Headwinds and Tailwinds: Implications of Inefficient Retail Energy Pricing for Energy Substitution
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Electrification of transportation and buildings to reduce greenhouse gas (GHG) emissions requires massive switching from natural gas and refined petroleum products. All three end-use energy sources are mispriced due in part to the unpriced pollution they emit. Natural gas and electricity utilities also face the classic natural monopoly challenge of recovering fixed costs while maintaining efficient pricing. We study the magnitude of these distortions for electricity, natural gas, and gasoline purchased by residential customers across the continental US. We find that the net distortion in pricing electricity is much greater than for natural gas or gasoline. Residential customers in much of the country face electricity prices that are well above social marginal cost (private marginal cost plus unpriced externalities), while in some areas with large shares of coal-fired generation, prices are below SMC. Combining our estimates of marginal price and SMC for each of the fuels with a large survey of California households' energy use, we calculate the distribution of annual fuel costs for space heating, water heating, and electric vehicles under actual pricing versus setting price at SMC. We find that moving prices for all three fuels to equal their SMC would significantly increase the incentive for Californians to switch to electricity for these energy services.
For outstanding research assistance and very helpful comments, we thank Sara Johns, Jenya Kahn-Lang and Dan Mazzone. For valuable comments and discussions, we thank Mohit Chhabra, Alejandra Meija Cunningham, Lucas Davis, Tatyana Deryugina, Ari Gold-Parker, Catherine Hausman, Matthew Kotchen, Matthew Lewis, Amber Mahone, Erin Mansur, Nicholas Muller, Allison Seel, James Stock, and participants in presentations at The Energy Institute at Haas-UC Berkeley and the 3rd Annual National Bureau of Economic Research Conference on Environmental and Energy Policy and the Economy. We also thank Catherine Hausman and Matthew Lewis for sharing data. This research was supported in part by a grant from the California Public Utilities Commission to the Energy Institute at Haas. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.