational marginal prices, developing real-time retail prices is an issue, but it is resolvable. Having such locational marginal prices, however, does not require adopting retail real-time pricing. Further, the benefits of AM depend, in part, on universal deployment within a geographic area. Finally, AM enables customers to have different pricing plans, thus making it possible for customers to choose DP options that are best for them. s the AM equity debate, which revolves around residential customers, much ado about nothing? Each sector – industrial, commercial, and residential – consumes approximately onethird of the electricity in the United States, although the amount may vary substantially within a particular region or state. Realizing the efficiency benefits of DP requires having a relatively small amount of load responding to the price signal.2 Moreover, the cost of AM does not increase for larger customers; in fact, the larger the customer, the smaller the percentage an advanced meter would be of that customer’s total electricity bill. The notions of equity discussed below and that are a concern of many do not apply to industrial and large commercial entities.
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The size, sophistication, and nonhuman status of industrial and large commercial entities do not warrant concerns about affordability, understanding different pricing options, or being able to take measures to respond to changing electricity prices. There may be economic development reasons to be concerned that AM and DP may increase costs to some of these businesses, but economic development rates can be designed to be dynamic. Typically, but not always, industrial and large commercial customers are concentrated in certain geographic areas, further lowering the costs of AM deployment. AM could be deployed to all customers in that region, but only require industrial and large consumers to pay DP. Thus, it is likely that most efficiency benefits of DP, which also benefit customers not on DP, can be obtained with these commercial and industrial customers. hat being said, there are additional benefits (and costs) of deploying AM to the residential sector and making it possible for households to select from different fixed priced and DP options. Furthermore, AM is a critical component of Smart Grid, a term that refers to a collection of technologies that improve the
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grid and particularly to the distribution system’s ability to communication information to enhance operations, maintenance, efficiency, and reliability. In addition, the ability of the distribution system to accommodate plug-in hybrids, a potentially large load, may require AM and DP.
II. Different Definitions of Equity and Their Implications Before providing different substantive definitions of equity that have been raised in the AM and DP context, it is worth discussing the regulators’ decision. Equity issues related to process are not analyzed based on the assumption that utility commissions have wellestablished processes that allow ratepayers and their advocates, among others, to articulate their positions for the consideration of regulators. Regulators, using equity and efficiency as the two objectives, could come to one of the four possible conclusions shown in Table 1. Clearly, the inequitable and inefficient outcome (lower right-hand box) would be rejected by all, whereas the equitable and efficient outcome would be accepted by all. One difficulty for
Table 1: Possible Outcomes of an AM Efficiency and Equity Analysis Equitable
Inequitable
Efficient
Equitable & Efficient – ACCEPT
Inequitable & Efficient – INCONCLUSIVE
Inefficient
Equitable & Inefficient – ??
Inequitable & Inefficient – REJECT
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the regulator is if there is a tradeoff between equity and efficiency. Another is that AM and DP may be considered equitable under one definition of equity but may not under another definition. ne strategy for resolving the equity issues in this particular context is to try to resolve them in all contexts. In this issue of The Electricity Journal, Prof. Bunzl reflects on equity issues raised by DP in a broader context. There are longstanding debates about society-wide issues of equity and social justice, however, that are not going be resolved in the context of AM and DP. As Prof. Hogan notes in this issue, these broader issues of social justice do not, however, have to be resolved prior to analyzing equity within a particular context. For practical reasons, society compartmentalizes issues of equity and does not attempt to coordinate distributive decisions across different domains; consequently, each problem is treated on its own merits and based on the norms and precedents that accumulated over time for that situation.3 Equity concerns are usually raised with respect to subgroups within residential households, such as low-income, elderly, fixed-income households, nightshift workers, and housebound residents. The underlying commonality is that these groups cannot afford higher electricity bills and are thus less likely to be able to respond to
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different price signals. It does not seem the case that those concerned with equity in this context are concerned with the equity implications of the highincome elderly couple or the emergency room surgeon who works nights. Moreover, the Federal Low-Income Home Energy Assistance Program (LIHEAP) uses income as the means to define the protected class. The purpose of this
There are longstanding debates about society-wide issues of equity and social justice that are not going be resolved in the context of AM and DP. program is to assist low-income households, particularly those with the lowest incomes that pay a high proportion of household income for home energy. An eligible household’s income must not exceed the greater of 150 percent of the poverty line or, in fiscal year 2009, 75 percent of a state’s median income.4 Households with elderly, disabled, and young children represent about 72 percent of LIHEAP’s income-eligible population.5 Thus, in this context, it is appropriate to focus on income as the means of addressing equity, rather than on some other
characteristic. It would be beyond a utility commission’s mandate and capabilities, as well as the compartmentalization that society employs, to try to develop some equity criteria based on age, disability, fixed income, or employment hours, among others. The disputes over what these criteria should be, whether each category should be considered individually or in combination, and what should be the individual or combined threshold for determining who is in the protected class would be endless. Moreover, collecting the necessary data with a reasonable degree of accuracy initially and over time would be administratively difficult. Finally, as previously noted, using the income criteria results in the inclusion of segments of the population that are vulnerable to high energy prices. Specific equity issues should be considered. Four AM and DP equity concerns are the inability to respond to DP, the longstanding precedents of uniform pricing, cross-subsidies, and regressive electricity costs. As Dr. Faruqui discusses in this issue of The Electricity Journal, DP benefits even those who do not or cannot respond to changing electricity prices because other consumers reduce their peak demand, which in turn reduces electricity prices for all.6 DP also reduces the ability of sellers of electricity to exercise market power and the probability of electricity shortages, with their resultant rolling blackouts. Again,
