Insights into Welfare Impacts from an Economic Efficiency Approach Melanie Craxton and James Sweeney November 13, 2017
Overview Motivation Research Questions Preview of Results Analytical Model Numerical Simulation An Illustrative Example A Tiered Rate System Discussion and Conclusions
Motivation
Motivation
Motivation Many policies seek to internalise externalities (both positive and negative)
Motivation Many policies seek to internalise externalities (both positive and negative) E.g. Learning by doing (positive) or pollution (negative)
Motivation Many policies seek to internalise externalities (both positive and negative) E.g. Learning by doing (positive) or pollution (negative) There are many externalities directly related to renewable energy (e.g. see Gillingham and Sweeney, 2010)
Motivation Many policies seek to internalise externalities (both positive and negative) E.g. Learning by doing (positive) or pollution (negative) There are many externalities directly related to renewable energy (e.g. see Gillingham and Sweeney, 2010) Some policies are specifically targeted to capture a given externalitiy (e.g. California s installation subsidies; Benthem, Gillingham and Sweeney (2008))
Motivation Many policies seek to internalise externalities (both positive and negative) E.g. Learning by doing (positive) or pollution (negative) There are many externalities directly related to renewable energy (e.g. see Gillingham and Sweeney, 2010) Some policies are specifically targeted to capture a given externalitiy (e.g. California s installation subsidies; Benthem, Gillingham and Sweeney (2008)) However, others are not as well targeted This can lead to distortions and inefficiencies
Motivation Net Energy Metering has been referred to as crude (Duke, Williams, and Payne (2005)), despite being a reasonable surrogate for efficient electricity pricing mechanisms
Motivation Net Energy Metering has been referred to as crude (Duke, Williams, and Payne (2005)), despite being a reasonable surrogate for efficient electricity pricing mechanisms But... how crude is it actually? And how much good does it actually do?
Motivation Net Energy Metering has been referred to as crude (Duke, Williams, and Payne (2005)), despite being a reasonable surrogate for efficient electricity pricing mechanisms But... how crude is it actually? And how much good does it actually do? In cost effectiveness terms, NEM costs Californian ratepayers $20million per year on net (CPUC comissioned study, 2010)
Motivation Net Energy Metering has been referred to as crude (Duke, Williams, and Payne (2005)), despite being a reasonable surrogate for efficient electricity pricing mechanisms But... how crude is it actually? And how much good does it actually do? In cost effectiveness terms, NEM costs Californian ratepayers $20million per year on net (CPUC comissioned study, 2010) Average median household income for customers with a NEM qualifying source $36,927 above Californian average
Motivation Net Energy Metering has been referred to as crude (Duke, Williams, and Payne (2005)), despite being a reasonable surrogate for efficient electricity pricing mechanisms But... how crude is it actually? And how much good does it actually do? In cost effectiveness terms, NEM costs Californian ratepayers $20million per year on net (CPUC comissioned study, 2010) Average median household income for customers with a NEM qualifying source $36,927 above Californian average Non-NEM customers on average had utility bills 54% greater than the utility s cost of providing service (2013 NEM Ratepayers Impact Evaluation)
Motivation Distributionally, NEM seen as a regressive policy and a headache for the industry (Cohen, 2013; Blackburn Magee and Rai, 2014)
Motivation Distributionally, NEM seen as a regressive policy and a headache for the industry (Cohen, 2013; Blackburn Magee and Rai, 2014) Much of the work regarding NEM has been from a bottom-up financial-engineering standpoint (e.g. Eid et al, 2014; LBNL, 2014)
Motivation Distributionally, NEM seen as a regressive policy and a headache for the industry (Cohen, 2013; Blackburn Magee and Rai, 2014) Much of the work regarding NEM has been from a bottom-up financial-engineering standpoint (e.g. Eid et al, 2014; LBNL, 2014) In 2014 Minnesota introduced its Value of Solar (VoS) tariff Contributed to the discussion of how efficient rooftop solar policies were
Motivation Distributionally, NEM seen as a regressive policy and a headache for the industry (Cohen, 2013; Blackburn Magee and Rai, 2014) Much of the work regarding NEM has been from a bottom-up financial-engineering standpoint (e.g. Eid et al, 2014; LBNL, 2014) In 2014 Minnesota introduced its Value of Solar (VoS) tariff Contributed to the discussion of how efficient rooftop solar policies were This project takes an economic efficiency approach to considering the economic optimality of the NEM policy
Research Questions To what extent is NEM an economically efficient policy?
