Net metering and the politics of utility pricing

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I think it is safe to say that most utility executives detest net metering, in which any excess electricity generated by solar panels and other home-based “green technology” is “bought back” by the electric utility at the same rate charged to that home for using electricity. I sat on a “green innovations” committee for my small Iowa town for a time and observed how the few green-power innovators in town were treated more as parasites on the local utility system than as ecology-conscious consumers.

Other than the “hassle factor” to local utilities, a common reason given for that opposition is that net metering is a “politically correct” environmental concept that runs counter to accounting principles. It is practically an article of faith in the Fox News community that, without massive taxpayer subsidies, solar and wind power generation will never be sustainable (ignoring the mass of other subsidies rampant throughout the utility industry and business in general).

My primary counter to this objection is that all utility pricing is, and always has been, deeply and unavoidably political, and maybe that’s okay. In this post, we will examine the unavoidable politics of utility pricing, particularly in respect to encouraging new power generation and delivery technologies, and try to get a better understanding of the debatable accounting involved.

The opposition to net metering

Net metering was instituted in many utility service areas as a way to encourage property owners to make the considerable investment in green technology such as solar panels. These property owners typically use less electricity from the grid overall, and often generate more than they consume at some points during the typical day. With a bit of technology, it is relatively easy for that excess electricity to go “back to the grid” to benefit other properties, and if this “returned” electricity were allowed to “reverse the meter,” a property owner might even see a positive utility cashflow come back to help pay for the investment.

In net metering, electricity returned to the grid is netted against electricity taken from the grid to determine that property owner’s utility bill. Theoretically, this is a “win-win,” because we are encouraging the more widespread use of green technologies to reduce fossil fuel and other centralized energy sources, and the utility company can service more customers with less overall capacity.

For the typical utility, however, the “win” is harder to see. The “green” property must still be connected to the grid, which involves installation and maintenance costs for the utility, and the property might still draw electricity at “peak demand” times when air conditioners and other energy consumption draw more power than the local property’s generating technologies can supply.

In short, the utility company opposition is that the true value of the electricity returned to the grid is less than the value of the electricity consumed. Although it is typically charged at the same rate, “peak demand” electricity usually costs more to deliver than low-demand power, and conversely, the excess power generated by a green homeowner often comes back into the grid at times when it is not needed. Utilities often push for much less lucrative compensation, or even no compensation, for that returned electricity, which can make the homeowner’s investment much harder to recover.

Utilities and the fixed-cost dilemma

I have written in the past about this concept called the fixed-cost dilemma in relation to ambulance rides, drug costs, and more recently, university education. The fixed-cost dilemma is an accounting paradox that occurs with any business that has a high fixed-cost investment to start up their business, but a much lower incremental, marginal cost to deliver each additional unit of product.

In the classic example of new drugs, it can cost many millions of dollars of research and regulatory costs to get one new drug into the marketplace, but once production is ramped up, the cost of each additional pill produced can be quite small in comparison. What, then, should be the price charged to the consumer? It turns out that there is no one best answer to that question. The fixed costs need to be “allocated” in some manner to the end consumer, but that allocation is always arbitrary, and in the end, prices are primarily set by what the customer is willing to pay.

All utilities that generate their own electricity (as opposed to just purchasing power from other utilities) are perfect examples of this. The cost to bring new power generation capacity online can be massive, running up to hundreds of millions of dollars for a new electricity generation plant. Once up and running, however, the marginal cost of generating one additional kilowatt of electricity can be quite small, even as low as just the cost of the additional fuel consumed.

This is especially an accounting problem in covering peak power periods. The utility company may need to put that one new plant online just to meet power demands for a couple of hours per day or a few very hot days per year, yet someone needs to pay the high fixed cost of that facility. How should that “fixed” capital cost be spread around fairly to the customers?

The politics of utility rate-setting

This is where, green power or not, utility pricing gets unavoidably political. How should you allocate the huge fixed costs among the customers of the electric utility? It is common for an electric utility to have a small number of very large electricity users, such as big manufacturing complexes, and a very large number of small users, mostly homeowners.