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this benefits all customers, not just those on DP.7 Even without questioning the assumption that there is a large group of residential customers who cannot change their consumption, the equity concern of inability to respond to changing prices does not stand on its own. For instance, having AM and DP for industrial and commercial classes would lower residential prices even if none of the residents had AM or were on DP. Obviously, regulators would not consider this an inequitable outcome that requires residential rates to be increased to pre-AM and -DM levels because residents could not respond to changing electricity prices. Furthermore, the information and feedback demonstrate that AM can provide energy savings without DP. According to one review of studies, direct feedback (immediate feedback from the meter or a display monitor in the building) reduces energy consumption by 5 to 15 percent, and indirect feedback (information that has been processed in some way before reaching the energy user, typically via billing) has savings of 0 to 10 percent.8 nother equity concern is the longstanding use of uniform pricing, which sets expectations for consumers. This precedent, however, is not inviolable. In the 1970s, rising fuel costs led to fuel adjustment clauses that allowed utilities to pass through these cost increases to consumers. Moreover, many
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utilities and states have introduced non-uniform pricing (NUP) such as seasonal rates and time-of-use rates. Finally, as discussed further below, DP can be phased in, supplemented with education and consumer information, and be part of a menu of choices that includes uniform prices to mitigate concerns of changing past policies. A survey of low-income households found that
It is important, in part due to fairness considerations, that consumers be given a choice of having a uniform rate as an option with DP. approximately two-thirds were favorably oriented towards timeof-day rates, one type of DP.9 Related to the precedent of uniform pricing is the issue that it minimizes consumer transaction costs. Uniform pricing is incredibly easy to understand. No matter when you use electricity, it costs the same amount. The consumer does not have to keep track of changing prices and then figure out what, if anything, should be done in response. With DP, there is a risk that consumers who leave their air conditioning on during a vacation may be exposed to a large electricity bill if prices spike. Of course, different
consumers have a different willingness to accept such a risk for the benefits of DP. Furthermore, technological advances may make it possible to respond to changing prices without direct human intervention, thereby reducing the associated transaction costs. That being said, it is important, in part due to fairness considerations, that consumers be given a choice of having a uniform rate as an option with DP. As Prof. Hogan notes in this issue, the problem is one of selecting the default rate that consumers are assigned. he remaining two notions of equity involve reducing or eliminating cross-subsidies and making electricity costs less regressive. Proponents of DP tend to focus on the former. They argue that it is inequitable to make someone else pay for something you use. One major reference notes that if equity is defined as reducing customer cross-subsidies, that is, a customer’s charges are based on the cost to serve that customer (which it acknowledges as one of several possible definitions), then dynamic electricity pricing is equitable.10 This is also the position taken by Dr. Faruqui in this issue. In contrast, opponents of AM and DP argue that they are inequitable because they would adversely (regressively) affect lower-income ratepayers. Lowincome households do not have the capital to invest in more energy efficient technologies and, therefore, in response to higher
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Table 2: Average and Low-Income U.S. Household Electricity Usage and Costs (2005) Below 100% of Poverty Line
100 to 150% of Poverty Line
Above 150% of Poverty Line
Average Household
Number and Percentage of Households Average Annual Electricity Consumption (kWh)
16.6 million 15% 9,037 kWh
12.9 million 12% 10,342 kWh
81.5 million 73% 12,158 kWh
111.1 million 100% 11,480 kWh
Average Cost Average Electricity Bill ($)
10 cents/kWh $904
$1,034
$1,216
$1,148
Source: 2005 Residential Energy Consumption Survey, Energy Information Agency.
peak prices can only curtail their electricity consumption at the ‘‘cost of severe discomfort, inconvenience or threats to health.’’11 t this juncture, it is useful to consider U.S. income and electricity consumption data in detail presented in Table 2. Using the most recent data available, the U.S. had 111.1 million households in the year 2005. Of these households, 6.4 million (5.1 percent) had someone home all day. Households that had members aged 65 or older numbered 26.9 million (24.2 percent).12 he percentage of income a household spends on
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electricity decreases dramatically as income increases, although households with higher incomes consume more electricity than lower-income households and, consequently, spend more in absolute terms. Table 3 presents for 2005 the annual amount of electricity, the cost, and the percentage of income for households as a function of income. Note that the lowestincome group spends about half the amount the upper-income bracket on electricity ($785 vs. $1,538), but 10 times more as a percentage of income (15.7 percent vs. 1.5 percent). A 10 percent change in electricity prices results in a 1.6 percent
change in the income of the lowest household income bracket but only a 0.15 percent change in the income of the highest bracket. According to one study, income accounts for 17.6 percent of the total variation in electricity use, and the number of persons in the household was the second most important variable, explaining 6.1 percent of the variation not accounted for by income.13 Table 4 breaks down the household consumption of electricity into three major categories that account for almost all household electricity consumption: other appliances and lighting, air conditioning, and refrigeration. All households
Table 3: U.S. 2005 Electricity Consumption and Costs by Household Income U.S. Households Household Income
Annual Electricity
Number (million)
%
kWh
Cost
Less than $10,000 $10,000 to $14,999
9.9 8.5
8.9% 7.7%
7,854 8,710
$15,000 to $19,999 $20,000 to $29,999
8.4 15.1
7.6% 13.6%
9,506 10,040
$ 951 $ 1,004
5.4% 4.0%
$30,000 to $39,999
13.6
12.2%
11,431
$ 1,143
3.3%
$40,000 to $49,999 $50,000 to $74,999
11.0 19.8
9.9% 17.8%
11,658 12,440
$ 1,166 $ 1,244
2.6% 2.0%
$75,000 to $99,999 $100,000 or More
10.6 14.2
9.5% 12.8%
13,559 15,382
$ 1,356 $ 1,538
1.5% 1.5%
Total
111.1
$ 785 $ 871
% of Income 15.7% 7.0%
100%
Source: 2005 Residential Energy Consumption Survey, Energy Information Agency.
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The Electricity Journal
Table 4: U.S. 2005 Electricity Costs by Major Uses and Household Income Other Appliances & Lighting Household
%
%
Air Conditioning
Refrigeration
%
%
%
%
Income
Cost
Elect.
