Fixed Costs and Solar
20/03/15 17:30
A reporter called saying that her local utility claimed that they have very high fixed costs - some 73% of their total costs.
My first response: A utility company with such high fixed costs should be actively exploring a new business model!
Here are the rest of my thoughts:
A fixed cost is a cost that does not vary (much) as the RATE of use changes (how much stuff flows through the pipe). Other drivers might be stronger for these costs - like the number of customers served, the geography, or the VOLUME (called capacity) of demand (think the size of the pipe, not the flow through it).
It is generally true that utilities across the country have been “finding” higher fixed costs, as a percentage of their costs, over the last few years. They find these costs in “cost of service” studies and as a result of the application of allocation methods that are not purely objective. Costs don’t come with labels; humans apply them. And, there is the basic financial truth that all costs are variable over the long term. So it only implies more questions - “Over what time frame?" being the most important. Others important questions include - “Why did you call this “fixed?” “How long does this fixed cost last?” “Does usage have any impact on replacement period?”
The actual process often involves the rate consultant distributing a spreadsheet to every/many utility employees or their supervisors. The spreadsheet asks them to report what work they do and whether it is the same every day or runs with electricity use; whether the wrench gets used the same number of times every day, or more on hot, sunny days. Up and down the system. Thousands of labels get applied and are rolled up into a massive database after a review. In the “logging” and in the “review” there is much opportunity to revise the outcome. Sometimes, staff members are directly asked to apply the label of “energy” or “demand” and “variable” or “fixed.” Sometimes, certain costs are pre-categorized as a function of the chart of accounts, the approved depreciation rate tables, Generally Approved Accounting Principles, and other regimes.
The relative shares among utilities tend to vary with local/regional economic conditions. Ironically, but logically, when the local economy is weak, the utilities get worried about profitability, and tend to "find" more fixed costs and tend to seek rates that increase their fixed charges. This is a common response from monopolies - they seek to “extract” their monopoly “rents” under all market conditions - and never vary their business model. In competition, the market would force innovation in response to these conditions. Regulators are supposed to act as a substitute for competition, but too often they tend to suffer from “regulatory capture” in which they defer to utilities and justify concessions to utility demands under the utility version of “what’s good for GM . . . “ The kind of people who tend to become utility regulators are also not typically known for creativity and innovation, like the utilities they regulate. (There are important notable exceptions, of course.) I have been a regulator in Texas.
I will concede that rates of consumption growth have slowed - utilities used to enjoy 4-6% growth every year. Now it is almost flat - 1-2% in many places. Just simple math would imply the “growth” in fixed costs as a fraction of total costs under this scenario. In addition, many utilities are trying to beef up their investments these days as generation has been made competitive and costs have been low. In some cases, we are seeing utilities tempted to “gold plate” their distribution system in order to beef up their profits and install effective barriers to competition.
So that addresses the reporter’s questions.
But wait, there’s more!
Spoiler alert - if the utility gets to charge solar and efficient customers with fixed charges, then they have an additional incentive to make more fixed cost investments. Feedback loops abound! That is, if utilities are always guaranteed recovery, with profit, for any costs that they label as “fixed,” it is only reasonable to assume that they will always seek to increase fixed cost investments.
This point by utilities about high fixed costs is the classic “begging the question” logic. That is, where they really want to go is “fixed costs do not change when customers use less energy (via solar and efficiency) - the pole is in the ground, the wires are hung and there is nothing we can do about it.”
The argument, which appears in anti-net metering rhetoric, is as follows - “If solar “gets” any more credit than just avoided energy cost (a subset of the retail total cost - basically just the fuel saved - the least “fixed” of costs), then solar is being subsidized. Since the poles and wires have to be paid for, we are gonna go bill a poor person who can’t afford solar or efficiency.”
This argument assumes that the utility had no opportunity to see it coming - they were completely surprised and could not have planned for any of this some time ago. But solar and efficiency advocates have been explaining how customer management of their electricity is growing for decades. Utilities ignored or dismissed these warnings and built out their systems as if it would not happen. In my opinion, willful ignorance is not an excuse for bad planning. Bad planning about changes in customer use patterns should not be rewarded by regulators who are supposed to act as a substitute for competition. Overbuilding your system might be more profitable for the utility; only prudent, used and useful investments are supposed to be recovered in rates.
This argument also assumes that solar and efficiency have no value, at all and ever. This in spite of a growing number of studies that show distributed solar generated energy is worth more than retail rates. That value comes from avoided energy costs, but also from avoided capacity, transmission, distribution, environmental, and others. Much of that value comes from the fact that solar systems operate virtually maintenance-free for 30 or more years. The difference is one of perspective. Utilities usually only ask “Can solar energy and efficiency avoid fixed costs today?” when considering resources that they do not own or control. They assume that they will have to ask the same question again next year. Value of solar studies, in contrast, ask, “Can solar energy avoid costs over the lifetime of the solar system?”
