The energy transition in your electricity bill

Many countries are revamping electricity-pricing systems to guarantee fixed-cost recovery, often by raising the fixed charge of two-part tariff schemes. The article “Major Reforms in Electricity Pricing: Evidence from a Quasi-Experiment“, co-authored by our researcher Jordi Teixidó and published in the scientific journal “The Economic Journal”, finds robust evidence that consumers fail to distinguish between fixed and marginal costs. After conducting a quasi-experiment with data from a major electricity price reform recently implemented in Spain, the authors concluded that policymakers are not achieving the goal of cost recovery.

We interviewed our researcher Jordi Teixidó on the rising of the electricity price in Spain in the recent months.

Why is the price of electricity going up? What do we learn from your research in this matter?

Our electricity bill is composed by two main parts. The first one is related to the energy cost: the more kWh we consume, the more expensive these are, the more we pay. The second part, however, is related to the contracted power (kW) and it is independent on how much electricity we consume; it is therefore a fixed charge that is usually more prone to governments’ regulations and hence might be more constant.

Our paper deals instead with the effects of a rise in the fixed component of the electricity bill. We are interested in studying the behaviour of households when they face increases in their electricity bill because of the fixed charge. If there is an increase in the cost of energy, the expectation is clear: people will try to use less electricity. But when the increase is in the fixed part this is less straightforward and may imply critical consequences, particularly relevant nowadays.

Why does it matter which part of the electricity bill increases its price?  

Because the very existence of fixed charge in your electricity bill responds to the need of covering the industry fixed costs (as the cost of energy is already covered with the energy component). Now we are facing an energy transition that requires more investments to include more renewable energy sources into the electricity grid. This requires investments that lead to an increase in the fixed costs of the sector. So far, these fixed costs have been covered with markups on the energy component, however, the need of those investments together with the general trend of using less electricity (because of more efficient appliances or the use of LEDs instead of light bulbs, etc), this coverage was at stake: markups did not make any more to cover fixed costs.

Accordingly, Spain, back in 2013, increased the fixed charge in the electricity bill to raise revenues and cover such increasing fixed costs (many other countries did the same or plan to do so). At the same time, the cost of energy (1st component) was reduced due to both the cost of energy and some regulated parts of the price in kWh. The result of it was a reform consisting in an increase in the fixed charge combined with a decrease in the energy component from which the government expected to increase revenues to better face the energy transition. However, we see that it did not work as expected.

By exploiting this reform, we design a natural experiment strategy that allows us to estimate the counterfactual scenario: a world where the government does not implement the reform. We see that the government would have raised more revenue without raising the fixed part of the electricity bill. Households responded to the overall reform with a further reduction of consumption that resulted in a further reduction of revenues to deal with energy transition.

This is important because proves that households do not distinguish between fixed and marginal costs. The main lesson we get from this, is that households may not respond to price signals as policy makers may expect them to, at least not as far as the electricity bill is concerned, which happens to be one of the prices more heavily regulated and with remarkable impacts on our climate action. Then, in the top of this we may also have important inequities at play here that need to be dealt with.

Which kind of inequalities?

The share of electricity expenditure on total household expenditure is much higher for poorer households than for richer households. Therefore, any increase in the electricity bill, especially if this is a fixed charge, will be regressive.

Besides, households can react to a rise in electricity pricing differently: from switching off lights more often when not using a room or by getting a new and more efficient fridge. It depends on ones’ income, and this is what we find: potentially richer households can reduce more their expenditure in their electricity bills after the reform.

Richer households not only have more money to invest in the new fridge, but they may also have better information and more room to adapt. In this regard, we find that those who reduced more their electricity bill as a response to the reform were the ones that had higher consumption levels. These households had spare capacity to reduce their consumption. However, when you are already consuming the minimum electricity in accordance with your most basic needs and you already switch-off lights when no using a room and, of course, do not have the money to buy the new fridge, you cannot further reduce your electricity bill. We find that households with the lowest consumption profiles were the only ones that were not able to reduce their electricity expenditure as response to the reform.

Inequities in energy transition need to be in the centre of the overall picture of today’s climate policies: we are just starting to understand as a society that beyond climate change consequences (more episodes of drought, flooding, or heat waves), we will also need to deal with higher energy costs; and this, unless properly addressed, will amplify current inequalities even further.

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