Utility Rate Design Is a Key Piece of the Energy Transition Puzzle

What is Rate Design?

In order to deliver energy in the form of electricity and gas, utilities oversee and operate the wires, substations, pipelines, and other equipment that together make up the energy distribution systems. Utilities make regular investments in that infrastructure to help meet demand and maintain reliability. Utilities then recover the cost of those investments through customers’ monthly bills. Rate design is the process of determining how exactly to allocate those costs to ratepayers across the many residential, commercial, and industrial customers that make up a utility’s service territory.

As states consider how to accelerate the clean energy transition, utility rate design is a vital piece of the puzzle. Rate design is one of the fundamental tools that regulators have to ensure that utilities have sufficient revenues to bring power to our homes and businesses. But rate design is also a powerful lever for achieving policy goals related to clean energy, equity, affordability, and greenhouse gas emissions.

Why does Rate Design Matter?

Today, as customers face increasingly high utility bills, it is vital for regulators to get rate design right. In Massachusetts, for example, average energy burden (the percentage of household income spent on energy expenses) for low-income households is around 10 percent, and—remarkably—energy burden for some low-income households can reach as high as 31 percent.¹ Experts generally agree that customers are energy burdened if they spend 6% of their incomes or more on energy. It is important to note that recent increases in utility bills in the Northeast have been a direct result of an overreliance on gas in the region. Gas and other fossil fuels used to generate electricity are susceptible to price spikes, which we have seen especially during recent winters, and these costs are passed on directly to customers.²

Decisions over how to allocate energy system costs through rates have enormous implications not only for the energy burdens that customers face, but also for the success of building and transportation electrification, deployment of distributed energy resources like rooftop solar and battery storage, and many other programs and policies.

Utility bills are made up of the 1) costs for the generating resources that provide power (e.g. a wind farm or a gas plant); 2) costs that cover building and operating the transmission and distribution systems; and 3) funding for range of important policies and programs, such as energy efficiency programs and bill assistance. These costs are recovered through a combination of fixed charges, which stay the same every month, and volumetric charges, which vary depending on the amount of electricity or gas a customer uses. The majority of a residential customer’s bill comes from volumetric charges (i.e. the volumetric rate times the amount of electricity or gas consumed), so energy efficiency improvements that reduce consumption are a primary way of lowering bills.

Smart Rate Design Can Accelerate the Clean Energy Transition

As states work to reduce greenhouse gas emissions, utility rates must enable affordable and efficient electrification of our buildings and transportation sectors. In an effort to incentivize customers to electrify their homes, some jurisdictions are considering higher fixed charges and lower average volumetric rates. This would mean that customers who install electric heat pumps, for example, would not be penalized for using more electricity. This may be a promising solution to enable broad electrification, but regulators must prioritize efficient electrification by ensuring that incentives for energy efficiency are preserved and that customers and installers right-size electrification measures and avoid unnecessary or overly expensive system upgrades.

Regulators must also be careful to consider potential knock-on effects for other customers. In the past, stakeholders, including Acadia Center, have rightly (and successfully) pushed back against higher fixed charges, which are unresponsive to changes in customers’ behavior and therefore stay the same no matter what a customer does to reduce their demand, such as installing more efficient lighting or appliances. Higher fixed charges can disproportionately burden lower income customers and create a disincentive for energy efficiency investments, which may become less financially attractive as volumetric charges are replaced by fixed charges.

At the same time, customers with rooftop solar may face different incentives, and rate designs that work in favor of electrification may have unintended negative consequences for those net metering customers. As fixed charges grow, the value of rooftop solar and the payments received for exporting excess power to the grid may decrease. As regulators consider the allocation of costs between fixed and volumetric charges, they must be sure to prioritize equity and affordability, while preserving sufficient price signals for energy efficiency and other distributed energy resources like rooftop solar and battery storage.

Although the rates paid over time for the electricity a heat pump or electric vehicle uses (i.e. the operational costs) are an important piece of the decision to electrify, the upfront costs of installation are perhaps an even greater barrier to customer adoption. States should pursue both rate design solutions and efforts to improve the upfront economics of electrification.

In designing rates to enable affordable electrification, regulators should explore all possible methods to help customers manage utility bills and reduce their energy burdens. This includes a broad set of solutions, such as low-income discount rates, as well as more comprehensive approaches, such as Percentage-of-Income Payment Plans, which cap energy costs as a percentage of household income (e.g. so that customers pay no more than 6% for energy, for example). Increased access to programs such as community solar can also help to reduce bills.

States in Northeast also have lots of room for growth in implementing rates that more closely track the changes in energy prices throughout the day. By creating an incentive for customers to adjust their demand throughout the day in response to clear price signals, time-varying rates can help customers lower their electricity bills while delivering benefits to the grid overall. Time-varying rates can help reduce peak demand, which in turn reduces the reliance on the dirtiest, most expensive sources of power used to meet periods of highest demand. The many consumer and system-wide benefits of electric vehicles, heat pumps, and other distributed energy resources cannot be fully realized without the use of time-varying rates.

The demand flexibility that time-varying rates enables—much of which can be automated—will become increasingly important as more renewable resources are deployed and more customers electrify. As regulators consider rate reforms to support affordable electrification, they must focus on making the transition as easy as possible for customers, providing actionable price signals that accurately capture the benefits of clean energy, and avoiding situations where customers are financially worse off if they choose to electrify.

As electrification becomes more common, regulators should explore innovative ways to pay for the transition away from gas and identify solutions to break down silos between gas and electric utilities, which can often frustrate electrification efforts. Regulators should pay close attention to the kinds of gas investments that are approved for cost recovery through customer rates. Gas infrastructure can last for decades, which means customers well into the future may still be paying for investment decisions made today, even if that equipment is no longer needed in light of states’ climate targets. Acadia Center is deeply involved in these complex issues in proceedings throughout the region and is focused on ensuring that regulators implement effective rate designs that help advance a clean and equitable energy system.

While rate design alone cannot ensure the success of the clean energy transition, it remains an essential tool that states should not neglect as they pursue a clean energy future.

1 Kimberly Clark, Metropolitan Area Planning Council, Reducing Energy Burden: Resources for Low-Income Residents (2022). https://www.mapc.org/planning101/reducing-energy-burden-resources-for-low-income-residents/

2 As an example of the relationship between gas and electricity prices, see: https://www.eia.gov/todayinenergy/detail.php?id=51158 and https://www.sciencedirect.com/science/article/pii/S2589004223028031#bib36