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California was the first state in the US to move ahead with full-scale deployment of smart meters.  That decision can be traced back to the energy crisis of 2000-01 which analysts showed was caused in part by the failure to transmit dynamic pricing signals to retail customers. 

In response, the California Public Utilities Commission (CPUC) held evidentiary hearings into policies to promote advanced metering, demand response and dynamic pricing.  To fill a much needed gap in knowledge, it authorized a two-year long pilot with dynamic pricing involving a random sample of some 2,500 residential and small commercial and industrial customers of the state’s three investor-owned utilities.

Each of the utilities filed a business case for the deployment of advanced metering infrastructure (AMI) based on a combination of demand response benefits, which were anchored around the findings of the dynamic pricing pilot, and operational benefits in distribution.  The CPUC approved all three business cases and meter deployment began at a rapid pace, hitting rates of 18,000 meter installs per day.

All was going well until another crisis erupted last autumn in the southern central valley town of Bakersfield.  Some residents who were served by Pacific Gas & Electric Company complained that the smart meters were doubling and tripling their energy bills.  Town hall meetings, encouraged in party by criticisms that were voiced by a state senator, were held in Bakersfield and in Fresno, a town further up the valley.  The senator called officials of both the utility and the CPUC to task and called for an independent inquiry to be held (which has recently been initiated).

In December, the New York Times carried an article entitled, “Smart Electric Utility Meters, Intended to Create Savings, Instead Prompt Revolt.” This was widely cited in the industry.  And more recently, Christine Hertzog posted an article on the Energy Collective website with the provocative title, “Is PG&E killing the smart grid?” [].

Ms. Hertzog’s article did not dwell on the Bakersfield problem.  It also criticized PG&E’s attempts to alleviate the problem by asking permission from the CPUC to replace its five-tiered inverted rate schedule with a three-tiered inverted tier rate schedule.  She stated, “The proposed flattening of this program rewards electricity guzzlers at the expense of energy-conscious consumers.  It is akin to asking drivers of gas-sipping cars to subsidize the gas for Hummers.  Solar companies are already on record stating that this tariff change, if approved by the California Public Utilities Commission, would remove financial incentives for many homeowners to add solar generation and thereby defeat two key Smart Grid objectives – increased renewable energy and more active consumer participation.”

PG&E’s rate design reform proposal also received extensive coverage in the print media.  It was praised by a leading daily that serves the warmer climates in the east bay as a long overdue reform while it was panned by a daily that serves San Francisco as being anti-conservation. 

The rate design proposal also came under fire from the solar lobby and from low income advocates (who have steadfastly opposed smart meters).  Why are these disparate groups united in their opposition?  Simply put, they are concerned that the subsidies they have been getting from years are about to be reduced or eliminated.

Their arguments to preserve the five tiered rates would have merit if those rates were based on PG&E’s marginal costs.  But they are not.   The five-tiered rate design is the unintended consequence of a law that was passed by the state assembly during the height of the energy crisis, Assembly Bill 1X.  That law froze the rates on the first two tiers for as long as it took to pay off the bonds that the state through its Department of Water Resources had sold to pay off the costs of the crisis.  It guaranteed that subsequent inflation in energy costs would have to be recovered from customers who consumed in the upper tiers (three to five). 

The first tier was the price that customers would pay for buying a “baseline” amount of power.  This amount varied with climate.  The second tier applied to the next 30 percent of usage.  The third tier applied to usage above the second tier but less than 200 percent of baseline.  The fourth tier applied to usage above 200 percent and below 300 percent while the fifth tier applied to usage above 300 percent.

The fifth tier rate is now around 50 cents per kWh which has to be the most precious price that one has to pay for a unit of electricity anywhere in the US.  Under PG&E’s proposal, a new third tier that would be created that covers all usage that now lies in tiers three, four and five.  The new third tier price will be 29.8 cents per kWh.  Contrary to the view being espoused that the new rates will be anti-conservation, they will provide plenty of incentive for energy efficiency since the second tier rate is under 13 cents per kWh and the new third tier will represent a doubling of price.

Before the energy crisis, PG&E had a two-tiered inclining block rates.  This was intended to provide an incentive for energy efficiency and was based on marginal cost studies.  The rise in prices between the lower and upper tiers was less than 20 percent. 

When the five tiered rate was introduced in 2001, the rise in prices between the first and fifth tiers rose to an astonishing 100 percent.  Now it stands at nearly 500 percent.  Not only does this have no relationship to marginal costs, it creates a grossly unfair system of subsidies where users in the first two tiers are subsidized heavily by users in the upper tiers. 

Of course, given the nature of rate of return regulation, PG&E will still get the same total revenue from its customers, whether they are on a five-tiered or a three-tiered rate design.  The issue is cross-subsidies between customers, not cross-subsidies between the utility and its customers.   

As for solar installations, it is true that many developers and customers invested in roof-top photovoltaic systems on the assumption that fifth tier rates would continue to rise as they have done in the past decade.  But just because uneconomic solar investments were made in the past is no reason to ask for their continuance.

In summary, the five tiered rate has no basis in marginal costs and should not be used as a guide to making long-term investments.  It is bad economics and bad politics.  Indeed, it is one of the factors that contributed to the Bakersfield problem.  Weather in July 2009 was a lot warmer than weather in July 2008.  That pushed up usage, especially for customers in upper tiers.  A rate increase earlier in the year of 8 percent was pushed entirely into the upper tiers due to the freeze on the first two tiers.  It is not surprising that bills went up dramatically for some customers who, without the benefit of any analysis, blamed it on one thing they knew had changed: their electric meter.  This is another instance of the “Post hoc, ergo propter hoc fallacy.”


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