Overcoming Economic Barriers to Electrifying Everything
“Electrify everything” has become a mantra of decarbonization, and it’s one of the key strategies to reducing reliance on fossil fuels. Yet the process of electrifying everything from home heating to transportation creates challenges for the electricity system, which will need to grow to accommodate renewable energy and rising demand for power.
This raises a fundamental question: How can society make costly investments to grow the supply of power, while keeping the cost of electricity low enough that electrifying everything remains an attractive proposition for all consumers?
Meredith Fowlie, an energy and environmental economist at the University of California, Berkeley, explains why existing frameworks for setting consumer electricity prices can be at odds with the need to rapidly decarbonize. She also explores potential solutions to ensure that electrification happens rapidly, with costs and benefits that are equitably shared among households at all income levels.
Andy Stone: Welcome to the Energy Policy Now podcast from the Kleinman Center for Energy Policy at the University of Pennsylvania. I’m Andy Stone. “Electrify everything” has become one of the mantras of decarbonization, and it’s one of the key strategies to reducing our reliance on fossil fuels. The process of electrifying everything means that many of the services that we rely upon in our daily lives, including fundamentals like home heating, hot water, and transportation are shifted from fossil fuel power to alternatives that run on cleanly-generated electricity. Yet the process of electrifying everything creates challenges for our electricity system, which will need to grow to accommodate renewable energy and rising demand for power. In addition, as ever more of our economy becomes dependent on electricity, the imperative that the power grid be reliable and resilient becomes even more critical.
So how can we make costly investments to grow power supply while simultaneously keeping the cost of electricity low enough that electrifying everything is an attractive proposition for all consumers? This is the challenge that we’ll be exploring with today’s guest, Meredith Fowlie. Meredith is an Energy and Environmental Economist at the University of California, Berkeley, whose recent research examines the regulatory foundations of residential electricity pricing. Her work explores solutions to ensure that electrification happens quickly, with costs and benefits that are equitably shared. Meredith, welcome to the podcast.
Meredith Fowlie: Thanks for having me.
Stone: So Meredith, to get us started, I wonder if you could describe the fundamental tension between the need to invest in new infrastructure to accelerate electrification, while at the same time keeping electricity affordable so that electrification is an economically attractive proposition for people of all socioeconomic classes.
Fowlie: Sure, so let’s jump in. And if I may, I might expand the scope of the question just a little bit. When we’re thinking about electrification, which as you correctly noted is a key pillar of our decarbonization strategy, there are actually two important components. One is to green the grid, to get the carbon out of the electricity sector so it’s clean and green, and then to electrify as much as we can, from transportation to buildings to some industrial applications.
And you pretty much touched on what I see as sort of the three-fold challenge. So first, greening the grid is a non-trivial exercise. Right now, about 40% of our kilowatt hours are zero carbon, and so we need to take that 40 closer to 90 to 100%. So that’s going to take major capital investment. As you also noted, we want everyone to have an electric car in their driveway and a heat pump in their basement. That’s going to dramatically increase demand for electricity between now and 2030 to 2050, so that’s going to mean we not only have to green what’s already on the grid, but we have to build more of it, significantly expand generation capacity, transmission, distribution infrastructure. So billions and billions and billions.
And third, as you noted, if we are going to convince you to trade your fossil fuel vehicle for an electric car, you want to know that the power will be flowing when you want to drive that car out of your driveway. Reliability is getting more expensive to guarantee in the face of more frequent extreme weather events. So we’re also spending billions making our grid more resilient. So where I live in California, 8 billion dollars a year in making the grid more resilient to wildfire risk.
So these are needed investments, but they are massive investments. We are attempting something that, at least in my lifetime, we have never attempted. So what that means is that we need to be really careful about how we raise those needed revenues, because how we choose to pay for them will have implications for how much it costs and who pays the price. Coming out of a crippling pandemic, possibly heading into a recession, equity and affordability need to be top of mind. So when allocating those costs across households, across sectors, we just need to be really mindful about the burden of costs — how those costs are allocated — particularly when we’re thinking about low-income households who spend a relatively large share of their income on electricity bills.
