Markets & Monopolies

I shared some thoughts recently on “Markets and Monopolies.”

Click above to get them. Or here:
NGA UBM Meeting KRR 150728

More Thoughts on Fixed Charges and Demand Charges

A colleague asked me to explain some comments that I made during a webinar. I will link the webinar when it is available, but for now:

Some utilities argue that fixed charges (or collecting fixed costs through demand charges) are appropriate as a way of sending a “price signal” to consumers. This implies that we seek some kind of elasticity response.

To be clear - if there is no elasticity, then changing your rates to match your costs is simply an exercise in trying to extract monopoly rents. If changing the price will not make a change in usage, then arguing for more fixed charges because more of costs are fixed is just a way of saying - “I have the market power to recover revenues without regard to changes in demand” - the very definition of monopoly.

This raises the concern about what signal we are sending back to the utility - you can incur highly fixed costs (which are also most expensive under the rate making formula) and we will make sure that you can recover them from customers.

Is there elasticity in the demand for electric services? And, importantly, is the elasticity in demand for energy and is there elasticity in the demand for capacity?

In the near term, elasticity of demand for energy is relatively low, but new smart grid technologies could increase it. Remember, most people do not see a bill more than once a month. Meters are difficult or impossible to read, etc. But, with innovations like OPower and critical peak pricing, we can imagine customers responses in the amount of energy they use. And this impacts their demand for capacity indirectly.

But even this is not likely to create or increase elasticity in demand for capacity directly. Residential capacity demand patterns and technologies are big and lumpy. A new air conditioner will last for 10 years, for example. A roof for 15. Solar for 25. A house for 70. Since these are the things that really drive capacity demand, what good does a monthly fixed charge do? When?

So, what exactly does a residential customer do in response to a “price signal” in the form of higher fixed charges or demand charges? Buy a new roof, a new air conditioner?

The best we can come up with today is “cycling your air conditioner.” Of course, if the customer is poor, and has a box fan or window unit and refrigerator that runs constantly, these ideas won’t help. And their cycling reduces energy more than anything, since there is no price signal guiding the coincidence of their demand for capacity and the system.

In fact, since the thing every residential customer can do is reduce their energy demand, the best signal back to the utility would be to put fixed costs in the variable charge. This would send them a signal to moderate their capital investment and reduce their over-building.

I said/often say a few more things -

1. The sunk fixed costs that utilities are trying to collect are based on investment decisions in the past. They act as if the impact of solar on fixed cost recovery is large (there is no data to support this in most of the country), and that they couldn’t see it coming. One of the benefits of age is knowing that we have been telling utilities that renewables and efficiency are coming for at least the 25 years that I have been in the system.

What did they do? Did they evaluate the risk that we were right and avoid over-building? No. Did they accelerate smart grid and demand response programs as a less expensive alternative to expensive capacity? No.

So, what should society say to these utilities now? Should we allow them to extract those rents and build on?

2. What is the distribution of ability to respond to residential rate price signals? For most customers, there is little ability, and it increases with income. Do utility rates create segmentation among residential customers so that those that can respond are charged rates to encourage this?

No. In fact, many utilities reduce volumetric rates when they increase demand or fixed costs - sending the opposite price signal. Use more! Modern competitive markets segment customers - when will the electric utility sector catch up. And why, in fact, are many utilities trying to increase the size of customer classes and reduce segmentation?

3. The fact is that the low income customers are more heavily distributed in the lower-than-average distribution of customers. What about the regressivity of fixed charges? Utilities are not really responding to this. Ironically, and hypocritically, some utilities are protesting solar because it impacts the poor while simultaneously imposing regressive fixed charges on all residential customers. (See WE Energies, WEPCO, Madison G&E)

4. All costs are variable over the long term. These utilities are confusing “sunk” costs - past investments that they fear are no longer use and useful (overbuilt and now potentially stranded), and fixed (currently not subject to change based on changes in customer demand for energy or capacity). Solar and efficiency and smart grid can all reduce fixed costs in the future - if given a chance. They can’t fix past mistakes in overbuilding. But, again, what signal should we send to the utility? Your overbuilding will always be covered by ratepayers? Remember, utilities are not guaranteed recovery of investments, and their shareholders were given very high returns to absorb market risk. 100% recovery and zero risk is not what a market competitor would tolerate from utilities — and regulators are supposed to serve as a substitute for competition, not an enabler of monopoly abuse.