Common Tragedies

Thoughts on Environmental Economics

The best sentence I read today

Posted by Daniel Hall on October 6, 2007

…the TOU rate places a high value on the solar production at peak times that replace peak consumption from the grid, but a tiered rate can put a high value on all of the solar PV substitution from grid consumption for a high-consumption household.

This is from a new working paper by Severin Borenstein on the installation of residential photovoltaic (PV) power systems in California and the requirement they use time-of-use (TOU) pricing. It examines whether homeowners who are considering installing a solar PV power system are better off under a flat-rate or TOU electricity pricing scheme.

The upshot is that which rate structure is more advantageous depends on which one has higher marginal prices, since solar power is displacing electricity use at the margin. And which rate structure has higher marginal prices can depend on whether the structure incorporates block-rate pricing.

First, a little background:

— Economists like time-of-use (TOU) pricing (rather than flat-rate pricing) for electricity, because it passes a price signal to consumers: electricity prices are higher during the parts of the day when generation costs are higher.

— Economists also like block-rate pricing, in which the marginal price for electricity rises with consumption. Block-rate pricing can be used in conjunction with either traditional flat-rate pricing or TOU pricing.

— Solar PV systems produce most of their power during times of peak power demand — and peak power prices under a TOU tariff.

Of interest from the paper:

1. Typically, the installer of a PV system would be better of under TOU pricing, because the power generation from the PV system would be displacing high-priced electricity use.

2. However, since residential PV systems provide only a portion of the total power demands of a residence, the most advantageous pricing structure will be the one with the highest marginal price.

3. If the flat-rate tariff has higher marginal block rates than the TOU tariff, it may be preferable for PV installers. As the paper says,

Tiering of only the flat rate tariff can cause it to result in lower overall bills, due to low prices from the first tranche of consumption, and still have higher marginal power rates for consumption. Since the value of solar PV is in the consumption it eliminates on the margin, adding solar can actually make the tiered, flat-rate tariff even more attractive compared to the untiered, TOU tariff.

4. PV systems are much more likely to be economically viable for large residential energy users who are paying the highest marginal electricity prices. In other words, it is the wealthy who are installing PV systems — not just because they are the ones who can afford them or in order to keep up with the Jones, but because the economics make more sense for them.

5. Under block-rate pricing, the incentives favor relatively smaller PV systems that shave off a portion of electricity use. This is because, while installation costs increase linearly with the size of a PV system, the smaller systems are displacing the most expensive marginal power, while larger systems are also displacing less expensive blocks of power.

6. In general, residential PV systems are not a good investment, assuming standard interest rates. They are currently a profitable investment for some large residential users in California, but this is largely because the state rebate can be more than 25% of the upfront system cost, and because the highest marginal block rates in California are among the highest in the country (and, in fact, are at historic highs relative to average electricity rates). The economics of PV will continue to make sense only if future electricity tariffs continue to have steep increasing block rates and/or if electricity generation becomes far more expensive in the future.

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