No one should entertain any argument about subsidies flowing to or from solar customers without data. In the utility industry, data about what customers cost to serve comes from a “cost of service study.” A value of solar study is the flip-side of a cost of service study and gets at the value that the solar provides. It asks, “What utility, ratepayer, and societal costs does this solar generation AVOID over the lifetime of the solar system?” When rates are set, the customer is charged basic customer charges and then, for what they use. Solar and efficient customers use less - just like the customer who shuts off their lights. Utilities seeking special fixed charges on solar customers are arguing that solar customers, unlike every other customer who otherwise reduces their use, should be charged for the electricity that they do NOT use in order to keep the utility “whole” on fixed charges that they EXPECTED to collect from the AVERAGE customer in the rate class. Utilities that are seeking fixed cost increases are making essentially the same argument based on increasing use of efficiency, and seeking to charge all customers for the lost sales revenue.
Pause for a moment to consider how all this works in rates. Utilities propose and regulators approve average rates. The rate applies to the entire class of, often, many thousands of customers. It is a FACT that very few of the customers will actually use the average amount of electricity every year. Since some of the costs that are put in the volumetric rate (the charge per kWh of energy) were originally labeled “fixed,” that means that customers who use less than the average amount will pay less of the fixed costs than a hypothetical average customer; customers who use more than the average pay more of the fixed costs than the average customer. Let’s say the rate is 10 cents, of which 7 cents has been called “fixed.” Let’s say average use is 100 kWh. The average “share” of fixed costs is $7. That is, if the utility gets, on average, $7 from every customer, then its fixed costs are covered. The 50 kWh user pays $3.50 towards fixed costs. The 150 kWh user pays $10.50. On average, the utility gets $7 per customer for fixed cost recovery.
Almost the entire argument about fixed costs in the business today is about how solar and efficiency customers don’t pay their “fair share” - meaning that they pay less than the average in fixed costs. And utility math for standby charges and adjustments to net metering most often are the crudest of math. Using my numbers, they say that a solar customer who uses only 10 kWh must be charged $6.30 MORE for the privilege of installing solar, at great personal expense, on their own roof. And there is the political irony that utilities are asking regulators to increase charges for customer who use less in order to force them to pay a socialist level of fees to the utility - this might be part of what pro-solar Tea Party folks have been talking about.
Special fixed charges on solar customers don’t make sense because they are punishing solar customers for doing what anyone who saves energy is doing. Increased fixed charges on all customers don’t make sense because they reduce the incentive for efficient use of energy and charge customers for something they didn’t use.
Note that utilities seldom have concerns about utility-owned solar. They recover fixed and variable costs and tidy profits on systems they own. But they almost always have concerns about efficient use of energy, because they are stuck in a commodity sales business model, even where they have revenue decoupling.
There are 2 simple responses to all this:
1. Under traditional net metering, where the customer receives offset credit for solar generation at the retail rate, it is already a fact that the customer is FULLY CHARGED for all the electricity they use, even if they OFFSET that use with solar power. That is why it is called “net” metering - it nets the consumption charge with the generation credit. Utilities that oppose solar have been very successful in rebranding offsetting as “avoiding.” They are not being truthful. You can offset a sugary snack with added exercise, but you still ate the entire snack. Exercise doesn’t mean you avoided the snack in the first place. Here is some algebra to illustrate the point:
Net metering (simplified) is: (Total Consumption minus Total Generation) times (Retail Rate) = Bill
This is EXACTLY equal to: (Total Consumption times Retail Rate) minus (Total Generation times Retail Rate) = Bill
As you can see, net metering charges the customer for total consumption of energy AT THE RETAIL RATE. There is no “avoiding” going on.
2. Utilities who oppose solar then argue that “solar is different” - that they receive and warehouse the excess solar production for the customer during sunny times and feed it back to them later - so the solar customer is using the grid more. Not really. First, they don’t store it - there is no “identity preservation” with electrons like there is with organic crops. That excess electricity goes directly to work next door or nearby. And given the way that prices work, it is probably doing so at a time when the utility cost of electricity is even higher than retail. Even if it is not, the utility is getting full retail from that other customer - so at worst they “break even.” In reality, the solar customer is bearing the financing, operating, and insurance cost for the solar - so the utility is getting full retail next door for something that costs the utility even less.
If the utility says they have additional costs, they need to do what every utility is REQUIRED to do before they charge any rate - conduct a cost of service study comparing a customer without solar to a similar customer with solar - and detail the differences. Value of solar analysis suggests that solar customers are cheaper to serve because their solar energy creates addition benefit that the retail credit doesn’t address. If the utility says these customers create costs that are different, the media and the regulators must demand DATA!
