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Inclining Toward Efficiency

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

Fortnightly Magazine - August 2008

savings that can be realized by switching to inclining block rates.

Predicting Energy Impacts

To predict the impact of energy-efficient rate designs, the Brattle Group constructed a rate inverter module in The Prismatic Suite of models the firm built last year to analyze the economics of dynamic-pricing rates. 15 The inverter is applied to a synthetic utility, dubbed Smart Power & Light Company (SP&L). It has 1 million residential customers who currently are being served power at a flat rate of 10 cents/kWh. 16 The average SP&L customer uses 1,000 kWh a month. Customer usage is spread out between 0 and 2,000 kWh a month (See Figure 1) . The mean value is 1,038 kWh.

Four inclining block-rate designs are developed to sketch out the possibilities (See Figure 2) . All feature inclining rates with two blocks. But they differ in the width of the first block and in the height of the step between blocks. For three of the rates, the first block lies below the average use per customer and in one of the rates it is above average use. The rates also differ in the ratio of prices between the blocks, which range from 1.27 to 3.72.

All the inclining block rates are designed to be revenue neutral for the residential class as a whole. So, in the absence of any price response, they will yield the same class revenue (See Figure 3) .

The amount of price response will depend on the price elasticity of energy consumption. Given the uncertainty in price-elasticity estimates, results are provided using Monte Carlo simulation.

For Rate A, the mean drop in usage in the short run is 5.9 percent, and given the standard deviation of 2.0 percent, the model provides a 95-percent confidence band ranging from 1.9 percent to 9.9 percent (See Table 2) . This band represents the uncertainty created by lack of precision in the available knowledge about price elasticities. Customer bills decline in the aggregate by 9.1 percent. Long-run responses are much higher, with the mean drop in usage at 18.4 percent and the mean drop in customer bills at 28.4 percent.

Moving from Rate A to B, C and D, the model produces lower values for usage reductions and bill reductions, because either lower amounts of class usage than those used in Rate A are being exposed to prices that exceed the current flat rate, or because the amount of the price change relative to the flat rate is smaller than in Rate A.

Optimizing Rate Design

Based on empirical estimates of price elasticity from a number of different sources, inclining block rates can provide energy consumption savings in the 6 percent range over a few years and even higher savings over the long run.

The costs associated with inclining block rates likely will be small, arising from the need to make simple modifications in billing systems, train customer-service personnel and educate customers on how to deal with the rates. It is possible to envision a bright future for energy-efficiency activities, with inclining block rates providing a complementary