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Inclining Toward Efficiency

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

Fortnightly Magazine - August 2008

Energy costs continue rising, driven largely by an unprecedented run-up in crude oil prices. As this issue went to press, crude oil futures were selling at more than $140 a barrel. Some analysts are projecting prices in the $200 range before year end.

More expensive oil means more expensive natural gas, with prices now exceeding $13/Mcf. Likewise, coal prices are rising dramatically, partly in a competitive response to higher oil and gas prices, and partly in response to anticipated carbon regulation. In addition, power-plant capital costs are expected to continue rising because of growing demand in China and India for basic construction raw materials, such as cement and metals. According to one study, the cost of building new power plants is up 19 percent from a year ago and up 69 percent from three years ago. 1 Another study estimates the industry might require $1.5 trillion to meet its generation, transmission and capacity needs between now and 2030. 2

Thus, in virtually every scenario, customer utility bills will rise significantly. 3 Regulators and utilities are searching for ways to avoid a repetition of the rate-shock syndrome of the 1970s.

Energy efficiency has risen to the top of potential solutions. It well may be the fastest way of helping customers cope with rising utility bills. In addition, it could help utilities and regulators deal with two related problems: greenhouse gas (GHG) emissions that induce climate change and resource shortfalls that threaten system reliability.

While many utilities and state regulators are pursuing dynamic pricing structures to improve demand-response and peak-shaving capabilities, the industry traditionally has assumed electricity is too price-inelastic for rate structures to produce meaningful reductions in total energy use. More recent studies and models, however, suggest some approaches to inclining block rates might encourage significant conservation, with long-run reductions in electricity use nearing 20 percent, and customer bills falling by more than 25 percent.

DSM Redux

The industry has begun responding to these challenges by reactivating demand-side management (DSM) programs. These programs, which have a long history going back to the late 1970s, were mothballed when industry restructuring arrived in the mid 1990s. DSM spending in the United States peaked in 1993. Industry restructuring put a halt to most DSM activities, because incumbent utilities feared that higher electric rates, which often accompanied large-scale DSM spending, would make them uncompetitive. In addition, after several utilities spun off their newly unregulated generation function from their regulated transmission and distribution functions, it was unclear who would be responsible for planning and implementing DSM programs. 4

As utilities and commissions reinstitute DSM programs, they