My first response: A utility company with such high fixed costs should be actively exploring a new business model!
Here are the rest of my thoughts:
A fixed cost is a cost that does not vary (much) as the RATE of use changes (how much stuff flows through the pipe). Other drivers might be stronger for these costs - like the number of customers served, the geography, or the VOLUME (called capacity) of demand (think the size of the pipe, not the flow through it).
It is generally true that utilities across the country have been “finding” higher fixed costs, as a percentage of their costs, over the last few years. They find these costs in “cost of service” studies and as a result of the application of allocation methods that are not purely objective. Costs don’t come with labels; humans apply them. And, there is the basic financial truth that all costs are variable over the long term. So it only implies more questions - “Over what time frame?" being the most important. Others important questions include - “Why did you call this “fixed?” “How long does this fixed cost last?” “Does usage have any impact on replacement period?”
The actual process often involves the rate consultant distributing a spreadsheet to every/many utility employees or their supervisors. The spreadsheet asks them to report what work they do and whether it is the same every day or runs with electricity use; whether the wrench gets used the same number of times every day, or more on hot, sunny days. Up and down the system. Thousands of labels get applied and are rolled up into a massive database after a review. In the “logging” and in the “review” there is much opportunity to revise the outcome. Sometimes, staff members are directly asked to apply the label of “energy” or “demand” and “variable” or “fixed.” Sometimes, certain costs are pre-categorized as a function of the chart of accounts, the approved depreciation rate tables, Generally Approved Accounting Principles, and other regimes.
The relative shares among utilities tend to vary with local/regional economic conditions. Ironically, but logically, when the local economy is weak, the utilities get worried about profitability, and tend to "find" more fixed costs and tend to seek rates that increase their fixed charges. This is a common response from monopolies - they seek to “extract” their monopoly “rents” under all market conditions - and never vary their business model. In competition, the market would force innovation in response to these conditions. Regulators are supposed to act as a substitute for competition, but too often they tend to suffer from “regulatory capture” in which they defer to utilities and justify concessions to utility demands under the utility version of “what’s good for GM . . . “ The kind of people who tend to become utility regulators are also not typically known for creativity and innovation, like the utilities they regulate. (There are important notable exceptions, of course.) I have been a regulator in Texas.
I will concede that rates of consumption growth have slowed - utilities used to enjoy 4-6% growth every year. Now it is almost flat - 1-2% in many places. Just simple math would imply the “growth” in fixed costs as a fraction of total costs under this scenario. In addition, many utilities are trying to beef up their investments these days as generation has been made competitive and costs have been low. In some cases, we are seeing utilities tempted to “gold plate” their distribution system in order to beef up their profits and install effective barriers to competition.
So that addresses the reporter’s questions.
But wait, there’s more!
Spoiler alert - if the utility gets to charge solar and efficient customers with fixed charges, then they have an additional incentive to make more fixed cost investments. Feedback loops abound! That is, if utilities are always guaranteed recovery, with profit, for any costs that they label as “fixed,” it is only reasonable to assume that they will always seek to increase fixed cost investments.
This point by utilities about high fixed costs is the classic “begging the question” logic. That is, where they really want to go is “fixed costs do not change when customers use less energy (via solar and efficiency) - the pole is in the ground, the wires are hung and there is nothing we can do about it.”
The argument, which appears in anti-net metering rhetoric, is as follows - “If solar “gets” any more credit than just avoided energy cost (a subset of the retail total cost - basically just the fuel saved - the least “fixed” of costs), then solar is being subsidized. Since the poles and wires have to be paid for, we are gonna go bill a poor person who can’t afford solar or efficiency.”
This argument assumes that the utility had no opportunity to see it coming - they were completely surprised and could not have planned for any of this some time ago. But solar and efficiency advocates have been explaining how customer management of their electricity is growing for decades. Utilities ignored or dismissed these warnings and built out their systems as if it would not happen. In my opinion, willful ignorance is not an excuse for bad planning. Bad planning about changes in customer use patterns should not be rewarded by regulators who are supposed to act as a substitute for competition. Overbuilding your system might be more profitable for the utility; only prudent, used and useful investments are supposed to be recovered in rates.
This argument also assumes that solar and efficiency have no value, at all and ever. This in spite of a growing number of studies that show distributed solar generated energy is worth more than retail rates. That value comes from avoided energy costs, but also from avoided capacity, transmission, distribution, environmental, and others. Much of that value comes from the fact that solar systems operate virtually maintenance-free for 30 or more years. The difference is one of perspective. Utilities usually only ask “Can solar energy and efficiency avoid fixed costs today?” when considering resources that they do not own or control. They assume that they will have to ask the same question again next year. Value of solar studies, in contrast, ask, “Can solar energy avoid costs over the lifetime of the solar system?”
