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Cross-Subsidies: Getting the Signals Right

Fortnightly Magazine - December 2004
  1. The former frowns on any rate that charges a differential rate to two customers with identical cost structures, while the latter would argue that a customer's willingness to pay should be factored into this determination. The difference does not substantively affect the arguments espoused herein.
  2. See .

  3. Appendix

    To better illustrate heterogeneity inside a rate class, consider the following data from Massachusetts Electric. The data shown is for all customers on the utility's G-3 rate, and it plots the ratio of the minimum and maximum power demand over the 1999 calendar year. As this ratio falls, customer-load profiles become flatter, while those at the other extreme have infrequent load spikes. These ratios are an expression of a customer's load factor as measured by the peak-demand charge on 12 months of utility bills. Consider how the rates for this customer class were set. Massachusetts Electric has fixed and variable charges. Some variable charges scale with power usage (kW) while others scale with energy usage (kWh). Utility rate engineers looked carefully at the characteristics of this rate class and devised a structure including demand and energy charges to meet the needs of these customers and recover the costs of service. A customer on the far left side of the above graph has a peak monthly kilowatt usage that is 10 times its minimum monthly kilowatt usage over a calendar year (such as might be found in a mid-size apartment building with high summer cooling loads). This customer is paying relatively little in the annual demand charge even though the utility must maintain infrastructure to serve the customer all year long. At the other end of the spectrum, a customer on the same rate classification has a very flat load profile (such as might be found in an industrial facility where electric loads are driven by process requirements). These customers are paying much more per year for the same peak capacity needs than those at the other extreme. Thus, the rate design implicitly includes a cross-subsidy.

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