Stone: Your research has looked at the framework under which retail electricity rates are set. I wonder if you could talk about that process at this point and why it might be a barrier to decarbonization efforts?
Fowlie: Yes, so electricity generation and distribution in retail. When you open up your undergraduate economics textbook, and you look up “natural monopoly,” electricity is sort of a textbook natural monopoly. And what that means is if you think about your house, and you think about your street, and you think about all that infrastructure that’s bringing power along lines, along poles to your house, it does not make sense to have many firms building that infrastructure to compete to supply you your electricity, because that would cost way too much.
What makes much more sense is to have one firm get the local monopoly and grant that monopoly to the firm, but in exchange for that monopoly, the firm accepts that a regulator will limit the prices that that firm can charge. So across the country, we have public utility commissions, and those regulators have to assess what it costs to produce and deliver electricity and then set the retail rates that utilities can charge households to recover those costs.
So traditionally, and looking again, there’s some variation across the country, but basically a lot of those investment costs, the transmission infrastructure, the generation infrastructure — we recover those fixed costs by increasing the per kilowatt hour price people are paying. So the price that you pay every time you run your dishwasher and consume a kilowatt hour reflects not only what it costs to generate that kilowatt hour on the margin, but also helps to recover those thick sunk legacy costs that we had to incur to make sure that electricity is there when you need it.
Stone: So a key concept that you talk about is that electricity is already more expensive than the societal cost that would be indicated for it. Can you explain the concept of societal cost or social marginal cost and the problems that over-pricing can lead to?
Fowlie: Yes, so this is a little bit of jargon, so I hope your listeners will indulge just for a minute. As an economist, if I was in charge of pricing electricity — and I am not — but if I was, I would want to set that electricity rate to reflect the cost to society, the cost we incur when I consume one more kilowatt hour. So back to my dishwasher load, when I run my dishwasher, we burn fuel, so we want to price in, let’s say the natural gas that’s required to generate that electricity. There are emissions released at the natural gas plant, so greenhouse gas emissions, local air pollution — we want to price those in, so that when I’m deciding whether to run one more load, I’m incorporating or accounting for those costs. There may be marginal capacity costs if I’m running that dishwasher load on peak. Maybe we had to build a little bit more distribution infrastructure to make sure the electricity was there when I needed it. So all those costs of me consuming one more kilowatt hour should be in that price so I can make efficient decisions as to how much I can consume.
Now, for the reasons that we just talked about, in some states the prices that we are charging customers to recover the all-in costs are well above that social marginal cost. So to put some specific numbers on it, we’ve estimated that where I live in California, the social marginal cost, the cost per kilowatt hour to society is on the order of 8 to 10 cents, and that’s all-in.
Stone: That’s much cheaper than the California rate.
Fowlie: Yes. I am now paying over 30 cents for a kilowatt hour. So how do you get from 8 to 10 cents to 30 cents? That is all those fixed costs in transmission, distribution, generation, making the grid resilient to wildfire, public purpose programs, subsidies for rooftop solar, low-income programs. All of those costs need to be recovered, and the way we’re doing it is by effectively taxing electricity at a pretty high rate, when you think about going from 10 to 30 cents per kilowatt hour.
And at least for me, there are two reasons that that kind of taxation should really sort of worry us and keep us up at night. One has to do with efficiency, so if we want to convince you to get into an electric car, that’s going to be a harder case to make at 30 cents per kilowatt hour versus 10 cents per kilowatt hour. So we’re basically putting a barrier in the path to electrification as I see it. And the second reason, and this has really been the focus of our research to date, is it turns out that this is a pretty regressive tax on electricity because low-income households spend a larger share of their income on their electricity bills.
Stone: So basically you’ve got a situation where you’re got all these additional costs that are in the retail rate, and that raises equity and affordability problems, I would imagine, for a lot of homeowners.
