As the American power sector confronts a broader shift towards cleaner, more distributed forms of energy, as well as the movement towards an increasingly electrified transportation and building sector, experts are taking a closer look at ways to structure electric rates and make them more equitable.
While there has been an evolving conversation over the last several decades around changing the way electricity is priced, residential power rates have looked fairly similar for the vast majority of the past century. Generally, they’re composed of a small, fixed customer charge along with a per-kilowatt hour rate to recover the bulk of power system costs, according to Mark LeBel, senior associate with the Regulatory Assistance Project — “and that works for most people, in most circumstances, the vast majority of the time,” he said.
However, in the last five to ten years, the electric sector has seen a new set of “pressures'' on the traditional ratemaking model, he added. Net metering frameworks, which credit customers for electricity they generate and send back to the grid, for instance, started in earnest around 15 years ago. In the last decade, there has been a push to electrify building heating and the transportation sector as well.
Meanwhile, the average monthly electricity bill for U.S. residential customers increased 13% from 2021 to 2022 – 5% when adjusted for inflation – driven by more extreme temperatures and higher fuel costs for power plants, the U.S. Energy Information Administration reported. This was the largest reported annual increase since 1984. And in the first quarter of 2023, average residential electricity bills were 5% higher than the same time last year.
As a result, different states and experts are taking a closer look at new ratemaking strategies that could respond to these pressures. A few states, like New York and New Hampshire, have tiered low-income discounts of various kinds, LeBel said.
In California, regulators are taking a look at proposals to implement a fixed charge on electric bills that varies based on a household’s income — a system that no other state currently has. Last October, regulators in Hawaii adopted an advanced rate design framework, with a time-of-use design that regulators say will allow customers to explore rate options and save money.
“I think we’re going to see a whole bunch of different ideas and proposals in the coming decades. And sometimes, I think people’s imagination is a little too restricted about what the possibilities are – but I think we’re going to see a lot of different experimentation,” LeBel said.
Three changing trends in the power sector
Currently, electricity rates across the U.S. are built up of some combination of the following elements, according to Eric Gimon, senior fellow with Energy Innovation: volumetric charges, which are per kilowatt hour; fixed charges, which are monthly charges that don’t vary based on usage; and demand charges, which are generally used only for commercial and industrial customers and vary based on usage.
Historically, policymakers and others have tended to favor volumetric rates for a variety of reasons. However, rate design experts have increasingly been pointing to changing dynamics in the energy sector that could warrant another look at different electricity pricing mechanisms.
Around a decade ago, the California Public Utilities Commission’s Public Advocates Office was one of the prime movers behind the push for fully volumetric rates, Matt Baker, the office’s director, said. But three big trends have forced his office to rethink that decision.
First, there’s the fact that grid costs are being increasingly driven by fixed costs rather than generation costs. Second, there’s the policy-driven need to electrify different sectors of the economy, which brings with it the need to make sure the marginal rate of electricity is low enough to allow people to switch from, say, a gasoline car to an electric vehicle. And third, there’s the large investments that the state has had to make in its electric grid, especially to adapt to a changing climate.
“And so those costs are going up, and they’re going up whether or not you’re using a lot of electricity or using a little bit of electricity,” he said.
"[I]f prices go up the same for everyone, it impacts low-income people more – it’s regressive."
Senior Fellow, Energy Innovation
There are two big downsides to sticking to the status quo of largely volumetric rates, according to Baker – the first is that it makes it harder to electrify different sectors of the economy. Second, “you end up with a grid that’s increasingly inequitable – you have a smaller and smaller share of the ratepayers paying for a greater and greater share of the fixed costs,” he said.
Another factor that plays into the affordability of electricity is cost containment.
“You could make a sound case that public utilities [commissions] across the country have been a little bit asleep at the switch on cost containment. They were a little too liberal with these utilities … in letting them build a lot of equipment that may or may not be necessary,” as well as with their rate of return, Gimon said.
In either case, increasing rates can have a disproportionate impact on lower-income communities and customers. Part of the issue is the “opportunity element,” Gimon said — they have less access to ways to mitigate the impacts of rising energy costs, like buying distributed energy resources, or to spend money on insulation. Renters, for instance, do not even have a say in how energy efficient the appliances in their buildings are.
“And then the main part is, if prices go up the same for everyone, it impacts low-income people more — it’s regressive,” Gimon added.
Strategies to make electric rates more equitable
There are multiple ways in which regulators and rate design experts are looking to deal with the issue of inequitable rates.
Last year, for instance, California lawmakers passed legislation that authorized the creation of an income-graduated fixed charge for residential electricity bills, that could cover fixed costs like wildfire prevention, with at least three income thresholds. In April, multiple stakeholders, including the state’s investor-owned utilities, filed initial proposals with the California Public Utilities Commission, outlining what this charge could look like.