The marginal costs to supply a very large user of electricity can be quite small relative to the actual electricity used. High-voltage power can often go directly to one substation near the plant, and there may be only one billing address. If a storm brings down the main line to that one factory, then restoring just that line brings that heavy-usage customer back online.

On the other hand, each residential neighborhood requires its own step-down transformers, and each residential customer requires a separate “last 100 feet” hookup to the house. One major snowstorm or hurricane can require many days of line work in order to restore service to every small-usage customer. And on the billing side, it might take a thousand residential accounts to be processed each month to equal the revenue of one large industrial user. Plus, many of these customers may be seasonal residents, using negligible amounts of billed electricity for long periods, and yet their lines also require maintenance.

In short, if you were to allocate the fixed costs of installation and maintenance in terms of actual dollars expended, you could likely justify putting a much higher fixed-cost weight on the individual homeowners than you would typically find in most pricing schedules. And when peak times hit, like especially hot days, it is the thousands of individual air conditioners turning on that cause the utility problems, and yet there is little the utility can do to moderate the demand of these customers. The utility company is more likely arrange peak-load management schemes with their biggest users instead of the homeowners. Large users of electricity certainly receive discounts, but if you were to do an analysis of how much time the maintenance and billing staff spend relative to the smallest accounts and bill accordingly, this would drive up the rates to the individual homeowners to politically unacceptable levels.

And so, utility pricing is already a very touchy political process. If you are in charge of the rate-setting, you need to give discounts to the big users in order to attract them to your community, but there is a likely a total-bill level to the individual homeowner that you really do not want to exceed. In the end, the allocation of those fixed costs among the customers is already an exercise in political interest-balancing. Adding “green users” into that mix complicates the politics, but my point is that the politics were already there to begin with.

Accounting alternatives

Utility companies have advanced several different ways to counter net metering. One easy-to-administer method is to rebate the electricity coming back to the grid from solar-power homeowners at “wholesale rates,” that is, the discounted rate charged to the biggest electricity users. The rationale for that rate is a bit hard to justify, other than that it is an established rate lower than the “retail rate” charged to homeowners, and easily systematized. But that rate is likely far too low for the owner to see a financial benefit to their solar investment.

The Iowa Utilities Board accepted a proposal from one power provider in 2017 to implement a cap on electricity usage eligible for net metering. In effect, the homeowners most effective in reducing power demand and investing the most in alternative generation would be hurt the worst, possibly losing credits for 50% to 70% of their excess power generation.

Another common proposal is the concept of an avoided cost rate, which is some calculation of the actual generation costs of those incremental units of electricity, which are then rebated to the customer. Depending on how those large fixed costs are allocated in an accounting sense, this avoided cost rate is likely also very low.

The question of how fixed costs are allocated is also dependent on the time scale over which costs are said to be “fixed.” In the very long run, say the life of a power plant, almost all costs are marginal from an accounting point of view, while in the very short run, most costs are fixed. The incentive for the utility is to set that “avoided cost rate” as low as possible, somewhere near the actual cost of the fuel consumed. In short, “avoided cost” is itself a very political term. As a variant of the classic accounting joke, a utility’s avoided cost rate is “whatever you want it to be.”

Embracing the politics

In its most positive sense, political decision-making is the balancing of competing interests toward achieving the overall common good. On one hand, productive tactics like advocacy, consensus-building and negotiation can yield an agreement between parties in conflict. On the other hand, brinkmanship, high-dollar lobbying and even more nefarious tactics can poison a political process. We have been living in the latter mode.

Without a doubt, a broader use of decentralized green power generation and storage would be far better for the planet than our continued reliance on fossil fuels. The technologies required to get there are still evolving, but overall this is a worthy, indeed planet-critical goal in the long run. Getting there will require capital investment by millions of individual homeowners, and making that investment pay off will clearly require some short-term “cost shifting,” giving the “green” homeowners a place at the rate negotiating table and a stake in the game.

This likely means some negotiated rate for returned-to-grid power that is less than the “retail rate,” yet is high enough to make that homeowner investment worthwhile. The best politicians are going to be the ones that can broker that agreement.

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