Fowlie: Yes, and if you think about it, like take the $8 billion that we’re having to spend to improve our grid and make it resilient to wildfires. There are a variety of ways we could raise those revenues. We could raise our income tax. We could raise the sales tax. We are, in the case of utility expenditures, taxing electricity, and that’s a relatively regressive way to raise those revenues, as compared to other ways, other tax instruments we use, such as the sales and the income tax.
Stone: Per your research, what has the impact of these high prices actually been on the rate of electrification?
Fowlie: This is a good question, and I guess I need to be careful here. Per our research and per research of my colleagues and peers, we are only now starting to dig into the data to understand the extent to which investment in rooftop solar systems has been accelerated as a consequence of high electricity prices. And we can come back to that. But I do want to give a shout-out to two recent papers that we’ve leaned on and leveraged to try to answer that really important question, which is, “Okay, I’m paying 30 cents. The social marginal cost is 10 cents. What impact has that had on the pace of electrification in the building sector and the transportation sector?
So Lucas Davis, my colleague at Berkeley, wrote a really nice paper that just looked at new home construction over the past several decades across the country and asked the question: How less likely are households to choose electric heat over natural gas or propane if their electricity prices are higher? And we asked Lucas if we could borrow his model, and he said, “Certainly.” And so basically what we did with Lucas’ model is we ran one simulation that simulates the home heating choices that we actually observe under existing prices, and then we ran a simulation which in California we swapped out the retail rate and swapped in the social marginal cost. And we estimated that home electrification in terms of fuel choice could have been a third higher, had we priced electricity efficiently.
Stone: That’s significant.
Fowlie: That is significant. All of these numbers are significant. On a podcast, we don’t usually talk loudly about large numbers, but perhaps I should, because that’s significant. In another paper by my colleague Jim Bushnell and colleagues at UC Davis, they had a similar exercise looking at electric car adoption. Now this is backwards-looking, and the electric cars of yesterday do not look like the electric cars of tomorrow. So with all those caveats, we were able to do a similar exercise, where we simulated EV adoption under observed rates and swapping out the retail rate in California and swapping in the more efficient rate. And we saw similar magnitude impacts on EV adoption.
So I think it’s safe to say that this current practice of effectively taxing electricity is slowing progress on a margin that we really need to be leaning into.
Stone: As an economist, you’re really interested in finding solutions to the problems that you identify, and in this case, finding a solution to the problem of high cost of electricity and its impacts. A couple of solutions come to mind. Can you walk us through those?
Fowlie: Yes. Economists are often known as sort of the wet blankets in the room. We like to elucidate problems. But I think in this particular context, it’s so important to also think creatively about reforms and solutions. So looking at how we’re pricing electricity, not only in California, but across the country. And maybe I’ll just take a minute to mention that my co-authors — I have two co-authors on this paper, this work, Jim Sallee and Severin Borenstein. And Severin Borenstein has done other work, where they look across the country to sort of coarsely calibrate social marginal costs for every state in the union and compare it to the retail prices that consumers are actually paying. And across the country, the majority of households are paying a higher retail price, as compared to the social marginal cost. So this is not a uniquely Californian phenomenon, although California, because it is on the frontiers of climate change, both in terms of mitigation and adaptation, we’re sort of pushing ahead, and the gap between social marginal costs and retail prices is particularly large. So it’s particularly imperative that California think about solutions.
So I think there are two related classes or types of reforms that we’ve been exploring. One — and we kind of referred to it earlier — is to ask the question why are we recovering costs of climate change, mitigation, and adaptation in electricity rates, particularly given the relative regressivity and the implications for electrification? So one direction that we’re starting to see a little bit of movement in is the re-evaluation of what’s in those rates, and the important conversation about what can be taken out.
For example, as I mentioned, billions of dollars are being spent on wildfire risk mitigation, and that involves a tremendous amount of money spent on vegetation management, like clearing the trees away from the lines. If the tree is being cut down to clear space around a power line, that cost is on the electricity bill. If a tree is being cut down to reduce wildfire risk in a state forest, that is on the state budget. So that seems like a fairly arbitrary distinction. I think that there are cost components that we can start moving out of those bills that will put downward pressure on rates.