Research Questions To what extent is NEM an economically efficient policy? What are the distributional consequences of NEM, particularly under tiered electricity prices?
Preview of Results
Preview of Results NEM not welfare-maximising in the second-best world in which we live
Preview of Results NEM not welfare-maximising in the second-best world in which we live Distributionally, solar haves seem to benefit at the expense of the solar have-nots
Preview of Results NEM not welfare-maximising in the second-best world in which we live Distributionally, solar haves seem to benefit at the expense of the solar have-nots Numerical simulation suggests an efficiency loss of approximately $600million per annum (about $53.60 per household per year) in the state of CA under tiered pricing
Preview of Results NEM not welfare-maximising in the second-best world in which we live Distributionally, solar haves seem to benefit at the expense of the solar have-nots Numerical simulation suggests an efficiency loss of approximately $600million per annum (about $53.60 per household per year) in the state of CA under tiered pricing Results driven by inefficiently high marginal pricing of electricity due to NEM
Preview of Results NEM not welfare-maximising in the second-best world in which we live Distributionally, solar haves seem to benefit at the expense of the solar have-nots Numerical simulation suggests an efficiency loss of approximately $600million per annum (about $53.60 per household per year) in the state of CA under tiered pricing Results driven by inefficiently high marginal pricing of electricity due to NEM Benefits from avoided environmental costs are far outweighed by consumer surplus losses
Preview of Results NEM not welfare-maximising in the second-best world in which we live Distributionally, solar haves seem to benefit at the expense of the solar have-nots Numerical simulation suggests an efficiency loss of approximately $600million per annum (about $53.60 per household per year) in the state of CA under tiered pricing Results driven by inefficiently high marginal pricing of electricity due to NEM Benefits from avoided environmental costs are far outweighed by consumer surplus losses Consumer behaviour pertaining to perception of electricity prices has important effects on the model
Analytical Model
Analytical Model Consumers choose D(pp) and R(ps) to maximise their consumer surplus levels: 8760 8760 CS = {V i (D i (pp)) pp D i (pp)} + {[ps pr] S i (R(ps))} i=1 pp- flat rate for retail electricity i=1 ps- price paid for electricity produced from solar panels pr- PPA price for rooftop panel production D(pp) - electricity consumption (i.e. demand) R(ps) - installed rooftop solar (1)
Analytical Model Utility profit can be represented by: 8760 π(pp, ps) = {[pp pw i ] DT i + [pw i ps] ST i } 8760 i=1 {cdm [DM i SM i ] + cdx [DX i SX i ]} FC i=1 (2) pw - wholesale price of electricity FC- utility fixed costs T, M, X - total, households net importing, households net exporting respectively cd[m or x] - marginal distributional cost of electricity
Analytical Model Social welfare can be represented by: i=1 W = Consumers 8760 i=1 { 8760 i=1 8760 } V i (D i ) pr S i i=1 { [ce + pw i ] [DT i ST i ] 8760 { } cdm [DM i SM i ] + cdx [SX i DX i ] } FC (3) ce- marginal environmental cost of wholesale electricity
Analytical Model First best solution: pp FB = ps FB = ce + pw i + cdm when importing (4) pp FB = ps FB = ce + pw i + cdx when exporting (5) The retail price and the rooftop solar price should be equal to one another and set to the total marginal cost of electricity (regardless of who is supplying it) Consider NEM to be when pp and ps are equal to one another Therefore in a first best world, NEM is an efficient policy!
Analytical Model First best solution: pp FB = ps FB = ce + pw i + cdm when importing (4) pp FB = ps FB = ce + pw i + cdx when exporting (5) The retail price and the rooftop solar price should be equal to one another and set to the total marginal cost of electricity (regardless of who is supplying it) Consider NEM to be when pp and ps are equal to one another Therefore in a first best world, NEM is an efficient policy! However, we don t live in a first best world...
