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Inclining for the Climate

GHG reduction via residential electricity ratemaking.

Fortnightly Magazine - May 2009

On the campaign trail, then-Senator Obama made ambitious statements regarding renewable energy investment and greenhouse-gas (GHG) reduction goals. For example, in October 2007, Senator Obama announced plans to, if elected president, reduce emissions to 1990 levels by 2020 and 80 percent below 1990 levels by 2050. 1 Achieving such ambitious goals will require major changes on many fronts. In the electric power sector, an essential component of significant GHG reduction is energy efficiency.

In the arena of electricity efficiency, much attention has been given to building codes and weatherization, efficient lighting and appliance standards, and other measures that can be undertaken by businesses and households, often with incentives from the local electric utility. Rate design has received less attention. However, building on a survey the authors performed for BC Hydro in its 2008 residential rate-design application, 2 a study by the authors suggests that rate design—in particular residential inclining block rates—can help achieve GHG-reduction goals. The same opportunity does not exist for time-varying rates.

Admittedly rough and based on simplifying assumptions, the study’s calculation suggests rate redesign could reduce GHG emissions by one to two percent. While seemingly negligible, this GHG reduction easily could be obtained at low cost and in short time. Thus, both regulators and electric utilities should consider residential inclining block rate design as part of their efforts in complying with the forthcoming GHG-reduction targets.

Fair and Functional

An inclining block rate has a per-kilowatt hour charge that increases with a consumer’s monthly kWh consumption. Most inclining block rates use a two-tier design, though three- or more tier designs do exist. The consumption and price levels set for each tier depend on the specific goals of the utility and the characteristics of its residential customer class. To collect the same revenue as an otherwise applicable flat rate, a revenue-neutral inclining block rate’s lowest tier charge must be below, and the highest tier charge above, the flat rate. For example, a hypothetical two-tier inclining block rate might provide an original flat rate of 10-cents per kWh, with a tier-1 rate 15-percent lower, and a tier-2 rate 25-percent higher (see Figure 1) .

To see how such an inclining block-rate design can be revenue-neutral, while still providing a strong incentive to conserve, consider the simplified case of two hypothetical customers with monthly consumption of 667 kWh and 2,000 kWh, respectively. Under the flat rate, utility revenue is given by total consumption multiplied by the flat rate, or (667 kWh + 2,000 kWh) * $0.10/kWh = $267. Under the new rate, if the tier-1 quantity is set at 1,000 kWh, then 1,667 kWh will be billed at the tier-1 rate (all 667 kWh of the small customer’s consumption plus the first 1,000 kWh of the large customer’s consumption) and the remainder (1,000 kWh) will be billed at the tier-2