The second avenue we’ve been sort of exploring — and here again, there’s some encouraging momentum, I think, is the reality is it’s going to be hard to move a lot of these costs out of electricity rates for a variety of reasons, some of them having to do with political economy. And as an economist, I might just gesture in that direction and not try to unpack that. But let’s take as an assumption that we’re going to have to recover significant costs in electricity rates. Then the question becomes: Can we design these rates in a way that improves both efficiency and affordability? And so when we as economists think about this, the sort of thought experiment we have in our heads is (1) How can we make electricity prices more efficient? Well, we could set them a lot closer to social marginal costs, closer to 10 cents versus upwards of 30. (2) Assume we have to recover all of these revenues in the electricity rates, how can we shift that burden away from lower-income households towards higher-income households who are in a better position to pay. And (3), we’ve got some real world feasibility constraints. What is feasible within the realm of the authority of the Public Utility Commission?
What we’ve come up with is something we’re calling an “income-based fixed charge,” and it’s fairly simple. The idea is as follows: Set the per kilowatt hour cost equal to social marginal cost so our consumers are making efficient decisions, and they have the right incentives when it comes to both consumption and investment choices. That leaves a lot of revenue still to recover. Let’s recover that in a fixed charge. So now your bill has not only the price per kilowatt hour, times your consumption, but also this fixed charge that doesn’t vary with how much electricity you consume. And let’s make that fixed charge per month scale with income.
So the lowest income households contribute nothing. They’re still paying the social marginal costs, but they’re not contributing anything to the residual revenue requirement as we’ve envisioned it. And then that fixed cost steps up with income. And when you have this kind of step function-type rate design, you — the public utility commissioner — have much more freedom in terms of controlling the relative regressivity of that cost step-up rate, because it just depends on the steepness of that staircase, as we step from lowest to highest income.
And so that’s a way, we’re arguing, that it’s efficient. We improve efficiency in terms of getting the prices right, but it’s also addressing affordability and equity concerns, in that it’s shifting the burden away from the households that can least afford to pay.
Stone: Stepping back a moment, if I may, to the state budget approach, as you and your colleagues point out in the research, if that were to go on a state budget, the state would raise that money through income tax and sales tax, which is more progressive than the utility rate at this point. So both of these are progressive solutions. I think you’re hinting that one may be preferable, but can you talk a little bit more about that?
Fowlie: Yes, and here again I am a little bit reluctant because I’m not the most politically savvy of my colleagues. But here’s how I see it. As you just pointed out, we’ve basically constructed an income tax or a sales tax on your bill by scaling the fixed charge with income. So it’s basically a way for an electricity sector regulator to recover rates as if it was an income tax or as if it was a sales tax. I think the crux of the issue is as follows: It’s hard to raise taxes in California. And when you move some of these programs onto the state budget, I think there’s a concern among the supporters of those programs that they may be more vulnerable as we head into a recession. Whereas when they’re on the electricity bill, they have, at least historically, a safer haven for important programs on those bills. Now I think that’s becoming less so as the level of rates and the extent to which they exceed efficient prices is more salient, but I think historically, constituents have been reluctant to try to fund programs on the state budget. They’ve been relatively safer on electricity bills.
Stone: To what extent are policy-makers aware of these issues that you’re talking about? And what are the prospects that electricity pricing based on the marginal social cost, regulatory form, will become reality in California?
Fowlie: Yes, that’s a great question. And I think the short answer is it’s clear that we have to do something. Public utility commissioners are hearing it from pretty much every stakeholder that’s weighing in on the California rate regulation process. I think one thing that’s been quite challenging in past years — because there has been clamoring for rate reform for some time now. Right now we’re in a fairly extreme situation, given the extent to which retail rates do exceed our best estimates of social marginal costs, but that has been the case for some time.
