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California's Green Gaffe

Some green-energy policies disregard the value of energy use, risking market distortion and consumer backlash.

Fortnightly Magazine - November 2007

Imagine a regulatory commission orders a utility to charge some customers high electricity prices to finance rebates for the commissioners’ friends and family members.

As absurd as this scenario might seem, it could qualify as a conservation program under California’s cost-benefit analysis because overcharged customers presumably would reduce their energy usage.

Similarly, a blackout might also score well in California by reducing energy consumption and consumer utility bills.

The problem is California’s cost-benefit analysis overlooks how consumers benefit from energy use. Such consumer-surplus benefits are a staple of modern economics, which consider the value of goods and services—not just their cost 1(see sidebar, “Econ 101: Surplus Value”) . Some value is lost if higher prices force usage cutbacks, or if less attractive ways to use energy are mandated for the sake of conservation. A corresponding measure, producer surplus, recognizes the value sellers get from market transactions.

Measuring changes in consumer and producer surplus is a necessary step in proper cost-benefit analysis. 2 But California’s approach omits this step.

Ironically, monopoly regulation is intended to prevent excessive prices—which not only hit consumers in the pocketbook, but also force them to give up the benefits of needed utility services. By ignoring such harm, California’s flawed analysis confounds basic principles of consumer protection.

This issue is more than technical, because economic losses not only hurt consumers, they also can undermine political support for beneficial and necessary green efforts.

Paying More for Less

To accomplish the state’s environmental and conservation goals, the California Public Utilities Commission and California Energy Commission rely on a cost-benefit analysis 3 that focuses on several important factors, including:

• The costs of generating electricity and of alternatives to its use;
• Program administration costs;
• Added out-of-pocket expenses to consumers; and
• The time value of money.

Further, California’s approach may identify revenue transfers between customers, which is helpful but doesn’t solve the problem. The value of energy use to consumers is left out of California’s cost-benefit analysis.

Unfortunately, faulty analysis can lead to bad policy choices. Errors can occur any time energy prices are raised, customers are paid to forgo usage, efficiency devices are sold at subsidized prices, or standards force customers into choices they rather would have avoided.

When rising prices reflect increased costs, it makes economic sense for consumers to reduce usage. But if a price is increased when costs stay the same, then consumers suffer an economic loss that California’s analysis ignores.

While probably small in particular cases, this impact could be substantial if green program costs raise retail prices significantly. California’s analysis now ignores such price impacts on consumption. If it did include this effect, California would get the answer backward by counting energy-production cost savings while ignoring the greater harm to consumers of being denied usage they valued and wanted.

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