Income
Cost
Elect.
Income
Cost
Elect.
Income
Less than $10,000
$398
50.7%
8.0%
$206
26.2%
4.1%
$111
14.1%
2.2%
$10,000 to $14,999 $15,000 to $19,999
$448 $453
51.4% 47.7%
3.6% 2.6%
$195 $213
22.4% 22.4%
1.6% 1.2%
$118 $114
13.5% 12.0%
0.9% 0.7%
$20,000 to $29,999
$535
53.3%
2.1%
$234
23.3%
0.9%
$122
12.2%
0.5%
$30,000 to $39,999 $40,000 to $49,999
$580 $651
50.7% 55.8%
1.7% 1.4%
$278 $277
24.3% 23.8%
0.8% 0.6%
$129 $132
11.3% 11.3%
0.4% 0.3%
$50,000 to $74,999 $75,000 to $99,999
$720 $818
57.9% 60.3%
1.2% 0.9%
$302 $312
24.3% 23.0%
0.5% 0.4%
$145 $155
11.7% 11.4%
0.2% 0.2%
$1,004
65.3%
1.0%
$380
24.7%
0.4%
$185
12.0%
0.2%
$100,000 or More
Income Relative to Poverty Line Below 100 Percent
$480
53.1%
$226
25.0%
$113
12.5%
100 to 150 Percent Above 150 Percent
$530 $699
51.2% 57.5%
$243 $291
23.5% 23.9%
$119 $145
11.5% 11.9%
Source: 2005 Residential Energy Consumption Survey, Energy Information Agency.
had lighting, and other appliances and refrigeration, and 91.4 million households (82.3 percent) had air conditioning. Households spent $647 on lighting and other appliances, $276 on air conditioning, and $137 per year on refrigeration. Over time, lowincome households have increased their use of central air conditioning from 8.5 percent in 1979 to 42.8 percent in 2005, coterminous with the decrease in the percentage of these households that do not have air conditioning of any kind from 62.8 percent to 20.1 percent.14 It is worth noting that in 2005, 34 percent of low-income households used electric heat, increasing from 10 percent in 1979.15 ccording to Dr. Faruqui’s paper in this issue, based on data from one utility and
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before considering the cost of AMI, 80 percent of low-income customers would gain from DP assuming no response by customers to DP, and over 90 percent would gain assuming a moderate response. The intuition for this result, consistent with the data just presented, is that lowerincome customers have a flatter load shape than do mid- and higher-income groups because they use less air conditioning. In other words, lower-income households are cross-subsidizing higher-income households. Obviously, if and to what extent
these results hold for other utilities in other regions and climates of the United States is an empirical issue but, as a working hypothesis, the equity notions of reducing cross-subsidies and reducing the regressive nature of electricity bills are aligned. That is, flat rates are inequitable under two very different definitions. f course, the cost of AM must be considered along with its transaction costs. Table 5 presents the monthly costs of an advanced meter under different meter cost and life assumptions.
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Table 5: Estimated Monthly Cost of Advanced Meters under Different Assumptions Meter Cost Meter Life
$200/meter
$250/meter
$300/meter
10 years 15 years
$2.64/month $2.15/month
$3.30/month $2.69/month
$3.96/month $3.22/month
20 years
$1.93/month
$2.41/month
$2.90/month
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A generic discount rate of 10 percent is assumed. ssuming a meter cost of $3 per month, or $36 per year, low-income households that spend approximately $900 per year on electricity would experience a 4 percent increase before accounting for any benefits from AM and DP. If for the lowest-income group, AM without DP resulted in a 2.5 percent savings due to indirect feedback, the corresponding monthly savings would be $1.63. If direct feedback is provided, these monthly savings would be several times higher. Regulators may not find this increase associated with AM acceptable even assuming these feedback benefits. Moreover, they may be risk-averse: even if they believe that AM and DP reduced costs for most low-income households, they may still find that the electricity bill increases on a small percentage of low-income households not offset by the reductions in the majority of low-income households. tarting from the philosophical position behind the veil of ignorance, Prof. Bunzl notes that these households – those that are both poor and peakier than average – are a legitimate equity concern. They also exist. According to one study, high-use customers in California earning less than $50,000 had bill increases under critical peak pricing. About 5 percent saw bill increases of 10 percent or more.16 Another study concluded
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(without accounting for the overall reduction in electricity prices due to DP) that although smaller low-income households and those headed by older persons would receive the most immediate benefits of time-of-day rates, larger households and those with younger household heads would have to alter electricity usage to benefit.17
This raises two related policy questions. First, is the standard that (almost) every low-income household must be the same or become better off before AM is to be adopted? Second, given such a standard, is it possible for regulators to identify and compensate low-income households that are worse off? As a practical matter, it would be difficult to guarantee with absolute certainty that with compensation, no lower-income household was worse off even with Herculean efforts. Such a policy standard, if more generally applied, would make almost any policy change impossible. There are actions regulators can take that may insulate low-
income households. First, since the benefits of AM accrue disproportionately to those who use more electricity, AM costs do not have to be allocated equally to each household or rate class. Costs can be allocated, in part, based on usage, further reducing the impact to low-income households. For instance, if the 19.5 million households that are at 150 percent or below the poverty line did not pay for their advanced meters, the additional cost paid for by remaining ratepayers would increase by slightly more than 20 percent, which is less than a dollar more a month. Second, regulators do not have to require DP and, in fact, can keep flat rates as the default for low-income households, although this raises some important rate design issues discussed below. Third, regulators can enhance energy efficiency and demand response programs for low-income households. Insulation of homes is important because it saves both on air conditioning and heating costs. Fourth, AM can provide important information that may reduce electricity costs even without DP, particularly in the case of direct feedback.