The way I see it, I think there’s been one important shift. When you think about stakeholders in any proceeding or any decision about rate reform, low-income consumer advocates are one important stakeholder. They’ve got serious skin in the game. These households are paying bills that they can’t afford. Another really important stakeholder are environmental groups. One of the reasons why retail rates are so high is we are recovering the cost of essential climate change mitigation and adaptation. I think it’s fair to say that in past years, environmental groups, at least some important ones, have resisted the idea that electricity prices are too high because there was this sense that, “We need to conserve. We need to invest in electricity efficiency. High prices are strong incentives to consume less.”
But that argument is evolving as electrification becomes central to our climate change mitigation strategy, because now high electricity prices are a drag on our progress, versus accelerating our progress. And so as you start to see important environmental groups move behind this idea that electricity rates are too high, you’re starting to see some momentum. And so July 1st, I think, this past summer the Governor did sign a bill that authorized the Public Utility Commission (1) to start charging fixed charges, and (2) to make those fixed charges escalate with household income.
So I think that’s a pretty encouraging sign that the Public Utility Commission and the various stakeholders are getting serious about rate reform in California.
Stone: Has this been modeled? I mean, what practical impact would you expect this new law to have on electrification in California?
Fowlie: I think it can only help. I think I’m watching the process closely. I think it’s scheduled to take effect in 2025, so there are a lot of important decisions that have to happen between now and then in terms of where the retail rate will be set and how the fixed charges will be structured. But I think it’s a safe bet that retail rates will come down, and that can only help the pace of electrification going forward.
Stone: Has pricing based on the marginal social cost been tried elsewhere? And to what extent are the challenges that you’re seeing in California — can they be addressed by similar solutions elsewhere?
Fowlie: I think across the country we do see retail rates exceed social marginal cost on average, and I think across the country, we’re seeing rates go up for all the reasons we’ve been talking about in terms of the scale of the investments we’ll need in transmission, distribution, generation. The list goes on. So yes, I like to think of California as a policy pioneer. It’s kind of a laboratory. It’s a really exciting place for someone like me to be doing research, because we’re trying a lot of things, and some of them work, and some of them don’t. And we learn hard lessons along the way. So yes, I think that this kind of experimentation with rate design is going to be important not only for California, but also across the country.
Stone: I also want to point out; this isn’t really a completely unique problem. Similar issues of equity and inequity have come up with solar net metering, as well as — and you’ve mentioned this in the past — the issue of legacy gas infrastructure in New England. This is also causing similar discussions going on. I wonder if you could dive into those a little bit.
Fowlie: Yes, so you touched on two important ones. Let me start with the first, and it’s basically, when we talk about net metering, perhaps your listeners are unfamiliar with the term, so let me quickly define it. I live in California, and when electricity rates started getting really high, I did what a lot of other households who could afford it have done, and we put solar panels on our roof. And what does that mean?
Well, it means that when we’re home and consuming electricity, we’re making our own. We’re not paying that 30 cents. We’re just taking it from our solar panels. But what net metering says is even when we’re not home — so right now my kids are at school, we’re at work, and we’re generating solar electricity, and we’re not consuming it. We’re injecting it into the grid. But what net metering says is, “Well, when you come home and you start plugging in your toaster, you get credited at the retail rate.” And the reason that that’s a problem is because when retail rates are so far above social marginal cost, that acts as a subsidy. And the higher above the social marginal cost that retail rates rise, the larger that subsidy.
And the reason it’s an issue in California and across the country is when you look at who is adopting solar, it tends to be higher-income households. They own their homes. They have access to capital. And so when we generate electricity with our solar panels, and we avoid paying that 30 cents, we’re only avoiding 10 cents in social costs. The remainder 20 cents isn’t avoided. It’s shifted. And it’s shifted onto the solar panel have-nots. So this is a sense in which we are arguing — and this is a line we’re pursuing in our research to assess just how important these high retail rates have been in accelerating solar adoption. We’re arguing that this, for feedback, is exacerbating the regressivity of this tax, insofar as more and more high-income households reduce their demand for grid electricity by installing solar panels to produce their own.
Stone: More has to fall onto the lower-income groups.