Analytical Model Second best world: A regulated utility Constrain the utility to make positive profits, i.e. π(pp, ps) > 0. Second best solution introduces a wedge between optimal retail and rooftop solar prices, i.e. pp sb > ps sb. To recoup its fixed costs a utility must raise its retail price and lower the solar price from the first best optimum therefore introducing an optimal wedge between the two prices
Analytical Model Second best world: A regulated utility Constrain the utility to make positive profits, i.e. π(pp, ps) > 0. Second best solution introduces a wedge between optimal retail and rooftop solar prices, i.e. pp sb > ps sb. To recoup its fixed costs a utility must raise its retail price and lower the solar price from the first best optimum therefore introducing an optimal wedge between the two prices NEM is no longer efficient in this world
Numerical Simulation
Numerical Simulation Households: Demand electricity (from which they obtain value) Install rooftop solar (modelled as a PPA agreement with a 3rd party) Face a bill from the utility
Numerical Simulation Households: Demand electricity (from which they obtain value) Install rooftop solar (modelled as a PPA agreement with a 3rd party) Face a bill from the utility Utility: Provides electricity to households Is regulated to make non-negative profits Is required to purchase electricity back from households with rooftop solar panels Can sell this back to the wholesale market at the wholesale price
Numerical Simulation Households: Demand electricity (from which they obtain value) Install rooftop solar (modelled as a PPA agreement with a 3rd party) Face a bill from the utility Utility: Provides electricity to households Is regulated to make non-negative profits Is required to purchase electricity back from households with rooftop solar panels Can sell this back to the wholesale market at the wholesale price Centrally Generated electricity: Incurs an external cost
Numerical Simulation- Data and Assumptions
Numerical Simulation- Data and Assumptions FLAT RATE: Separate prices for retail and solar electricity NEM when pp=ps=$0.15 per kwh Solar value (ps - pr) determines installed solar level (fractional adoption curve) Consider a range of ps, allow model to choose pp such that utility profits equal zero
Numerical Simulation- Data and Assumptions 11.2million IOU serviced households 10% overall residential solar feasibility (source: E3) Household types heterogeneous in PPA s Extreme distribution purely illustrative External cost: $0.03 per kwh (appox. equivalent to $50/tonne carbon)
Numerical Simulation- Illustrative Example From a world with No Solar to a world with NEM
Numerical Simulation- Illustrative Example From a world with No Solar to a world with NEM
Numerical Simulation- Illustrative Example Optimal Solar Price: $0.11 per kwh Optimal Wedge: $0.05 per kwh NEM represents a loss of $34million from the optimum
Numerical Simulation- Tiers
Numerical Simulation- Tiers TIERS: No more separate pp and ps, only NEM or no NEM 4 Electricity Tiers: Modelled as different demand functions Basis for tiers: PG&E residential tariffs Tiers 1 and 2 frozen at $0.15 per kwh and $0.18 per kwh respectively Consumption responds to average electricity price (Ito, 2010)
Numerical Simulation- Tiers Solar feasibility: Tiers 2, 3, and 4 only Within tiers with solar feasibility, same distribution of PPA prices as before Solar installed when average marginal savings > pr Installations scaled to place households solidly in tier 1 (even after demand increases due to lower perceived average electricity prices) NEM instituted at $0.15 per kwh Model chooses marginal prices for tiers 3 and 4 such that profits are zero and tier 4 s price exceeds tier 3 s
Numerical Simulation- Tiers From a world with no solar to a world with NEM:
Numerical Simulation- Tiers From a world with no solar to a world with NEM: Note- welfare loss from institution of tiers: $3.47billion
Numerical Simulation- Tiers From a world with no solar to a world with NEM:
Numerical Simulation- Tiers From a world with no solar to a world with NEM: per thousand households
Numerical Simulation- Tiers From a world with no solar to a world with NEM: per thousand households
Numerical Simulation- Tiers From a world with no solar to a world with NEM: Solar Haves do better than Solar Have-Nots Potential explanation for tier 3 behaviour: misperception of electricity price
Discussion
Discussion Clear that NEM has distributional consequences, particularly for those in the upper tiers Who is consuming in what tier and how feasible rooftop solar is for them is critical in determining magnitudes and directions of aggregate effects Given the current distribution of PPA prices, NEM is not a welfare enhancing subsidy Would need much lower solar costs in order to reap full benefits of rooftop solar without incurring excessive costs
Discussion- The Behavioural Side of Things
Discussion- The Behavioural Side of Things The Solar-Haves in Tier 3 lose even though they are optimising agents...