III. Outlines of an Advanced Meter and Dynamic Pricing Proposal In summary, the reductions in AM costs and the efficiency benefits of DP make a compelling
1040-6190/$–see front matter # 2010 Elsevier Inc. All rights reserved., doi:/10.1016/j.tej.2010.06.002
The Electricity Journal
case to adopt both, particularly for industrial and commercial facilities. Regulators should seriously consider such policies for residential households as well. There are multiple definitions of equity and, for practical reasons, they should be applied based on income and resolved in the context of electricity regulation and rates. Of the handful of different equity definitions and concerns, the one regarding the regressiveness of electricity rates (and energy costs in general) warrants serious consideration, especially for a minority of low-income ratepayers that may be adversely affected by DP. Regulators can take meaningful steps to mitigate, if not entirely offset, the possibility that some low-income
ratepayers may have higher electricity bills with AM and DP by allocating some of the cost of AM based on electricity usage and having a uniform price as an option for all residential customers (and possibly as the default for low-income ratepayers). he above suggests the following proposal outline as a starting point: 1. Cost–benefit analyses of AM would be conducted, including scenarios assuming no DP.18 If these no-DP results show that AM results in a net social benefit under reasonable assumptions, AM would proceed. If AM is not cost-justified without combining it with DP, then regulators would have to evaluate the package of AM and DP.
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2. All industrial and commercial should have advanced meters and DP rates. For these customers in regions with locational marginal prices, their default DP should be real-time pricing based on wholesale prices. If the individual state permits retail access for these customers, they can negotiate different electricity pricing options. If the state does not allow retail access for these customers, then the utility should offer several other costbased alternatives that these customers could select from that include the appropriate risk premiums. 3. All residential (and smaller commercial customers, if this is a concern) should have advanced meters but under their current
Low-income households would not be charged for the advanced meter.
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rate structure. Retail customers would be allowed to switch to other pricing structures with reasonable limitations on switching back to their original rate. For those in states that allow retail access, the market would provide those alternatives, perhaps with some options being provided by utilities. For those states that do not have retail access, the utility would be required to offer several cost-based alternatives, again including, as appropriate, any risk premium as well as a means to avoid the ‘‘death spiral’’ associated with customers continuing to exit fixed-priced plans due to their increasing costs associated with the loss of customers.19 4. Retail customers would be provided information via the Internet or bill inserts indicating what their monthly electricity bill would have been under various alternatives, assuming their usage pattern and level did not change. There would also be concurrent educational campaigns. 5. Low-income households would not be charged for the advanced meter, and the allocation of the cost of AM would be established on a sliding scale based on usage. 6. Subject to confidentiality concerns, data on switching behavior, usage patterns, and levels would be used to evaluate the impact of DP 64
and AM on all residential consumers, including low-income households, particularly those negatively affected by DP. 7. After two years and with advance notice, retail customers would be required to select among a set of DP and uniform pricing options, but the default would be a simple DP tariff administered on a cost-
2. A. Faruqui, The Ethics of Dynamic Pricing, Brattle Group (2010). 3. H. PEYTON YOUNG, EQUITY IN THEORY AND PRACTICE (Princeton Univ. Press, 1984). 4. LIHEAP Fact Sheet from http:// www.acf.hhs.gov/programs/ocs/ liheap/about/factsheet.html 5. LIHEAP Home Energy Notebook for Fiscal Year 2007, U.S. Dept. of Health & Human Services (2009). 6. See S. Borenstein, M. Jaske and A. Rosenfeld, 105, Ðynamic Pricing, Advanced Metering and Demand Response in Electricity Markets, CSEM (Oct. 2002). 7. Id. 8. S. Darby, The Effectiveness of Feedback on Energy Consumption: A Review for DEFRA of the Literature on Metering, Billing and Direct Displays, Environmental Change Institute, Univ. of Oxford (April 2006). 9. T.J. Blocker, 4, Reforming Electricity Rates: Benefits to Low-Income Households, POPUL. RES. POL. REV., 67 (1985).
based basis by the utility, such as time-of-use or critical pricing, as opposed to a uniform rate. Consumers would be provided recommendations regarding which plan to subscribe to and be allowed to switch their pricing plans subject to reasonable limitations. If the utility were required to provide a uniform pricing option, the associated hedging cost would be included. &
10. F. SCHWEPPE, M. CARAMANIS, R. TABORS AND R. BOHN, SPOT PRICING OF ELECTRICITY (Kluwer Academic Publishers, 1988). 11. National Energy Policy Plan, Securing America’s Energy Future, U.S. Dept. of Energy, cited in Blocker, supra note 9 (1981). 12. Residential Energy Consumption Survey, Dept. of Energy (2005). 13. Blocker, supra note 9. 14. LIHEAP Home Energy Notebook, supra note 5. 15. Id. 16. K. Herter, Residential Implementation of Critical-Peak Pricing of Electricity, 35, ENERGY POL., 212 (2007). 17. Blocker, supra note 9.
Endnotes: 1. W. Vickery, Responsive Pricing of Public Utility Services, 2.1, BELL J. ECON. MGMT. SCI., 337 (Spring 1971). J. Action and B. Mitchell, Evaluating Time-of-Day Electricity Rates for Residential Customers, Rand R-2509-DWP (Nov. 1979).
18. See R. Hornby, C. Salamone, S. Perry, D. White and K. Takahashi, Advanced Metering Infrastructure: Implications for Residential Customers in New Jersey, Synapse Energy Economics, Inc. (July 2008). 19. Borenstein et al., supra note 6.
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Frank A. Felder is Director of the Center for Energy, Economic and Environmental Policy (CEEEP) at the Edward J. Bloustein School of Planning and Public Policy, Rutgers University. He benefited tremendously from the discussion during a one-day meeting on the Ethics and Dynamic Pricing sponsored by the Rutgers Initiative on Climate Policy and CEEEP.
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I. Introduction For more than 35 years, research has documented the efficiency benefits of having electricity retail prices fluctuate over relatively short time periods to reflect changing marginal costs.1 The concept of advanced meters (AM) has re-invigorated the debate concerning whether to implement dynamic pricing (DP) because AM lowers the implementation costs.