This included the Public Advocates Office, whose proposal included three different rates for households that earn less than $50,000 a year, those between $50,000 and $100,000 a year, and those who make more than $100,000 annually. For the first category, the office recommended bringing the fixed charge down to zero using California’s climate credit, a refund that goes to ratepayers in the state. For ratepayers who are not on a state assistance program and fall in the second or third category, the office recommended a fixed charge of between $30 and $37, and between $35 and $42, depending on utility service area.
Under their proposal “anybody who is a high user does better — and that’s to reflect the incentive to electrify. Anyone who makes less than $50,000 does better,” Baker said.
Southern California Edison also filed a proposal with the commission, which it says would give lower-income customers a 16% to 21% bill reduction, and lower the monthly bills of around half its customers, assuming their electricity use stays the same. Under SCE’s proposal, the top 19% of earners would see the highest fixed charge, of $85 a month. Lower-income customers would see monthly fixed charges of between $15 and $20 a month.
The implementation of this fixed charge doesn’t add anything to customer bills, Michael Backstrom, vice president of regulatory affairs at SCE, said. Instead, it moves around where certain costs are recovered in that bill.
“So as you create that fixed component that is aligned with fixed costs in our system, you actually are able to reduce the volumetric rate … so as a result, you see a much lower rate on a per kilowatt-hour basis in the rate design, which then supports that adoption of electrification,” he said.
“If the customer charge for upper-income people is quite high, people will try to structure their affairs in order to avoid it... just like with income taxes, there’s tax avoidance.”
Senior Associate, Regulatory Assistance Project
However, the idea of an income-based fixed charge has received its fair share of criticism, according to Ahmad Faruqui, an energy economist. Income-based fixed charges, like those proposed in California, essentially mean that “even if I don’t use any electricity at all, and I happen to be in the middle-income group, I’m going to have to pay … the electric utility just for the privilege of being connected to the grid,” he said.
At the end of May, Faruqui along with 14 other experts sent comments to the commission warning that the proposed fixed charges are “way too high compared to the national landscape.” The income-graduated fixed charge would also fail to incentivize low-income customers to electrify homes and vehicles, they said.
Income-based customer charges also come with a host of complexities around income verification for electricity customers that LeBel worries hasn’t been fully appreciated yet.
“If the customer charge for upper-income people is quite high, people will try to structure their affairs in order to avoid it,” he said, adding, “just like with income taxes, there’s tax avoidance.”
In June, a CPUC administrative law judge said in a ruling that the agency plans to issue in early 2024 a proposal to create a pathway for implementing these income-graduated fixed charges over several years.
‘We can no longer afford to do every approach’
A separate measure that could help reduce the inequity in electric rates is to simply take fixed costs out of electric bills, and put them into taxes instead. Faruqui, for instance, describes a potential policy of “energy stamps,” based on the current model of food stamps in the U.S., that are funded by either state or federal taxpayers.
Last September, the Energy Institute at UC Berkeley’s Haas School of Business put out a paper that touched on the possibility of shifting some costs from the electricity payment system to California’s state budget, a strategy that the paper said is likely to be more efficient and equitable than the current system.
The authors also took a look at costs that could potentially be switched over to the state — for instance, public purpose programs, like those for energy efficiency and EV charging stations, as well as investments in wildfire mitigation and compensating the victims of fires. Another category of costs that could be considered for the state budget are historic renewable energy purchases at above-market prices, as well as existing power contracts that are now above market prices, such as those signed before the fracking revolution lowered natural gas prices, the report said.
But this strategy raises its own set of questions, according to LeBel.
“[There is the] question of how big a taxpayer cheque should be to an investor-owned utility, that is simultaneously paying executive salaries and dividends to shareholders – you want to be careful about how you structure that, and what the conditions are, in order to have fairness to all parties, ratepayers, taxpayers and the utility itself,” he said.
There are more direct ways in which regulators can help keep energy more affordable – for instance, if federal lawmakers, say, doubled fuel assistance funding, that could go a very long way towards making sure people don’t lose their utility service, Charlie Harak, senior attorney with the National Consumer Law Center, said.
“But I think increasingly, we’re going to have to talk about how do we keep the overall costs lower for everyone — because within the electricity system, if you’re trying to give somebody a subsidy, it’s coming from somebody else,” Baker said.
As overall costs continue to increase, “it doesn’t matter how progressive it is, it’s unaffordable at the highest and the lowest level,” he added.
This means regulators are going to have to set priorities to keep costs under control while pursuing clean energy goals.
“We can no longer afford to do every approach to decarbonization, market reform, electrification,” Baker said.
Correction: A previous version of this article erred in describing state tiered low-income discount efforts. New York and New Hampshire offer some such discounts.