No one should entertain any argument about subsidies flowing to or from solar customers without data. In the utility industry, data about what customers cost to serve comes from a “cost of service study.” A value of solar study is the flip-side of a cost of service study and gets at the value that the solar provides. It asks, “What utility, ratepayer, and societal costs does this solar generation AVOID over the lifetime of the solar system?” When rates are set, the customer is charged basic customer charges and then, for what they use. Solar and efficient customers use less - just like the customer who shuts off their lights. Utilities seeking special fixed charges on solar customers are arguing that solar customers, unlike every other customer who otherwise reduces their use, should be charged for the electricity that they do NOT use in order to keep the utility “whole” on fixed charges that they EXPECTED to collect from the AVERAGE customer in the rate class. Utilities that are seeking fixed cost increases are making essentially the same argument based on increasing use of efficiency, and seeking to charge all customers for the lost sales revenue.
Pause for a moment to consider how all this works in rates. Utilities propose and regulators approve average rates. The rate applies to the entire class of, often, many thousands of customers. It is a FACT that very few of the customers will actually use the average amount of electricity every year. Since some of the costs that are put in the volumetric rate (the charge per kWh of energy) were originally labeled “fixed,” that means that customers who use less than the average amount will pay less of the fixed costs than a hypothetical average customer; customers who use more than the average pay more of the fixed costs than the average customer. Let’s say the rate is 10 cents, of which 7 cents has been called “fixed.” Let’s say average use is 100 kWh. The average “share” of fixed costs is $7. That is, if the utility gets, on average, $7 from every customer, then its fixed costs are covered. The 50 kWh user pays $3.50 towards fixed costs. The 150 kWh user pays $10.50. On average, the utility gets $7 per customer for fixed cost recovery.
Almost the entire argument about fixed costs in the business today is about how solar and efficiency customers don’t pay their “fair share” - meaning that they pay less than the average in fixed costs. And utility math for standby charges and adjustments to net metering most often are the crudest of math. Using my numbers, they say that a solar customer who uses only 10 kWh must be charged $6.30 MORE for the privilege of installing solar, at great personal expense, on their own roof. And there is the political irony that utilities are asking regulators to increase charges for customer who use less in order to force them to pay a socialist level of fees to the utility - this might be part of what pro-solar Tea Party folks have been talking about.
Special fixed charges on solar customers don’t make sense because they are punishing solar customers for doing what anyone who saves energy is doing. Increased fixed charges on all customers don’t make sense because they reduce the incentive for efficient use of energy and charge customers for something they didn’t use.
Note that utilities seldom have concerns about utility-owned solar. They recover fixed and variable costs and tidy profits on systems they own. But they almost always have concerns about efficient use of energy, because they are stuck in a commodity sales business model, even where they have revenue decoupling.
There are 2 simple responses to all this:
1. Under traditional net metering, where the customer receives offset credit for solar generation at the retail rate, it is already a fact that the customer is FULLY CHARGED for all the electricity they use, even if they OFFSET that use with solar power. That is why it is called “net” metering - it nets the consumption charge with the generation credit. Utilities that oppose solar have been very successful in rebranding offsetting as “avoiding.” They are not being truthful. You can offset a sugary snack with added exercise, but you still ate the entire snack. Exercise doesn’t mean you avoided the snack in the first place. Here is some algebra to illustrate the point:
Net metering (simplified) is: (Total Consumption minus Total Generation) times (Retail Rate) = Bill
This is EXACTLY equal to: (Total Consumption times Retail Rate) minus (Total Generation times Retail Rate) = Bill
As you can see, net metering charges the customer for total consumption of energy AT THE RETAIL RATE. There is no “avoiding” going on.
2. Utilities who oppose solar then argue that “solar is different” - that they receive and warehouse the excess solar production for the customer during sunny times and feed it back to them later - so the solar customer is using the grid more. Not really. First, they don’t store it - there is no “identity preservation” with electrons like there is with organic crops. That excess electricity goes directly to work next door or nearby. And given the way that prices work, it is probably doing so at a time when the utility cost of electricity is even higher than retail. Even if it is not, the utility is getting full retail from that other customer - so at worst they “break even.” In reality, the solar customer is bearing the financing, operating, and insurance cost for the solar - so the utility is getting full retail next door for something that costs the utility even less.
If the utility says they have additional costs, they need to do what every utility is REQUIRED to do before they charge any rate - conduct a cost of service study comparing a customer without solar to a similar customer with solar - and detail the differences. Value of solar analysis suggests that solar customers are cheaper to serve because their solar energy creates addition benefit that the retail credit doesn’t address. If the utility says these customers create costs that are different, the media and the regulators must demand DATA!