a non-green argument for efficiency standards

The above chart shows the historical per-capita energy use in California, a state with aggressive appliance standards and energy efficiency programs, as compared to the rest of the United States. This image comes from the California Attorney General's Website (click the image for a larger version).

On January 1st 2012, as a result of a provision contained in the Energy Independence and Security Act of 2007, the U.S. will start phasing out incandescent light bulbs.* This provision has prompted some outrage amongst conservative and libertarian pundits lately as an infringement on the rights of Americans to choose their lighting. Sen. Rand Paul from Kentucky has a somewhat infamous rant against efficiency standards where he discusses the fact that the toilets that he has to buy as a result of government mandates cannot handle the job: he has to “flush them 10 times”, so they’re not even saving water! (One wonders what Sen. Paul is eating to cause such a demanding workload for his toilets.)

Via Andrew Sullivan a few weeks ago, I came across this article by Virginia Postrel criticizing the measure, with approving nods of support from Reihan Salam, Conor Friedersdorf, and Jacob Sullum. The argument against the ban is this (from Postrel’s article):

What matters, from a public policy perspective, isn’t any given choice but the total amount of electricity I use (which is itself only a proxy for the total emissions caused by generating that electricity). If they’re really interested in environmental quality, policy makers shouldn’t care how households get to that total. They should just raise the price of electricity, through taxes or higher rates, to discourage using it.

Instead, the law raises the price of light bulbs, but not the price of using them. In fact, its supporters loudly proclaim that the new bulbs will cost less to use. If true, the savings could encourage people to keep the lights on longer.

A simplification of this issue down to “just raise the price of electricity” indicates, to me, a profound misunderstanding of the way electricity pricing works.

The biggest missed point is that on some level, due to the shared nature of generation, transmission, and distribution resources, electricity must be priced on an average rather than marginal basis. This leads to problems of free-ridership under almost any conceivable electricity pricing scheme. Allow me to attempt to explain.

The most common way that electricity is priced for residential use in the United States is as a flat rate per kilowatt-hour (kWh) of electricity used. The calculation of these rates is usually relatively straightforward:

  • A utility determines (usually subject to review by a state regulatory agency) the total cost of providing electricity service to its customers, including generation, transmission, distribution, and operating costs.
  • The cost of providing service is increased by some percentage determined to be a reasonable rate of return for the utility, resulting in a number called the revenue requirement.
  • The revenue requirement is divided by the total number of kWh used by consumers, resulting in a rate per kWh used.

Some states (16, according to this FAQ on the Colorado Public Utilities Commission website) introduce a measure of total usage in to this average rate by introducing pricing tiers, which increase the cost of electricity as you use more each month. For example, in a two-tier pricing system, the first 100 kWh of consumption each month might be priced at $0.14/kWh, while consumption beyond that is priced at $0.18/kWh. But the rates for each tier are still a function of the total cost of producing electricity, and so are set on an average rather than marginal basis.

Going a step further, some utilities have time-of-use (TOU) rates for their residential customers which determine the price per kWh of electricity by when that electricity is consumed. This is a step closer to marginal pricing, differentiating between usage during the most costly periods of the day (summer afternoons in most areas) and those less costly periods (nights, weekends, winter). But even at this level of disaggregation, these prices still represent average costing rather than marginal costing. The cost of electricity in a given TOU period will always be determined not only by my use, but by the use of other customers during that same period. This remains true as you get into continually smaller TOU periods, and even if you introduce tiers into the different TOU periods (as PG&E’s TOU rate does). You can get closer and closer to marginal pricing, but at no point will your energy rates be unaffected by the consumption choices of others unless you allow consumers to individually contract for generation, transmission, and distribution service. Realistically, is anyone going to argue for that?

As the free-rider problem can never really be eliminated from electricity pricing schemes, I believe that this provides a basis for arguing for public policy interventions in the form of efficiency standards. And let’s be clear: these efficiency standards are not typically set capriciously. In California, there is an extensive public review process for the efficiency programs that the utilities put together. Programs are evaluated using the Total Resource Cost (TRC) test in order to “focus on programs that serve as resource alternatives to supply-side options”.

I’m open to discussion about the metrics by which these programs are evaluated, including discussion of the appropriate discount rate to use when valuing programs, the value of avoided energy, whether the tests should include avoided external costs like a proxy price for CO2 emissions, etc. But I disagree with the idea that there is no place for the government in this discussion because some people don’t like the way CFLs look (especially when the options for CFLs have expanded so dramatically as to make it difficult to tell the difference between light from an incandescent bulb and a CFL**). When your electricity use impacts the price of my electricity (i.e. property rights are not clearly defined), there is a role for an independent arbitrator to fix an inefficient allocation of resources.

Sidenote: One thing that interests me about this idea that “properly pricing electricity is the only solution to this problem” is that it is, in a sense, just a different argument for government intervention in the electricity market. Because properly pricing electricity is beyond the capabilities of the meters that many people currently have installed in their homes, which just track total use and not when the power was used. Instead, getting to a point where it would even be possible move dramatically towards a more accurate price of electricity (though as I’ve discussed above, I don’t think it’s possible to move all the way there) would require the installation of smart meters for all customers which would likely take . . . a government mandate. I’ve yet to find any articles by the people calling for changes in the price of electricity that advocate this.

(As always, when talking about energy I feel obliged to mention my previous full-time and ongoing as-needed employment with Energy and Environmental Economics, Inc. All opinions expressed here are my own and do not necessarily reflect the views of E3.)

——

* The legislation is not an out-and-out ban on incandescents, but rather sets efficiency standards for incandescents that will result in most of them being taken off of the market.

** This statement is partly based on personal experience. It is supported by a claim made by Russ Leslie, the Associate Director of the Lighting Research Center, in this radio interview, where he claims people were able to distinguish between CFLs and incandescents with an approximately 50% success rate, i.e. no better than if they were just guessing randomly. I have not read that study, so take that data point with a grain of salt. Popular Mechanics also reviewed CFLs, and found that “they all outperformed a traditional incandescent” (emphasis theirs).

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