Electricity Pricing and the Social Cost of Carbon
New estimates of the SCC make it more important than ever that we lower the cost of electrification.
In California’s current discussions of electricity rate restructuring, the focus has been almost entirely on the design and size of monthly fixed charges. But that is not at all the genesis of this initiative. The primary driver has been to lower our shockingly high volumetric (per kilowatt-hour (kWh)) prices, more than twice the national average if your power is delivered by Pacific Gas & Electric (PG&E), Southern California Edison (SCE), or San Diego Gas & Electric (SDG&E).
The rates we currently pay are far above society’s actual cost of providing one more kWh. In PG&E territory, a typical household now faces a price of around 40 cents per kWh (averaged over the year), while the social marginal cost (SMC) of supplying additional kWhs is about 10 cents, including society’s cost of emissions. The gap is a bit larger for SDG&E customers and a bit smaller for SCE customers, but the basic concern is the same. So the proceeding at the California Public Utilities Commission (CPUC) is aimed at lowering the volumetric price of electricity, and then making up the lost revenue by introducing monthly fixed charges.
We’ve talked in many previous blog posts and reports about the cause of this yawning gap. And we have pointed out many times that this gap is a concern for two reasons. First, research shows that these high prices discourage customers from electrifying their homes (heat pumps, electric cooktops, electric dryers, etc) and switching to an electric vehicle and, second, the high prices disproportionately hit low-income families.
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Advocates of keeping the current volume-based collection of fixed costs have argued among other things that the true incremental cost of supplying electricity is higher than the CPUC thinks. They’ve bolstered this view by pointing to recent research and the Environmental Protection Agency’s stance that society’s cost of emitting greenhouse gases (GHGs), what is known as the “social cost of carbon”, is around $190 per metric tonne, not $50/tonne as assumed in the estimated 10-cent cost of electricity.
Max discussed this change in the social cost of carbon, and some of its uncertainties, last fall. For today, I’m going to take $190 as the “right” cost to put on GHGs.
The direct impact of that higher cost is straightforward to incorporate in the social marginal cost (SMC) of electricity. California’s marginal emissions for electricity is about 0.4 tonnes/MWh, so increasing the social cost of carbon by $140 increases the SMC of electricity by $56 per MWh, which is $0.056 per kWh. That’s more than a 50% increase in the SMC of electricity from the 10 cents we started from. Still, it doesn’t change the imperative of lowering volumetric rates, for one obvious reason and another somewhat-less-obvious reason.
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The obvious is that when you incorporate the higher social cost of carbon, the SMC of electricity is still about 16 cents per kWh, far below the volumetric rates that households pay. Furthermore, the SMC will likely be falling in the near future as zero-marginal-cost renewables increasingly are the marginal source of supply, either in real time or after having been stored in batteries. At the same time those fixed costs that are feeding the retail rate monster are set to rise further, as the CPUC has been telling us. And none of the current proposals in the CPUC proceeding suggest lowering the volumetric price close to 16 cents. Even under the biggest proposed declines, the volumetrice price would still be above 20 cents per kWh averaged across all customers, including those on low income tariffs.
The less obvious reason goes back to the rationale for tying prices to SMC in the first place: so that customers make consumption choices across goods that incorporate their relative costs to society. Relative is a critical word here, because there are two types of reactions customers may have to high electricity prices: they may consume fewer energy services or they may consume energy services powered by other fuels, such as natural gas or gasoline.
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An increase in the social cost of carbon to $190/tonne raises the SMC of electricity, but it increases the SMC of natural gas by 40% more for the same amount of home heating. And it increases the SMC of gasoline by about twice as much as electricity, normalized to the same travel distance. In other words, at $190/tonne, it is more important than ever to transition away from burning natural gas in our homes and gasoline in our cars. Meanwhile, with the increase to $190/tonne, electricity is still dramatically overpriced while gasoline is substantially underpriced and natural gas is priced at or below SMC.[1]
Does this relative price comparison matter? It sure does if you think the most promising route to reducing GHGs is to electrify most things and decarbonize the grid. If that’s the plan, it’s all about fuel switching. We could accomplish that by increasing the cost of gasoline and natural gas, but there is no sign of any political stomach for that. So, the option that remains if we still want to decarbonize homes and transportation is to drastically reduce the volumetric price of electricity in California, while still keeping it at or above SMC. A big increase in the social cost of carbon makes that policy more important than ever.
