The California PUC is in the midst of a proceeding to implement legislative direction to adopt “income-graduated fixed charges” (IGFC), designed to increase bills for those with higher income, decrease bills for those with lower income, and reduce the per-kWh charge.
The last of these is intended to make electrification of energy uses now served with fossil fuels more economically attractive. California is committed to decarbonizing the state economy, and use of petroleum, propane, and natural gas are all problems. But current electricity prices are so high that the economics of electrification are, at best, not very compelling for the California investor-owned utility consumers.
The IGFC proposals from the utilities raise fixed charges by an average of about $50/month, and reduce prices per kWh by an average of about $0.10/kWh, a simple calculation based on average customer usage of about 500 kWh/month. Here is the fixed charge proposal that the utilities made in their filing with the CPUC earlier this year:
There are many issues with the IGFC, which have been addressed by experts across the nation. First, they are likely impossible to implement, as I described in an earlier note. Second, they deviate from the concept that electricity rates should be based on the cost of providing service. Third, they will shift cost responsibility dramatically from the interior of California (where usage is generally higher) to the coastal communities (where incomes are generally higher).
The California problem can be solved with a combination of tough regulation, creative regulation, and modern electric rate design. The concept of the IGFC is simply not practical, nor is it necessary. There are rough estimates for each category of costs and policies addresses; these are not the result of rigorous analysis, just educated estimates.
The Basic Problem: High Revenue Requirements and High Rates
This challenge has its roots in the very high average rates for the investor-owned utilities in the state of California. The rates are so high that electrification is unattractive.
Below are the current rates for PG&E and for Puget Sound Energy (PSE), which serves the Seattle suburbs. PSE has almost exactly the average residential rate per kWh for all electric utilities in the US: about $0.13/kWh.
The PG&E volumetric rates are 3-4 times those of PSE, and average utility. Less than one cent of this difference ($7.49 / ~ 1,000 kWh/month average usage for PSE) is explained by the lack of a customer charge. PSE is unlike the consumer-owned utilities in the Northwest which get most of their power from hydro; PSE’s power supply is mostly thermal. Both PG&E and PSE get about a quarter of their power from hydropower.
Why are electric rates for the California utilities so high? Almost every possible influence on the average cost and unit price for electricity is present, including basic revenue requirement issues, above-market costs in rates, social programs, and rate design.
A similar objective – a ten-cent per kWh reduction in the volumetric price of electricity, can be achieved through a much less onerous and politically-fraught set of steps:
- Implement a cost-based fixed charge. California is unique in having a “disappearing minimum bill” rate form. Every other state has fixed charges to recover at least the cost of metering and billing from every customer, independent of usage. This should consist of two parts:
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- A customer charge for metering and billing, the same for all customers, plus
- A site infrastructure charge for the cost of the site infrastructure: final line transformer and service drop, larger for customers with larger connections to the grid.
This will add up to about $10/month for apartments, $20/month for small single-family homes, and $30 - $40/month for large single family homes and rural homes with dedicated line transformers. Hawaii, Nevada, Manitoba, municipal utilities in California, and several utilities overseas have similar forms of fixed charges.
These can then be discounted for low-income (FERA) consumers, and set at zero for very-low income consumers (CARE) to satisfy the statutory directive for a minimum of three income-based tiers in the fixed charges. The amount recovered in fixed charges can then be subtracted from the volumetric charges.
This will also ensure that solar customers pay 100% of the costs to remain connected to the grid. Reduction in volumetric rate per kWh: $.03 – $.05/kWh
- Securitize out-of-market costs. California utilities have above-normal costs for some things like wildfire protection investments and nuclear power cost recovery. If the CPUC believes these should be paid by electricity consumers, they should be paid by issuing state revenue bonds backed by electricity revenues, as was done in 2000-2001 for power purchased during the power crisis. Transmission costs can also be transferred to a state revenue bond funding mechanism, as the state's high-voltage transmission system serves the entire state. Replacing utility financing at ~10% (including taxes) with state financing at ~4% will reduce these costs reflected in rates by about half. Reduction in volumetric rate per kWh: $.02 - $.04
- Reduce utility allowed return on equity, equity capitalization ratio, and executive compensation. California allows a higher-than-average return on equity, a higher-than-average equity capitalization ratio, and very high expenses for top management and technical staff of utiilties. This drives up cost recovery for capital investments and operating expenses. Reducing the cost of capital to the lower end of the national rate is appropriate, because California allows adjustments such as a fuel and purchased power mechanism and a decoupling mechanism which greatly reduce utility income volatility. Limiting compensation for utility employees at no more than a modest premium over what executives and technical employees of state government would also ensure that electricity consumers are not paying more for utility workers than they pay for state workers with equivalent duties. Reduction in volumetric rate per kWh: $.01 – $.02
- Use carbon auction revenues to offset higher-cost renewable energy. California IOU consumers currently receive twice-yearly lump-sum distributions of carbon auction revenues. That was done specifically to avoid suppressing electricity prices, but that is no longer an explicit goal. Instead, these funds should be used to offset the high cost of early renewable energy contracts that drive up rates. California’s early investments in wind and solar were instrumental to facilitating growth of these industries, and the above-market costs should be paid as a part of the state carbon reduction program. Reduction in volumetric rate per kWh: $.02 - $.03/kWh
- Shift social program costs to the state budget. California’s generous low-income discount programs reduce bills by up on 35% for about one-third of residential consumers. A sample on the PG&E website shows a $113/month credit for a customer with 1,194 kWh of consumption, or about ten-cents per kWh. If one-third of customers are receiving a ten-cent discount, then the other two-thirds must be paying a five-cent surcharge. Reduction in volumetric rate per kWh: $.05
- Recover allowed costs through a well-designed TOU rate. This combination of steps described above would reduce California volumetric rates by $.10/kWh to $.19/kWh, bringing them to about the current level of the California consumer-owned utilities like Sacramento, Los Angeles, Anaheim, Burbank, Glendale, and Pasadena.
The final step is to re-design rates to provide a much lower off-peak rate, which will be attractive to electrification of water heating and transportation loads. The optional TOU rate for Burbank Water and Power is an excellent example of this. The very low off-peak rate, under $.09/kWh is extremely favorable for electrification: it is the cost-equivalent of about $1.00/gallon gasoline for powering an EV, or $1.00/therm natural gas for operating a heat pump water heater.
Burbank Water and Power Optional TOU Rate (6/13/23)
A rate design of this type would meet the objectives of the California IGFC proceeding, and with a discount to the fixed charges for qualified low-income households in the CARE and FERA programs, would meet the legislative direction for three income tiers in the fixed charge.
What about Space Heating? The Burbank rate design works great for electrification of automotive and water heating energy usage, but space heating consumption cannot easily be concentrated into the low-cost hours. Fortunately, California has, for decades, had a "baseline rate" mechanism that allocates each customer a block of low-cost energy, differentiated by climate zone and housing type. Customers that convert a fossil fuel heating system to an electric heat pump can simply qualify for a larger baseline allocation, using the housing type and climate zone method that was formulated in the 1980's. This is not an obstacle.
The bottom line: There is no need to deviate sharply from long-established regulatory principles in order to achieve the objectives of the new California law or to provide an inviting market opportunity for electrification of transport and water heating loads. The combination of enacting a cost-based fixed charge, reducing some cost recovery to the utilities, securitizing above-market costs and transmission investment, and designing a smart time-varying rate can achieve the purposes of the California legislation.