The Persistence of Volumetric Pricing

Abstract

How to recover the costs of electricity distribution has become a prominent and controversial issue in the wake of California Public Utilities Commission proposals to reform compensation for solar electricity homeowners who sell into the grid, with subsequent proposals to recover more of the distribution costs through fixed charges based on household income. This debate raises questions about the ubiquity of volumetric pricing for fixed-cost recovery in regulated industries. Ideal cost recovery entails marginal cost pricing of kilowatt-hours delivered, per-user connections, and capacity needed to handle coincident peak use. Remaining uncovered costs of distribution should be recovered by fixed charges. Equity and efficiency considerations suggest assigning fixed charges on the basis of willingness to pay or income, although neither is perfect. Nevertheless, volumetric recovery of fixed costs has persisted for several reasons: mistaken analogies to competitive markets, simplicity, network effects, incumbent resistance, and fairness and rights. Getting pricing right matters not just for general efficiency but also to remove pricing barriers to decarbonization. For this reason, electricity regulators should consider recovering more fixed costs through fixed charges.