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[1] Showing my work:
Gasoline: California gasoline emits about 0.0085 tonnes of CO2 per gallon, 0.0079 from the 90% that is gasoline and about 0.0006 from the 10% that is ethanol. Assume what the rental car companies call a “midsized” vehicle (but is actually pretty small) gets 35 miles per gallon and emits 0.0085 tonnes of GHG per gallon. For an equivalent electric vehicle, it takes about 10kWh to travel 35 miles, which puts out 0.01 MWh*0.4 tonne/MWh=0.004 tonnes of GHG given the marginal emissions intensity of 0.4 tonnes per MWh, less than half as much as using gasoline.
The total burden of taxes and fees for gasoline in California is about $1.20 per gallon, including federal taxes, state and local taxes, cap and trade costs, and LCFS costs. At a SCC of $190 per tonne and 0.0085 tonne per gallon, the social cost of GHG emissions alone would be about $1.62, before even accounting for the pollution damages from criteria pollution emissions, which Borenstein and Bushnell (2022) find to be very significant. The $1.62 alone exceeds the entire tax and fee burden on gasoline, so assuming that the gasoline market is competitive, price would exceed SMC. But even assuming that the mystery gasoline surcharge is about $0.40 per gallon, price would be well above SMC when criteria pollutants are included.
Natural gas: Natural gas puts out 0.053 tonnes of CO2/MMBTU. Divided by 0.95 efficiency factor to account for furnace efficiency yields 0.056 tonnes of CO2 per delivered MMBTU. A heat pump has an efficiency factor of 3 or more. 1 One MMBTU of delivered heat is 0.29307 MWh by the standard energy conversion. At an efficiency factor of 3, that means it takes about 0.1 MWh of generation, or 0.04 tonnes of CO2. Raising the social cost of carbon from $50 to $190 increases SMC of heating with natural gas by $140*0.056=$7.84. It raises the SMC of electricity to provide the same heating service by $140*0.1*0.4=$5.60. Both of these numbers are increased somewhat by methane leaks, but if anything that probably increases the gap, as discussed below.
Across PG&E, Southern California Gas Company, and SDG&E, the non-commodity volumetric retail price of natural gas varies in the range of $1-$1.50 per therm, or $10-$15 per MMBTU. At $190 per tonne, the CO2 from 1 MMBTU is $10. The social cost of methane leaks in the production and delivery (see Meredith and Duncan’s blog post from last fall for more details) are likely to raise the GHG impact by about one-third. But the impact of leaks is likely to be substantially larger going to residential users than in delivering natural gas by large trunk lines to electricity generation. It also does not include the social cost of NOx, PM 2.5 and other pollutants that are more damaging when emitted inside homes.
Keep up with Energy Institute blog posts, research, and events on Twitter @energyathaas.
Suggested citation: Borenstein, Severin, “Electricity Pricing and the Social Cost of Carbon”, Energy Institute Blog, UC Berkeley, June 20, 2023
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Severin Borenstein View All
Severin Borenstein is Professor of the Graduate School in the Economic Analysis and Policy Group at the Haas School of Business and Faculty Director of the Energy Institute at Haas. He received his A.B. from U.C. Berkeley and Ph.D. in Economics from M.I.T. His research focuses on the economics of renewable energy, economic policies for reducing greenhouse gases, and alternative models of retail electricity pricing. Borenstein is also a research associate of the National Bureau of Economic Research in Cambridge, MA. He served on the Board of Governors of the California Power Exchange from 1997 to 2003. During 1999-2000, he was a member of the California Attorney General's Gasoline Price Task Force. In 2012-13, he served on the Emissions Market Assessment Committee, which advised the California Air Resources Board on the operation of California’s Cap and Trade market for greenhouse gases. In 2014, he was appointed to the California Energy Commission’s Petroleum Market Advisory Committee, which he chaired from 2015 until the Committee was dissolved in 2017. From 2015-2020, he served on the Advisory Council of the Bay Area Air Quality Management District. Since 2019, he has been a member of the Governing Board of the California Independent System Operator.