Fowlie: Those costs have to be recovered somewhere, absent rate reform, and where’s that somewhere? It’s the folks that don’t have solar panels. So I do think it’s an important and related concern having to do with affordability and regressivity.
You also mentioned natural gas, and this is an interesting one because it’s the sort of same textbook, right? You’ve got a textbook natural monopoly. It doesn’t make sense to have multiple firms building natural gas pipelines. It makes sense to have one. So you’ve got a public utility commissioner regulating a gas utility. This should sound familiar.
Stone: And this is at the retail level, right?
Fowlie: This is at the retail level, yes. So if you are a natural gas customer, which so many of us are, the rate you pay was set by a regulator. That regulator looks at the cost the utility has to recover and says, “Okay, this is the price that we need to charge you to recover those costs.”
Now what’s happening in the natural gas sector is different but related to the electricity sector. We are succeeding in getting a lot of folks to buy heat pumps to replace their gas furnaces, to buy electric water heaters to replace their natural gas water heaters. So what that means is the demand is falling, particularly among higher-income households who are better able to make these new investments. But the costs still need to be recovered. So what you’re starting to see is retail rates rise. You’re shifting that cost recovery into a smaller base. So we have similar concerns about affordability being driven by our electrification success, and so we need to think hard about how we’re going to recover those so-called “legacy” costs on natural gas bills going forward.
Stone: We’ve been talking really in the context of state policy, public utility commissions, the way they set rates. I want to ask you, though: Generally, are there policies or solutions that we might see at regional or national levels to support progressive electricity pricing?
Fowlie: Yes, so the big one is the Inflation Reduction Act. So that was huge. It feels huge. It was like 360, 370 billion. So that sounds like a big number, but it’s actually nowhere near what we’re going to have to invest over the long run. But why is that important?
The Inflation Reduction Act offers subsidies for all the things we’ve been talking about — heat pumps, electric cars, utility scale renewables. And what that means is a state like California or Pennsylvania or wherever you are now has an incentive to go after those federal dollars to accelerate climate progress in its own state. So it’s making clean energy cheaper, and it also means that then, when the California utility or the Pennsylvania utility comes to the Public Utility Commission to recover its costs, well some share of those costs have been paid with subsidies and loans, et cetera, under the Inflation Reduction Act. And my understanding is much of that is being funded off of increases in corporate taxes. So shifting costs off of utility bills onto less regressive, more progressive corporate taxation.
So in my mind, when I think about the federal landscape, that’s the big one, and it’s really important going forward. It’s going to shift some of the burden and ease some of the stress that’s going to be associated with making these needed investments.
Stone: Before we finish up, I’d like to ask you a final question. What are your thoughts about are we going to succeed in creating a more equitable system nationwide, state-by-state, or federally as we go forward that’s really going to address the need to accelerate electrification, make sure it’s equitable — the whole bucket?
Fowlie: I really hope so. And I hope so for a number of reasons. I think one is I think there’s a pragmatic sense that we’ve got to do it in a way that helps everybody, because this is like a marathon, and we need to have people engaged and supporting this effort over the long haul. And so if we do it in a way that doesn’t serve everyone and that leaves some communities behind or exacerbates versus mitigates some of the social inequity that we have, I just don’t think that’s going to be a durable strategy.
So we should do it for all the right reasons, but we should also do it for the pragmatic reason that we need this to have broad-based support if it’s going to have lasting success. And I think if that’s the case, we need to put equity and affordability at the forefront.
Stone: And if we’re going to decarbonize, everybody has to take part, right?
Fowlie: Exactly. Yes.
Stone: Meredith, thank you very much for talking.
Fowlie: Thanks so much for having me. This was really fun.
Stone: Today’s guest has been Meredith Fowlie of the University of California, Berkeley. Check out the Kleinman Center for Energy Policy website for more podcasts, research, and upcoming events. To keep up with the center, subscribe to our monthly newsletter on our website or follow us on Twitter. Our handle is @KleinmanEnergy.
Thanks for listening to Energy Policy Now, and have a great day.