The Importance of Marginal Cost Electricity Pricing to the Success of Greenhouse Gas Reduction Programs

Abstract

This paper identifies a previously unnoticed problem important for the efficient reduction of GHG emissions: the pricing of off-peak electricity. There may be many opportunities to reduce emissions by substituting relatively clean and inexpensive off-peak electricity in place of a more GHG-intensive fuel, with the most important example being vehicle electrification. However, off-peak electricity for residential consumers is currently priced at 331% above its marginal cost in the United States as a whole. Even for the 1.3% of residences that are on some form of time-of-use rate schedule, the off-peak rate is still almost three times higher than the marginal cost. A primary barrier to the increased use of marginal-cost based TOU rates is that less than 5% of U.S. households have the “smart” meters in place that can measure and record the time of consumption. A FERC report estimates the deployment rate of these meters for residences by 2019 will reach only 40%; policies should be put in place so that this deployment rate nears 100% by that time. Another important barrier is TOU rate design. I describe two TOU rate designs (baseline and two-part tariff) that utilize marginal-cost based rates, ensure appropriate cost recovery, and minimize bill changes from current rate structures. A final barrier is to get residences on to these rates. I consider whether a marginal-cost based TOU rate design should remain as an alternative for which residences could “opt-in,” or become the default choice, or become mandatory. I conclude that it should become mandatory. Time-invariant rates are a historical anachronism that subsidize very costly peak-period consumption and penalize off-peak usage to our environmental detriment. There is no reason for such a system to continue. This paper is the earlier working paper version of the final paper published in Energy Policy