Discussion- The Behavioural Side of Things Why do we see this model behaviour?
Discussion- The Behavioural Side of Things Why do we see this model behaviour? Consumer surplus change is determined by the change between the world with no solar and the world with NEM
Discussion- The Behavioural Side of Things Why do we see this model behaviour? Consumer surplus change is determined by the change between the world with no solar and the world with NEM Consumers choose to install solar according to their potential average marginal savings
Discussion- The Behavioural Side of Things Why do we see this model behaviour? Consumer surplus change is determined by the change between the world with no solar and the world with NEM Consumers choose to install solar according to their potential average marginal savings But consumers are perceiving the electricity price they pay as an average over their entire month s consumption
Discussion- The Behavioural Side of Things Why do we see this model behaviour? Consumer surplus change is determined by the change between the world with no solar and the world with NEM Consumers choose to install solar according to their potential average marginal savings But consumers are perceiving the electricity price they pay as an average over their entire month s consumption The Punchline:
Discussion- The Behavioural Side of Things Why do we see this model behaviour? Consumer surplus change is determined by the change between the world with no solar and the world with NEM Consumers choose to install solar according to their potential average marginal savings But consumers are perceiving the electricity price they pay as an average over their entire month s consumption The Punchline: Consumer surplus values are inflated in the no solar world due to their misperception of their marginal costs of electricity If you change this perception to reflect the true marginal costs of electricity, the bias disappears and model behaviour is more intuitive
Discussion- The Behavioural Side of Things Getting the price right is an important component of much optimal economic policy... but sometimes this isn t enough to induce optimal behaviour Ito (2010); Liebman and Zeckhauser (2004); Pratt, Wise, and Zeckhauser (1977)
Discussion- The Behavioural Side of Things Getting the price right is an important component of much optimal economic policy... but sometimes this isn t enough to induce optimal behaviour Ito (2010); Liebman and Zeckhauser (2004); Pratt, Wise, and Zeckhauser (1977) Even for a perfectly targeted policy, not taking into account individual behaviour can lead to threats to program efficiacy
Discussion- The Behavioural Side of Things Getting the price right is an important component of much optimal economic policy... but sometimes this isn t enough to induce optimal behaviour Ito (2010); Liebman and Zeckhauser (2004); Pratt, Wise, and Zeckhauser (1977) Even for a perfectly targeted policy, not taking into account individual behaviour can lead to threats to program efficiacy Previously ignored behavioural baises as reasoning for observed efficacy gaps? Examples: Energy efficiency gap; sluggish program uptake (e.g. Fowlie et al, 2014; Allcott and Taubinsky, 2015; Gillingham and Palmer, 2014)
Discussion- The Behavioural Side of Things Getting the price right is an important component of much optimal economic policy... but sometimes this isn t enough to induce optimal behaviour Ito (2010); Liebman and Zeckhauser (2004); Pratt, Wise, and Zeckhauser (1977) Even for a perfectly targeted policy, not taking into account individual behaviour can lead to threats to program efficiacy Previously ignored behavioural baises as reasoning for observed efficacy gaps? Examples: Energy efficiency gap; sluggish program uptake (e.g. Fowlie et al, 2014; Allcott and Taubinsky, 2015; Gillingham and Palmer, 2014) Dissertation work: Incorporating behavioural biases alongside other market failures in considerations of optimal policy choice and efficacy
Conclusions
Conclusions NEM is a successful subsidy in the sense that people are installing rooftop solar and there are economic benefits being reaped However, the costs seem to be outweighing the benefits Often severely for certain members of the population The regulated utility business model is a key driver of these results
Conclusions NEM is a successful subsidy in the sense that people are installing rooftop solar and there are economic benefits being reaped However, the costs seem to be outweighing the benefits Often severely for certain members of the population The regulated utility business model is a key driver of these results Given the world we live in, it is important to understand that in a non-first best world there can be many unintended consequences
Thank You Questions??