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What if we install solar panels and batteries and not purchase any electricity from the dirty utilities? Even though PG&E says only 8.5% of the electricity they produce is created by fossil fuels, at night, it is almost 50% Nuclear, geothermal and battery and 50% imported fossil fuels generated electricity. During the summer months I can run my home off of my “off grid solar and batteries” but in the Winter, I need to use either firewood or natural gas to heat my home since the days are short and the nights are long. Pricing a fixed charge per month based on wealth rather than service size and usage will hurt seniors living in smaller residences that use very little electricity but have larger pensions, social security income and savings interest. Since when did private utilities get to be “Tax Collectors”? If this passes the CPUC and gets by the California Supreme court, then those with solar and batteries would disconnect from the grid on April 1 and not re-connect until November 1 each year to save the monthly “wealth tax fee.
There is no sign of any political stomach for increasing the cost of gasoline and natural gas. The question is, will there be the political and producer will to lower electricity prices if the social cost of the fuel to be used in electricity generation is to increase because of the $190 per tonne of carbon emitted? More so if the social cost of NOx, PM 2.5 and other pollutants are to be internalized?
Surely, the impact of leaks is likely to be substantially larger going to residential users than delivered natural gas to electricity generation. Also carbon emitted at exhaust of the gas turbines that generate the electricity can be captured before they enter the atmosphere. However, the plant level carbon capture will also add some cost to electricity generation.
Certainly, as the picture in the post depicts, the renewables outweight natural gas as the prefered choice for generating electricity. Until the cost of storage systems are brought down further so that they can make electricity generated from renewables available as and when when they are needed and at lowest costs, there will be neither the political nor producer will to lower electricty prices. The political will is further supressed by the political resentment to policies that attempt to urge the haves to sacrifice a little to provide some comfort for the have nots.
Somehow, the political custodians of policy may have to intervene and carefully remove the allocative inefficiency introduced by the taxes in electrcity prices and that is what the suggestion to drastically reduce the volumetric price of electricity in California is about.
[[this is not the likely ‘expected’ economic argument; more a social issue. ]]
A fixed connection charge must be low for multi-unit housing. a comparison for water: each apartment pays the same fixed charge of about $40pm, even if no water is used. older multiunit residences have one meter for water and for electricity. charges are added to each rent based on number of residents in each unit – perhaps annually adjusted. OR each unit gets its own smart meter which allocates charge to each unit.
The solution to this typical homeowner & apartment or commercial tenant dilemma will not come from the utility monopolies. It doesn’t fit their business model. What does fit their utility business model is providing new transmission capacity to exploit massive offshore wind resources and for new strategically distributed 24/7 Advanced Geothermal power plants to replace aging nuclear & fossil gas peaker plants.
The typical homeowner & tenant solution is to rapidly exploit vast areas of valuable, widely distributed, but ridiculously under-utilized urban land we have locked up in parking lots. CA state Senator Josh Becker has already proposed modest tax incentive legislation for this:
Ubiquitous, standardized, scalable parking lot solar canopies +on-site stationary storage batteries +V2G chargers covering large parking lots at apartments, condos, business parks, shopping centers, hospitals, schools, etc…….everywhere. This will quickly pay off for the commercial property owners, employees & tenants alike. And these large, power producing & storing parking lots will begin to build the matrix of reliable neighborhood micro grids we need, networked across typical suburban communities . All it takes is local building dept permits, with no new utility transmission spending, and little if any public opposition.
One suggestion. I agree with the conclusion that we should “drastically reduce the volumetric price of electricity in California, while still keeping it at or above SMC”. However, price signals can be more precise. Smart meters and dynamic real-time retail pricing could signal consumers and their smart buildings that the marginal fuel has a real environmental cost (or not). Today, this would mean that early morning and late afternoon/evening prices would spike as gas-fired peakers ramp to follow loads and solar. Smart buildings would then shift load to avoid environmental costs. SMC is not a time-invariant price.
I am delighted to see Dr. Borenstein raise his “social marginal cost” estimate from ten cents to sixteen cents.
97% of the electricity utilities in the United States have volumetric prices below sixteen cents. That means that net metering is appropriate in all of those places. Basically everywhere in the continental US except for the California IOUs and a few utilities in New York / New England.