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he question of whether to implement AM raises a tangle of efficiency and equity policy issues, and it is helpful to clarify some important items at the outset. AM is not needed to implement DP, although it lowers the cost of doing so and facilitates more DP variations, such as realtime pricing. The benefits of AM are not limited to DP, although the ability to implement DP is often identified as one, if not the major, AM benefit. DP does not
1040-6190/$–see front matter # 2010 Elsevier Inc. All rights reserved., doi:/10.1016/j.tej.2010.06.002
The Electricity Journal
require having wholesale electricity markets with locational marginal pricing, although having such prices, if competitive, could be extremely useful in determining the dynamic retail prices used in DP. Without wholesale locational marginal prices, developing real-time retail prices is an issue, but it is resolvable. Having such locational marginal prices, however, does not require adopting retail real-time pricing. Further, the benefits of AM depend, in part, on universal deployment within a geographic area. Finally, AM enables customers to have different pricing plans, thus making it possible for customers to choose DP options that are best for them. s the AM equity debate, which revolves around residential customers, much ado about nothing? Each sector – industrial, commercial, and residential – consumes approximately onethird of the electricity in the United States, although the amount may vary substantially within a particular region or state. Realizing the efficiency benefits of DP requires having a relatively small amount of load responding to the price signal.2 Moreover, the cost of AM does not increase for larger customers; in fact, the larger the customer, the smaller the percentage an advanced meter would be of that customer’s total electricity bill. The notions of equity discussed below and that are a concern of many do not apply to industrial and large commercial entities.
I
The size, sophistication, and nonhuman status of industrial and large commercial entities do not warrant concerns about affordability, understanding different pricing options, or being able to take measures to respond to changing electricity prices. There may be economic development reasons to be concerned that AM and DP may increase costs to some of these businesses, but economic development rates can be designed to be dynamic. Typically, but not always, industrial and large commercial customers are concentrated in certain geographic areas, further lowering the costs of AM deployment. AM could be deployed to all customers in that region, but only require industrial and large consumers to pay DP. Thus, it is likely that most efficiency benefits of DP, which also benefit customers not on DP, can be obtained with these commercial and industrial customers. hat being said, there are additional benefits (and costs) of deploying AM to the residential sector and making it possible for households to select from different fixed priced and DP options. Furthermore, AM is a critical component of Smart Grid, a term that refers to a collection of technologies that improve the
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grid and particularly to the distribution system’s ability to communication information to enhance operations, maintenance, efficiency, and reliability. In addition, the ability of the distribution system to accommodate plug-in hybrids, a potentially large load, may require AM and DP.
II. Different Definitions of Equity and Their Implications Before providing different substantive definitions of equity that have been raised in the AM and DP context, it is worth discussing the regulators’ decision. Equity issues related to process are not analyzed based on the assumption that utility commissions have wellestablished processes that allow ratepayers and their advocates, among others, to articulate their positions for the consideration of regulators. Regulators, using equity and efficiency as the two objectives, could come to one of the four possible conclusions shown in Table 1. Clearly, the inequitable and inefficient outcome (lower right-hand box) would be rejected by all, whereas the equitable and efficient outcome would be accepted by all. One difficulty for
Table 1: Possible Outcomes of an AM Efficiency and Equity Analysis Equitable
Inequitable
Efficient
Equitable & Efficient – ACCEPT
Inequitable & Efficient – INCONCLUSIVE
Inefficient
Equitable & Inefficient – ??
Inequitable & Inefficient – REJECT
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the regulator is if there is a tradeoff between equity and efficiency. Another is that AM and DP may be considered equitable under one definition of equity but may not under another definition. ne strategy for resolving the equity issues in this particular context is to try to resolve them in all contexts. In this issue of The Electricity Journal, Prof. Bunzl reflects on equity issues raised by DP in a broader context. There are longstanding debates about society-wide issues of equity and social justice, however, that are not going be resolved in the context of AM and DP. As Prof. Hogan notes in this issue, these broader issues of social justice do not, however, have to be resolved prior to analyzing equity within a particular context. For practical reasons, society compartmentalizes issues of equity and does not attempt to coordinate distributive decisions across different domains; consequently, each problem is treated on its own merits and based on the norms and precedents that accumulated over time for that situation.3 Equity concerns are usually raised with respect to subgroups within residential households, such as low-income, elderly, fixed-income households, nightshift workers, and housebound residents. The underlying commonality is that these groups cannot afford higher electricity bills and are thus less likely to be able to respond to
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different price signals. It does not seem the case that those concerned with equity in this context are concerned with the equity implications of the highincome elderly couple or the emergency room surgeon who works nights. Moreover, the Federal Low-Income Home Energy Assistance Program (LIHEAP) uses income as the means to define the protected class. The purpose of this
There are longstanding debates about society-wide issues of equity and social justice that are not going be resolved in the context of AM and DP. program is to assist low-income households, particularly those with the lowest incomes that pay a high proportion of household income for home energy. An eligible household’s income must not exceed the greater of 150 percent of the poverty line or, in fiscal year 2009, 75 percent of a state’s median income.4 Households with elderly, disabled, and young children represent about 72 percent of LIHEAP’s income-eligible population.5 Thus, in this context, it is appropriate to focus on income as the means of addressing equity, rather than on some other
