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Inclining Toward Efficiency

Is electricity price-elastic enough for rate designs to matter?

Fortnightly Magazine - August 2008

in peak demand. 6 However, by itself, dynamic pricing is not likely to have much of an impact on overall energy consumption, since the high prices prevail during critical-pricing periods only. For the same reason, it cannot make a huge dent in customer bills.

Inclining Block Rates

There is another type of rate design that can make a major contribution to a utility’s energy-efficiency goals. This is the inclining block rate, variants of which have been around for a long time. Under such a rate design, the price of electricity rises with increasing usage. But rather than rising uniformly with each kilowatt hour consumed, it rises in blocks of several hundred kWh.

The most common example is the lifeline rate created in the 1970s to mitigate the effect of rising prices on low-income users and to ensure that essential uses of electricity remained affordable for all customers. However, most customers today receive electric service under some type of energy-cost adjustment clause, which means their bills rise as energy costs rise, even though the underlying base rate in the tariff does not change. Lifeline usage, as well as usage above that amount pays more, and the issue of affordability is rendered moot.

The inclining block rate can be very effective in promoting energy efficiency if it is applied as the default rate. Unlike voluntary DSM programs, it would apply to all customers, not just to those who choose to participate. It has very small administrative or overhead costs and would cost only a fraction of the amount expended when low-interest financing or rebate programs are used to buy-down purchases of high-efficiency appliances, building materials and processes. A final benefit, for those regions that still are evaluating the economics of advanced metering, is that it does not require changing out existing meters. Of course, the availability of new technologies such as in-home displays enabled by AMI or smart-grid functionalities would further enhance the appeal of inclining block rates and magnify the energy and bill savings.

A recent survey of 61 U.S. utilities carried out by BC Hydro reveals that only a third had inclining block rates. About half had year-round flat rates and the rest had declining block rates in at least one season. 7

Even where inclining block rates are present, they might no longer reflect current cost conditions or energy-efficiency goals. In many cases, they likely are remnants of yesterday’s lifeline considerations, which primarily focused on equity criteria. These rate designs need to be re-tooled and modernized.

The process of constructing, re-constructing or modernizing inclining block rates will vary by jurisdiction, but the analytical steps will be quite similar.

The first step is to pin down the ratemaking objectives. Is the rate-design goal to reflect costs more accurately than existing rates, promote social objectives such as income re-distribution, or promote energy efficiency? Are there other goals that must be accounted for, such as revenue stability or rate continuity?

Second, begin gathering the relevant data. Depending on how the first question is answered, different data will be needed. If the desire to reflect