My own electric utility charges me about twelve cents. So that tells us that net metering is FAVORABLE to the utility’s other customers, and the utility should be offering a premium to solar customers to install oversized systems.
Now, “sixteen cents” is a single figure, and I know that Dr. Borenstein agrees with me that prices should be time-varying. Conveniently, this sixteen cent figure closely matches the TOU price for the “middle” price period for one California utility. Disaggregating “sixteen” cents into on-peak, mid-peak, and off-peak prices can (very roughly) come out to eight cents off-peak, sixteen cents mid-peak, and twenty-four cents on-peak.
Here’s Burbank Water and Power’s optional TOU rate:
Customer Charge: $9.76/month (versus zero for PG&E)
Service Size Charge:
Apartments: $1.48/month (versus zero for PG&E)
Small Single-Family: $3.00/month
Single Family >200A $8.99/month
Energy Charge
Off-Peak $.0887/kWh
Mid-Peak $.1776/kWh
On-Peak $.2664/kWh
Since all of these prices include the Burbank 7% “in lieu of” tax, which replaces property tax revenue, the “net of tax” prices are almost exactly (on a weighted average basis) the sixteen cents that Dr. Borenstein presents in this post.
This points to a better solution for California’s electricity pricing dilemma:
a) establish cost-based customer and service size charges;
b) disallow or securitize above-market costs built into electricity prices; and
c) establish a steep TOU price that produces an off-peak price that is attractive to EV charging and water heating (the Burbank off-peak rate is approximately equal to $1/gallon gasoline).
I discuss these concepts in greater detail in my Energy Central post, A Better Solution for California’s Electricity Rate Challenge, at:
https://energycentral.com/c/um/better-solution-californias-electricity-rate-challenge
I’ll close with an observation: Dr. Borenstein and I still disagree on the level of marginal transmission and distribution costs. He estimates these at about penny each. Recent transmission addition costs in California, divided by the power these new lines carries, comes to more like four cents.
With long-run marginal transmission costs included at these levels, even the California municipal utilities should still be welcoming new net-metering solar customers. Only the high-cost investor-owned utilities have a volumetric pricing problem. The California PUC needs to address the revenue requirement for those utilities, not punish customers who are contributing to a clean energy future.
This is the first of two posts on this, addressing very different elements of Dr. Borenstein’s timely contribution. This one deals with embedded carbon in gasoline. The second will deal with electricity prices.
Dr. Borenstein states, in footnote 1, that the embedded taxes and fees in a gallon of gasoline is $1.20 in California. I think this understates the amount by 15% or more, but the “missing” twenty cents IS embedded in the price of gasoline. I just think it should be recognized as “taxes and fees” because these same costs do not occur in most other states.
First, there is the embedded energy use in refining gasoline from crude oil. Refineries use about 10% of the energy value of their final product in the refining process. https://www.gao.gov/products/emd-80-55 Where that energy use is subject to carbon fees, as is the case in California and now Washington, refining is more expensive (which is why the Western States Petroleum Association is sponsoring a multi-million dollar campaign against the Washington State cap and trade program that launched in January, and for which the most recent auction cleared at $56.01/ton). So this alone adds to the $1.20 per gallon in “taxes and fees.” Perhaps as much as ten or fifteen cents more.
Second, the pipeline transportation that brings refined products to the community (mostly electrically driven in California) and the final trucking that brings gasoline to the neighborhood pump (mostly diesel trucks) ALSO requires not only the fuel used, but also the carbon cost associated with that fuel use. Since the price of gasoline already includes these carbon costs, consumers are paying them. But I think that Dr. Borenstein’s $1.20 in taxes and feesdoes not include the carbon cost associated with the transportation fuel that brings the gasoline to us; I think he bundles that with the distribution cost. But that distorts the result when comparing California (and Washington) petrol prices to other states. It’s more expensive to deliver the fuel in California in part because of the taxes and fees on the fuel used for delivery. That perhaps adds another nickel or so.
There are also other minor impacts. For example, the employees at a California refinery are paid more than at an Oklahoma refinery. This is mostly because they are likely to be union workers in California, and they can demand and receive better pay. But the justification for this is in part because their cost of living is higher, including the carbon costs and renewable energy costs embodied in their home energy use and the carbon costs embodied their vehicular energy use to get to and from work.