characteristic. It would be beyond a utility commission’s mandate and capabilities, as well as the compartmentalization that society employs, to try to develop some equity criteria based on age, disability, fixed income, or employment hours, among others. The disputes over what these criteria should be, whether each category should be considered individually or in combination, and what should be the individual or combined threshold for determining who is in the protected class would be endless. Moreover, collecting the necessary data with a reasonable degree of accuracy initially and over time would be administratively difficult. Finally, as previously noted, using the income criteria results in the inclusion of segments of the population that are vulnerable to high energy prices. Specific equity issues should be considered. Four AM and DP equity concerns are the inability to respond to DP, the longstanding precedents of uniform pricing, cross-subsidies, and regressive electricity costs. As Dr. Faruqui discusses in this issue of The Electricity Journal, DP benefits even those who do not or cannot respond to changing electricity prices because other consumers reduce their peak demand, which in turn reduces electricity prices for all.6 DP also reduces the ability of sellers of electricity to exercise market power and the probability of electricity shortages, with their resultant rolling blackouts. Again,
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this benefits all customers, not just those on DP.7 Even without questioning the assumption that there is a large group of residential customers who cannot change their consumption, the equity concern of inability to respond to changing prices does not stand on its own. For instance, having AM and DP for industrial and commercial classes would lower residential prices even if none of the residents had AM or were on DP. Obviously, regulators would not consider this an inequitable outcome that requires residential rates to be increased to pre-AM and -DM levels because residents could not respond to changing electricity prices. Furthermore, the information and feedback demonstrate that AM can provide energy savings without DP. According to one review of studies, direct feedback (immediate feedback from the meter or a display monitor in the building) reduces energy consumption by 5 to 15 percent, and indirect feedback (information that has been processed in some way before reaching the energy user, typically via billing) has savings of 0 to 10 percent.8 nother equity concern is the longstanding use of uniform pricing, which sets expectations for consumers. This precedent, however, is not inviolable. In the 1970s, rising fuel costs led to fuel adjustment clauses that allowed utilities to pass through these cost increases to consumers. Moreover, many
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utilities and states have introduced non-uniform pricing (NUP) such as seasonal rates and time-of-use rates. Finally, as discussed further below, DP can be phased in, supplemented with education and consumer information, and be part of a menu of choices that includes uniform prices to mitigate concerns of changing past policies. A survey of low-income households found that
It is important, in part due to fairness considerations, that consumers be given a choice of having a uniform rate as an option with DP. approximately two-thirds were favorably oriented towards timeof-day rates, one type of DP.9 Related to the precedent of uniform pricing is the issue that it minimizes consumer transaction costs. Uniform pricing is incredibly easy to understand. No matter when you use electricity, it costs the same amount. The consumer does not have to keep track of changing prices and then figure out what, if anything, should be done in response. With DP, there is a risk that consumers who leave their air conditioning on during a vacation may be exposed to a large electricity bill if prices spike. Of course, different
consumers have a different willingness to accept such a risk for the benefits of DP. Furthermore, technological advances may make it possible to respond to changing prices without direct human intervention, thereby reducing the associated transaction costs. That being said, it is important, in part due to fairness considerations, that consumers be given a choice of having a uniform rate as an option with DP. As Prof. Hogan notes in this issue, the problem is one of selecting the default rate that consumers are assigned. he remaining two notions of equity involve reducing or eliminating cross-subsidies and making electricity costs less regressive. Proponents of DP tend to focus on the former. They argue that it is inequitable to make someone else pay for something you use. One major reference notes that if equity is defined as reducing customer cross-subsidies, that is, a customer’s charges are based on the cost to serve that customer (which it acknowledges as one of several possible definitions), then dynamic electricity pricing is equitable.10 This is also the position taken by Dr. Faruqui in this issue. In contrast, opponents of AM and DP argue that they are inequitable because they would adversely (regressively) affect lower-income ratepayers. Lowincome households do not have the capital to invest in more energy efficient technologies and, therefore, in response to higher
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Table 2: Average and Low-Income U.S. Household Electricity Usage and Costs (2005) Below 100% of Poverty Line
100 to 150% of Poverty Line
Above 150% of Poverty Line
Average Household
Number and Percentage of Households Average Annual Electricity Consumption (kWh)
16.6 million 15% 9,037 kWh
12.9 million 12% 10,342 kWh
81.5 million 73% 12,158 kWh
111.1 million 100% 11,480 kWh
Average Cost Average Electricity Bill ($)
10 cents/kWh $904
$1,034
$1,216
$1,148
Source: 2005 Residential Energy Consumption Survey, Energy Information Agency.
peak prices can only curtail their electricity consumption at the ‘‘cost of severe discomfort, inconvenience or threats to health.’’11 t this juncture, it is useful to consider U.S. income and electricity consumption data in detail presented in Table 2. Using the most recent data available, the U.S. had 111.1 million households in the year 2005. Of these households, 6.4 million (5.1 percent) had someone home all day. Households that had members aged 65 or older numbered 26.9 million (24.2 percent).12 he percentage of income a household spends on
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electricity decreases dramatically as income increases, although households with higher incomes consume more electricity than lower-income households and, consequently, spend more in absolute terms. Table 3 presents for 2005 the annual amount of electricity, the cost, and the percentage of income for households as a function of income. Note that the lowestincome group spends about half the amount the upper-income bracket on electricity ($785 vs. $1,538), but 10 times more as a percentage of income (15.7 percent vs. 1.5 percent). A 10 percent change in electricity prices results in a 1.6 percent
change in the income of the lowest household income bracket but only a 0.15 percent change in the income of the highest bracket. According to one study, income accounts for 17.6 percent of the total variation in electricity use, and the number of persons in the household was the second most important variable, explaining 6.1 percent of the variation not accounted for by income.13 Table 4 breaks down the household consumption of electricity into three major categories that account for almost all household electricity consumption: other appliances and lighting, air conditioning, and refrigeration. All households
Table 3: U.S. 2005 Electricity Consumption and Costs by Household Income U.S. Households Household Income
Annual Electricity
Number (million)
%
kWh
Cost
Less than $10,000 $10,000 to $14,999
9.9 8.5
8.9% 7.7%
7,854 8,710
$15,000 to $19,999 $20,000 to $29,999
8.4 15.1
7.6% 13.6%
9,506 10,040
$ 951 $ 1,004
5.4% 4.0%
$30,000 to $39,999
13.6
12.2%
11,431
$ 1,143
3.3%
$40,000 to $49,999 $50,000 to $74,999
11.0 19.8
9.9% 17.8%
11,658 12,440
$ 1,166 $ 1,244
2.6% 2.0%
$75,000 to $99,999 $100,000 or More
10.6 14.2
9.5% 12.8%
13,559 15,382
$ 1,356 $ 1,538
1.5% 1.5%
Total
111.1
$ 785 $ 871
% of Income 15.7% 7.0%
100%
Source: 2005 Residential Energy Consumption Survey, Energy Information Agency.
