Vernon Smith and I have a commentary in today’s Wall Street Journal (subscription required). Entitled “Socket to Arnold”, our point is that the existing system of average pricing is unfair to off-peak users. Off-peak users subsidize peak energy use, and that’s both inefficient and unfair:
But current policy unfairly forces consumers to pay rates based on the average hourly cost of energy and industry capital investment. As a result, peak utility cost is much higher than what consumers pay, and off-peak and weekend cost is much lower than what consumers pay. The utility earns an abnormally high profit from off-peak consumption and loses money from peak sales. Peak period sales are thus subsidized by the implicit transfer of funds from the utility’s high profit on off-peak users. In effect, utilities profit on energy needed to dry clothes at 6 a.m. and subsidize clothes dried at 4 p.m.
Relieving this disparity requires a significant shift in thinking and corrections in the regulatory environment. Under the current regime, local utilities enjoy a government-protected monopoly on energy and the wires for delivering it — bundling the sale of energy with an additional charge for the rental of the facilities and wires leading to homes and businesses. Divesting these separable activities — the market for energy and the market for delivery — would create a competitive environment that benefits customers while opening opportunities for new market entrants and the development of new technologies.
We then propose some options that would take advantage of splitting the energy market from the wires market, which makes economic sense because the energy generation portion of the industry is not subject to the same network characteristics that the wires are. So why regulate the bundle if only one part of the bundle has the traits that induce us to regulate an industry?
Unbundling the energy commodity from the wires, and from the bundled regulatory treatment, is a long-run recommendation, so we also make some recommendations for beneficial changes that Governor Schwarzenegger could implement in the short run, within the existing regulatory environment:
- Option 3: Allow wholesale prices to be passed on to any retail customers by giving all customers a choice between a fixed average price or one of the many time-of-use pricing program technologies, such as remote appliance switches, time-of-use metering or load management systems.
- Option 4: Allow customers to supply their own energy through a distributed generation source without charges for the utilities’ wires and infrastructure costs. If a customer uses grid wires only some of the time, the cost should be prorated hourly, giving the customer credit for hours off the grid. This requires utilities to meet the opportunity costs created by new technologies, and it removes the utilities’ ability to use regulatory cost-averaging rules to block new cost-saving sources of power. This model has the important effect of making the transmission and the distribution grid contestable, and would relieve transmission congestion.
Even within a regulated rate tariff, giving customers choice from among a menu of contracts would break the unfair and inefficient subsidy of peak use. And removing the barriers to distributed generation interconnection allows distributed power to bolster the grid, both in terms of reliability and security.
With active retail choice and potential entry of distributed generation, the likellihood of energy efficiency goes up, power plant and grid construction goes down, and it is even possible that energy use would fall. Thus markets and choice are not only good for efficiency and equity, they are good for the environment too, because demand response promotes conservation.