The good thing about carbon pricing is that all of this use of carbon-based fuel gets bundled into the final price of what we buy, in this case, a gallon of gasoline at our neighborhood pump. And that tells us to pursue efficiency alternatives and non-carbon solutions. But it’s not itemized the prices we pay, so when it’s time to analyze these costs, the analyst needs to look a couple layers deeper.
A good point about the magnitude of the social cost of carbon and its importance in properly pricing electricity. California is far from including this price directly, but one might argue that it’s included indirectly in the generation component through the legacy costs of renewable PPAs that have added as much as 4 cents per kWh to retail rates in the PCIA.
That said, the direct marginal cost of utility service in California is at least 13 cents per kWh (higher of residential customers) based on the 2021 filing of the lowest cost IOU, Southern California Edison. See https://mcubedecon.com/2022/04/12/proposing-a-clean-financing-decarbonization-incentive-rate/
For PG&E and SDG&E, these will be much higher after their most recent General Rate Case revenue requirements are adopted.
But a more important question is why are utility rates rising so fast and how does this relate to true marginal costs? After stripping out the various non bypassable charges and other external policy factors, PG&E’s residential distribution rate component has risen from 7.2 cents per kWh in July 2012 to 12.9 cents in March 2023, and the transmission component from 1.3 cents to 5.3 cents over the same period. We know that when average costs are rising, that marginal costs must be above average costs. (See https://mcubedecon.com/2022/12/20/the-fundamental-truth-of-marginal-and-average-costs/) That implies a much higher marginal cost than even what is calculated in the utility rate cases where many experts collectively estimate the value. We probably need to have a serious discussion about what constitutes marginal cost when rigorously related to total costs.
Which brings us to looking for the most effective solutions to this existential problem. Trying to hide high utility rates from customers through a fixed charge is unlikely to work for long. And if consumers are so gullible, that means that ALL electricity consumption will rise, not just for electrification (the latter will be less than 10% of the increased usage.) Instead we will face a near term reliability crisis if the presumption about consumer response is correct.
The two most effective policies need to be (1) rates that target electrification specifically (again see https://mcubedecon.com/2022/04/12/proposing-a-clean-financing-decarbonization-incentive-rate/) and more direct and enforceable means of controlling and reducing utility costs, such as long term fixed price contracts between customers and utilities. Without those, we’re just rearranging the deck chairs.
Excuse me, but “What?” Lower the price of electricity to encourage more electricity consumption, which somehow lowers greenhouse gasses? No, that only encourages keeping GHG generators on line longer.
How about this? More subsidies to encourage more solar and storage to allow the sources of GHGs to be retired earlier. Since more transmission lines will be costly and risk further GHGs (from wildfires) give those subsidies to rooftop solar/garage storage (which are installed at home owners’ expense).
Look! No two ways about it! Mitigating climate change is going to be expensive. This slight of hand being proposed is absurd. The sooner we bite-the-bullet, the less painful it will be. And it’s going to be painful!
If I correctly understand the logic, the answer to the failure of current decarbonization policies is to further distort the marketplace by increasing cross-subsidies. It would be fantastic if some university would study the “progress” made by our current decarbonization policies. It would appear from high level results (global/U.S. emissions vs. spend and/or time) that our current policies are having no appreciable positive effect.
Unfortunately, our “analysts” come up with ever more ways to jigger the electricity markets, with CA being a prime example of how to harm our less wealthy as a result.
Shouldn’t we tackle analysis of why our current policy approaches are by-all-measures failing and figure out how to make them effective?
Blithely (even if accurately) stating “We could accomplish that by increasing the cost of gasoline and natural gas, but there is no sign of any political stomach for that.”
– An analysis of bi-partisan approaches would be helpful A single party approach is only going to last until the next election.
– Most/all economists state that a carbon tax is the most efficient (and likely therefore the fastest) way to decarbonize. D’s reject a net-zero revenue carbon tax as “not going fast enough”, yet current policies are taking us in reverse.
– Without reaching throughout the world to influence emissions we have approx. zero probability of success.
– A carbon tax, though devishly complicated, would address the global emission that are currently the primary factor in our failure to make progress.