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Table 4: U.S. 2005 Electricity Costs by Major Uses and Household Income Other Appliances & Lighting Household
%
%
Air Conditioning
Refrigeration
%
%
%
%
Income
Cost
Elect.
Income
Cost
Elect.
Income
Cost
Elect.
Income
Less than $10,000
$398
50.7%
8.0%
$206
26.2%
4.1%
$111
14.1%
2.2%
$10,000 to $14,999 $15,000 to $19,999
$448 $453
51.4% 47.7%
3.6% 2.6%
$195 $213
22.4% 22.4%
1.6% 1.2%
$118 $114
13.5% 12.0%
0.9% 0.7%
$20,000 to $29,999
$535
53.3%
2.1%
$234
23.3%
0.9%
$122
12.2%
0.5%
$30,000 to $39,999 $40,000 to $49,999
$580 $651
50.7% 55.8%
1.7% 1.4%
$278 $277
24.3% 23.8%
0.8% 0.6%
$129 $132
11.3% 11.3%
0.4% 0.3%
$50,000 to $74,999 $75,000 to $99,999
$720 $818
57.9% 60.3%
1.2% 0.9%
$302 $312
24.3% 23.0%
0.5% 0.4%
$145 $155
11.7% 11.4%
0.2% 0.2%
$1,004
65.3%
1.0%
$380
24.7%
0.4%
$185
12.0%
0.2%
$100,000 or More
Income Relative to Poverty Line Below 100 Percent
$480
53.1%
$226
25.0%
$113
12.5%
100 to 150 Percent Above 150 Percent
$530 $699
51.2% 57.5%
$243 $291
23.5% 23.9%
$119 $145
11.5% 11.9%
Source: 2005 Residential Energy Consumption Survey, Energy Information Agency.
had lighting, and other appliances and refrigeration, and 91.4 million households (82.3 percent) had air conditioning. Households spent $647 on lighting and other appliances, $276 on air conditioning, and $137 per year on refrigeration. Over time, lowincome households have increased their use of central air conditioning from 8.5 percent in 1979 to 42.8 percent in 2005, coterminous with the decrease in the percentage of these households that do not have air conditioning of any kind from 62.8 percent to 20.1 percent.14 It is worth noting that in 2005, 34 percent of low-income households used electric heat, increasing from 10 percent in 1979.15 ccording to Dr. Faruqui’s paper in this issue, based on data from one utility and
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before considering the cost of AMI, 80 percent of low-income customers would gain from DP assuming no response by customers to DP, and over 90 percent would gain assuming a moderate response. The intuition for this result, consistent with the data just presented, is that lowerincome customers have a flatter load shape than do mid- and higher-income groups because they use less air conditioning. In other words, lower-income households are cross-subsidizing higher-income households. Obviously, if and to what extent
these results hold for other utilities in other regions and climates of the United States is an empirical issue but, as a working hypothesis, the equity notions of reducing cross-subsidies and reducing the regressive nature of electricity bills are aligned. That is, flat rates are inequitable under two very different definitions. f course, the cost of AM must be considered along with its transaction costs. Table 5 presents the monthly costs of an advanced meter under different meter cost and life assumptions.
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Table 5: Estimated Monthly Cost of Advanced Meters under Different Assumptions Meter Cost Meter Life
$200/meter
$250/meter
$300/meter
10 years 15 years
$2.64/month $2.15/month
$3.30/month $2.69/month
$3.96/month $3.22/month
20 years
$1.93/month
$2.41/month
$2.90/month
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A generic discount rate of 10 percent is assumed. ssuming a meter cost of $3 per month, or $36 per year, low-income households that spend approximately $900 per year on electricity would experience a 4 percent increase before accounting for any benefits from AM and DP. If for the lowest-income group, AM without DP resulted in a 2.5 percent savings due to indirect feedback, the corresponding monthly savings would be $1.63. If direct feedback is provided, these monthly savings would be several times higher. Regulators may not find this increase associated with AM acceptable even assuming these feedback benefits. Moreover, they may be risk-averse: even if they believe that AM and DP reduced costs for most low-income households, they may still find that the electricity bill increases on a small percentage of low-income households not offset by the reductions in the majority of low-income households. tarting from the philosophical position behind the veil of ignorance, Prof. Bunzl notes that these households – those that are both poor and peakier than average – are a legitimate equity concern. They also exist. According to one study, high-use customers in California earning less than $50,000 had bill increases under critical peak pricing. About 5 percent saw bill increases of 10 percent or more.16 Another study concluded
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(without accounting for the overall reduction in electricity prices due to DP) that although smaller low-income households and those headed by older persons would receive the most immediate benefits of time-of-day rates, larger households and those with younger household heads would have to alter electricity usage to benefit.17
This raises two related policy questions. First, is the standard that (almost) every low-income household must be the same or become better off before AM is to be adopted? Second, given such a standard, is it possible for regulators to identify and compensate low-income households that are worse off? As a practical matter, it would be difficult to guarantee with absolute certainty that with compensation, no lower-income household was worse off even with Herculean efforts. Such a policy standard, if more generally applied, would make almost any policy change impossible. There are actions regulators can take that may insulate low-
income households. First, since the benefits of AM accrue disproportionately to those who use more electricity, AM costs do not have to be allocated equally to each household or rate class. Costs can be allocated, in part, based on usage, further reducing the impact to low-income households. For instance, if the 19.5 million households that are at 150 percent or below the poverty line did not pay for their advanced meters, the additional cost paid for by remaining ratepayers would increase by slightly more than 20 percent, which is less than a dollar more a month. Second, regulators do not have to require DP and, in fact, can keep flat rates as the default for low-income households, although this raises some important rate design issues discussed below. Third, regulators can enhance energy efficiency and demand response programs for low-income households. Insulation of homes is important because it saves both on air conditioning and heating costs. Fourth, AM can provide important information that may reduce electricity costs even without DP, particularly in the case of direct feedback.
