Issues, Questions, and a Research Agenda for the Role of Pricing in Residential Electrification

This working paper examines the objectives and implementation of utility rates, while exploring how mispricing energy can affect incentives for residential electrification.



Dec. 1, 2021


Working Paper

Reading time

2 minutes


Within most developed economies, the general blueprint for reducing greenhouse gas emissions involves decarbonizing the electric sector, followed by significant transitions to electricity within the transportation, commercial, and residential sectors. Recent trends summarized in Figure 1 reveal how early in this process the United States is. Overall US greenhouse gas (GHG) emissions declined from 5,631 mmTons in 2010 to 5,298 in 2018 despite a decade of economic growth. However, this drop of 333 mmTons reflected a nearly 500 mmTon/year decline in the electric sector partially offset by increases in all other major sectors, including the residential (958 to 1,007) and transportation (1,874 to 1,935) sectors.

Substantial progress has been made in electricity, and the combination of rapidly increasing renewable generation and looming retirements of substantial coal generation capacity suggest this will continue, if not accelerate. The GHG growth in all other sectors during the 2010s indicates just how important decarbonization in these sectors will be to accelerate declines in overall emissions. In this paper, we focus on two of these sectors: residential transportation (i.e., light-duty vehicles) and direct residential emissions. Unlike the decarbonization of electric generation, decarbonizing these sectors will require decisions by millions of individual consumers, who will in turn need to commit to newer technologies capable of providing services powered by electricity. There are a myriad of factors driving such choices, including the relative convenience of using the new technologies, the potential need for upgrading household electrical systems, and the relative costs of the new appliances or vehicles. Another factor is the age of these durable goods. Residential furnaces and water heaters can last more than 20 years, yet according to the Residential Energy Consumption Survey, over two-thirds of these appliances are currently less than 15 years old (Figure 2).

One other fundamental factor is the costs of powering an electric vehicle (EV) or appliance relative to their conventional counterparts. While electric vehicles and appliances have been touted as significantly less expensive to use, this is not the case in all locations or circumstances. In a survey of the current electrification landscape, Davis (2021) shows that electricity price relative to other energy sources is the key consideration in consumer choices regarding space heating. Consumer acceptance of electric appliances will be impaired if they are only modestly less expensive, let alone more expensive, to use than their conventional counterparts, given the other challenges confronting a transition to electrification. This challenge is even more daunting when one considers how local environmental and utility regulatory policies affect energy prices. In the next two sections of this paper we characterize the marginal retail prices of the key fuels—electricity, gasoline, and natural gas—relative to the social marginal costs of those fuels. One key takeaway is that gasoline is underpriced relative to its social marginal cost in nearly all of the United States, while electricity is highly overpriced in some of the most populous parts of the country. In section 4 we discuss why the price of electricity, and to a lesser extent natural gas, came to be so much higher than social marginal cost, while gasoline remains underpriced. The main point here is that traditional approaches to utility rate design have created large upward biases in utility prices. While the underpricing of environmental externalities somewhat offsets this upward bias, on both coasts of the United States the externality costs are not sufficient to offset regulatory rate distortions in electricity. In Section 5 we explore options for correcting this situation. Most options involve a rethinking of both the objectives and implementation of utility rate design. In Section 6, we explore how mispricing energy is likely to affect incentives for residential electrification. Section 7 concludes with a list of topics for future research raised by the issues and analysis discussed.

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