Why New Electricity Pricing Approaches Are a Sheep in Wolf’s Clothing

There is a looming disconnect between the rapidly evolving new world of distributed energy technologies and the old world of electricity pricing, where relatively little has changed since the early 20th century. e-Lab’s recent report Rate Design for the Distribution Edge discusses changing electricity pricing to more fully reflect the benefits and costs of electricity services exchanged between customers and the grid. This can unleash new waves of innovation in distributed energy resource investment that will help to reduce customer and grid costs while maintaining or increasing system resilience and reliability.

For more than half a century, the Bonbright principles, laid out by James Bonbright in Principles of Public Utility Rates in 1961, have guided public utility ratemaking. These principles promote rate simplicity, stability of the customer experience, utility revenue recovery, fair distribution of cost among customers, and efficiency of energy use. And though the more sophisticated pricing approaches suggested in Rate Design for the Distribution Edge may feel like a departure, the principles behind the rate design remain quite similar. The Bonbright principles remain relevant today; they simply require an updated interpretation.

Reinterpreting the Bonbright Principles

With today’s changing customer behavior, inexpensive energy efficiency options, and competitive on-site generation, storage, and automation technologies, certain facets of the principles need a more nuanced interpretation to apply to a 21st-century electricity grid. “Interpreting Bonbright’s brinciples is like interpreting the U.S. Constitution,” says RMI Associate Devi Glick. “The foundation of the principles is just as valid today as when they were written 50 years ago; what has changed is the context in which they are applied. We have to expand how we think of the principles in light of our current dynamic, bidirectional energy system.”

Following are the five Bonbright principles and how expanding or updating their interpretation can keep them relevant today.

Preserving Important Values

RMI advocates for more sophisticated rate designs—by partially or wholly unbundling the attributes implicit in bundled electricity prices; honoring the way the cost of electricity generation and consumption varies over the course of hours, days, and seasons; and recognizing the differential cost to serve customers at different locations throughout the distribution network. “The cost to serve customers can vary depending on if the customer has distributed generation or an electric vehicle or uses power during peak or off-peak periods,” says RMI Senior Associate Matt Lehrman. “It is important for rates to be dynamic enough to reflect this variation without dividing customers into many different customer classes.” However, the social equity, resource efficiency, and simple customer experience that today’s rate design offers can still be preserved.

Social Equity

In addition to broadly providing reliable, affordable electric service for customers generally, utilities and policymakers have also afforded protections to low-income, fixed-income, and other special customer classes. It is critical to ensure that the transitions that are needed and occurring in the electricity system, including around rate design, address the needs of these important customer groups. “Evidence suggests that low-income customers can benefit from more sophisticated rate designs. Sacramento Municipal Utility District has demonstrated promising results from time-of-use pricing, for example,” explains Owen Smith, a principal in RMI’s electricity practice. “We’re seeing that well-constructed rate designs can and do work for a broad array of customers, including low-income customers.” Providing customers with well-designed rates, and offering them multiple options, is necessary in order to protect these customer classes from undue burdens or fluctuations in costs.

Resource Efficiency

Resource efficiency and conservation must be preserved as rate design evolves. For instance, if increasing portions of customer bills were collected in the form of fixed monthly charges—and less in the form of volumetric charges or other types of charges that the customer has the ability to influence—the incentive to conserve would be diminished. New rate designs can maintain the focus on resource efficiency by limiting the portion of a customer bill collected through fixed charges, or layering in tiered-volumetric rates with time-of-use pricing to simultaneously promote resource efficiency and peak-time load shifting.

Simple Customer Experience

A shift to more granular and dynamic rates will need to be undertaken in tandem with tools and services that can automate customer responses to price signals to maintain simplicity. Greater rate sophistication doesn’t have to also mean a more complicated customer experience. Smart grid technologies are being rapidly deployed and there are increasing opportunities for solution providers (including third-party aggregators, utilities, and others) to manage complexity on behalf of the customer, so that the customer experience is at least as simple or more so than it is today. For example, home energy management systems can respond to price signals from the utility and can manage the load with user-defined instructions, such as avoiding peak pricing, minimizing the bill, etc.

Minimal Cross-Subsidization

Cross-subsidies have always been present in rates. For example, the actual cost to serve an electricity customer may be higher or lower than the prevailing per-kWh price most customers pay. The difference between those who pay a little more and those who pay a little less than their true cost of service reflects the cross-subsidy. By averaging that cross-subsidy across large customer classes, the impact on any individual customer is very small while society shares the “cost” of values it holds important. For example, rural electrification policies have provided rates for rural customers that are consistent with customers in more densely populated regions, even though it is more expensive on a per-customer basis for utilities to serve rural regions. The important thing is to ensure that any subsidies within and across customer classes achieve the policy goals they were designed to achieve without creating undue burden on individuals or groups of customers. And actually, as retail electricity prices take a step closer to a customer’s true cost of service, the magnitude of cross-subsidies will decrease.

Just as we need rate structures that reflect the electric grid’s evolution, we need updated principles that guide those structures. Fortunately, simply expanding our interpretation of the Bonbright principles that formed the basis of today’s rate design can meet the needs of all resources competing to provide reliable, affordable, clean electric service to all customers.

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