III. Outlines of an Advanced Meter and Dynamic Pricing Proposal In summary, the reductions in AM costs and the efficiency benefits of DP make a compelling
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case to adopt both, particularly for industrial and commercial facilities. Regulators should seriously consider such policies for residential households as well. There are multiple definitions of equity and, for practical reasons, they should be applied based on income and resolved in the context of electricity regulation and rates. Of the handful of different equity definitions and concerns, the one regarding the regressiveness of electricity rates (and energy costs in general) warrants serious consideration, especially for a minority of low-income ratepayers that may be adversely affected by DP. Regulators can take meaningful steps to mitigate, if not entirely offset, the possibility that some low-income
ratepayers may have higher electricity bills with AM and DP by allocating some of the cost of AM based on electricity usage and having a uniform price as an option for all residential customers (and possibly as the default for low-income ratepayers). he above suggests the following proposal outline as a starting point: 1. Cost–benefit analyses of AM would be conducted, including scenarios assuming no DP.18 If these no-DP results show that AM results in a net social benefit under reasonable assumptions, AM would proceed. If AM is not cost-justified without combining it with DP, then regulators would have to evaluate the package of AM and DP.
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2. All industrial and commercial should have advanced meters and DP rates. For these customers in regions with locational marginal prices, their default DP should be real-time pricing based on wholesale prices. If the individual state permits retail access for these customers, they can negotiate different electricity pricing options. If the state does not allow retail access for these customers, then the utility should offer several other costbased alternatives that these customers could select from that include the appropriate risk premiums. 3. All residential (and smaller commercial customers, if this is a concern) should have advanced meters but under their current
Low-income households would not be charged for the advanced meter.
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rate structure. Retail customers would be allowed to switch to other pricing structures with reasonable limitations on switching back to their original rate. For those in states that allow retail access, the market would provide those alternatives, perhaps with some options being provided by utilities. For those states that do not have retail access, the utility would be required to offer several cost-based alternatives, again including, as appropriate, any risk premium as well as a means to avoid the ‘‘death spiral’’ associated with customers continuing to exit fixed-priced plans due to their increasing costs associated with the loss of customers.19 4. Retail customers would be provided information via the Internet or bill inserts indicating what their monthly electricity bill would have been under various alternatives, assuming their usage pattern and level did not change. There would also be concurrent educational campaigns. 5. Low-income households would not be charged for the advanced meter, and the allocation of the cost of AM would be established on a sliding scale based on usage. 6. Subject to confidentiality concerns, data on switching behavior, usage patterns, and levels would be used to evaluate the impact of DP 64
and AM on all residential consumers, including low-income households, particularly those negatively affected by DP. 7. After two years and with advance notice, retail customers would be required to select among a set of DP and uniform pricing options, but the default would be a simple DP tariff administered on a cost-
2. A. Faruqui, The Ethics of Dynamic Pricing, Brattle Group (2010). 3. H. PEYTON YOUNG, EQUITY IN THEORY AND PRACTICE (Princeton Univ. Press, 1984). 4. LIHEAP Fact Sheet from http:// www.acf.hhs.gov/programs/ocs/ liheap/about/factsheet.html 5. LIHEAP Home Energy Notebook for Fiscal Year 2007, U.S. Dept. of Health & Human Services (2009). 6. See S. Borenstein, M. Jaske and A. Rosenfeld, 105, Ðynamic Pricing, Advanced Metering and Demand Response in Electricity Markets, CSEM (Oct. 2002). 7. Id. 8. S. Darby, The Effectiveness of Feedback on Energy Consumption: A Review for DEFRA of the Literature on Metering, Billing and Direct Displays, Environmental Change Institute, Univ. of Oxford (April 2006). 9. T.J. Blocker, 4, Reforming Electricity Rates: Benefits to Low-Income Households, POPUL. RES. POL. REV., 67 (1985).
based basis by the utility, such as time-of-use or critical pricing, as opposed to a uniform rate. Consumers would be provided recommendations regarding which plan to subscribe to and be allowed to switch their pricing plans subject to reasonable limitations. If the utility were required to provide a uniform pricing option, the associated hedging cost would be included. &
10. F. SCHWEPPE, M. CARAMANIS, R. TABORS AND R. BOHN, SPOT PRICING OF ELECTRICITY (Kluwer Academic Publishers, 1988). 11. National Energy Policy Plan, Securing America’s Energy Future, U.S. Dept. of Energy, cited in Blocker, supra note 9 (1981). 12. Residential Energy Consumption Survey, Dept. of Energy (2005). 13. Blocker, supra note 9. 14. LIHEAP Home Energy Notebook, supra note 5. 15. Id. 16. K. Herter, Residential Implementation of Critical-Peak Pricing of Electricity, 35, ENERGY POL., 212 (2007). 17. Blocker, supra note 9.
Endnotes: 1. W. Vickery, Responsive Pricing of Public Utility Services, 2.1, BELL J. ECON. MGMT. SCI., 337 (Spring 1971). J. Action and B. Mitchell, Evaluating Time-of-Day Electricity Rates for Residential Customers, Rand R-2509-DWP (Nov. 1979).
18. See R. Hornby, C. Salamone, S. Perry, D. White and K. Takahashi, Advanced Metering Infrastructure: Implications for Residential Customers in New Jersey, Synapse Energy Economics, Inc. (July 2008). 19. Borenstein et al., supra note 6.
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