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Economic Currents

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Bringing together energy and climate change policy

We hear a lot about Hawaii’s Renewable Portfolio Standard (RPS) which requires 100% of the utilities’ net electricity sales to come from renewable sources by 2045. Subsidies, rapidly declining solar panel costs, and high electricity prices have led to the proliferation of distributed rooftop solar photovoltaic (PV). By the end of 2016, roughly 1 out of 7 occupied housing units on Oahu had a solar PV system (City and County of Honolulu, 2017; ACS, 2017). Integrating increasing amounts of intermittent renewable energy, including utility-scale solar and wind, presents a challenge for electricity grid operators since at any moment supply must equal demand. While it is easy to get wrapped up in how to enable more cost-effective renewable energy on an outdated grid, designed for centralized generation and a one-way flow of electricity, I’d like to step back for a moment and remind ourselves of the rationale for renewable energy policies to ensure we meet our policy objectives and, towards that end, are using the appropriate policy instruments.

Like the U.S., Hawaii relies heavily on fossil fuels to meet its electricity needs (see Figure 1 for Hawaii’s generation mix in 2016).1 Since fossil fuels are a depletable resource, the transition to renewable energy is theoretically inevitable absent any policy intervention. It is the speed of transition that is inefficient from a social perspective due to the presence of environmental externalities (Gillingham and Sweeney, 2010).2 The damages from greenhouse gas (GHG) emissions are spillover costs not reflected in current market prices for fossil fuels. As a result, there is both more fossil fuel consumption than socially optimal and the transition time to renewable energy is slower. Basic economics tells us that the best way to mitigate climate change is to “get prices right” by imposing a tax equal to the marginal damage cost of emissions or apply emissions trading.3 Such market-based incentives are less costly and allow for more flexibility than traditional command-and-control policies in which uniform standards (ambient, emissions, or technology) must be met by affected sources. The marginal damage cost of GHG emissions can be given by the "social cost" of carbon—the per unit present value of the total damages from carbon dioxide (CO2) emissions or alternatively the benefit from emissions abatement.

Figure 1. Hawaii’s Electricity Generation Portfolio, 2016.

Source: EIA, 2017.

Instead of a broad carbon tax, most of the focus in Hawaii has been on taxing the barrel of oil. This of course also discourages fossil fuel use; however, the barrel tax we have is quite modest so its major impact is as a source of funding. As only $1.05 per barrel is levied—and this excludes aviation fuel and fuel sold to a refiner—it does not capture the full externality cost. And the dirtiest fuel, coal, is also currently exempted.4 We also rely on policy instruments like the RPS or subsidies for renewable energy, which though they likely reduce carbon, not necessarily at least-cost.5 These policies were not founded on the basis of environmental impacts (namely climate change), but instead were primarily driven by affordability6 and a stronger local economy.7

To address climate change specifically, we have a separate policy, Act 234 (2007), which requires Hawaii to reduce its GHG emissions to 1990 levels by 2020. The statewide GHG limit is 13.66 million metric tons of carbon dioxide equivalent (MMTCO2e), excluding air transportation and international bunker fuel emissions and including carbon sinks. In response, GHG rules were established for the electricity sector in 2014; facilities emitting over 100,000 tons of CO2e per year (excluding municipal waste combustion operations and municipal solid waste landfills) are required to reduce emissions by 16% from 2010 levels in 2020. Partnering across the 20 affected facilities is allowed to achieve cost-effective emissions reduction.

Figure 2. GHG Emissions Inventory, 1990 and 2007.

Source: ICF, 2008.

Figure 2 shows Hawaii’s 1990 and 2007 GHG emissions inventory—the most recent inventory to date.8 It shows that the electricity sector produces approximately 30% of GHG emissions. Other sectors matter too, especially transportation. By focusing on economy-wide GHG emissions reduction, coupled with the appropriate policy instrument to meet the policy objective, not only will it encourage more renewable energy in the electricity sector, but it will also facilitate coordinated efforts in other sectors. For instance, ground transportation comprises many individual actors, which together account for 14-18% of emissions. It is also the fastest growing sector (38% increase between 1990 and 2007). Emissions from ground transportation have likely continued to increase despite increased fuel efficiency and the growth of electric vehicles (EVs) in recent years.9 This suggests that even if the electricity sector were to comply with or exceed the 16% reduction, the growth of ground transportation likely outpaces the decline in the electricity sector; without coordinated state action we may not meet Act 234.10

Climate change policy offers a potentially economy-wide approach that can align multiple policy goals—whether it is more affordable, locally produced electricity or the electrification of transportation. An economy-wide carbon tax also means that the same $/ton cost would be levied on gasoline. While there is a federal gasoline tax of 18.4 cents/gallon and a state gasoline tax of 16 cents/gallon (EIA, 2017), this does not necessarily amount to the full externality cost of pollution.11 With the proper price signals, getting more EVs on the road will happen without any other overarching goals or mandates in the transportation sector. Whereas federal Corporate Average Fuel Economy (CAFE) standards increase the fuel efficiency of new vehicles, they do not encourage people to drive less. A carbon tax would target both vehicle purchase and driving decisions for new and used vehicles. Moreover, a carbon tax offers the opportunity to address distributional impacts. Carbon taxes are perceived to be regressive because fuel comprises a greater share of spending for low-income households. However, mandates are more regressive than a revenue-neutral carbon tax which can redistribute revenues to taxpayers by cutting other taxes (e.g. payroll, personal income, and corporate taxes) or through direct payments (flat “check in the mail”).12

Lastly, a carbon tax would also address flaws in today’s current energy policies. For instance, the 100% RPS, as currently calculated, does not translate into Hawaii generating all its electricity from renewable sources since distributed rooftop PV is counted in the numerator (renewable generation) but not in the denominator (total electricity sales). As calculated, only electric utilities are subject to the law. The gas utility and other large commercial customers who install their own generators are not part of the picture, perhaps prompting large customers to switch to gas or defect from the grid entirely. Instead of devising an amended metric to close such loopholes,13 stronger GHG policy—a carbon tax to either complement or replace the RPS—would align statewide goals and avoid the consequences of any “leakage” across sectors.

A carbon tax could also help to make good on the goals of Hawaii’s energy efficiency portfolio standards (EEPS). In contrast to an RPS which targets the supply-side, the EEPS focuses on electricity consumption, calling for a 30% reduction by 2030, equivalent to 4,300 gigawatt hours based on a 2008 baseline forecast of electricity consumption in 2030. Measuring progress according to the design of the standard is extremely difficult without a “counterfactual”—that is, electricity consumption absent any energy efficiency savings. In addition, similar to CAFE standards in the transportation sector, some efficiency gains are offset by increased consumption (a rebound effect). There are also many individual actors, some regulated by the Public Utilities Commission, and others, unregulated. An economy-wide carbon tax would incent fossil fuel conservation by all. Note also the volumetric surcharge design to support energy efficiency programs currently presents regressive impacts.14

There’s a lot of background activity around compliance with Act 234 on the horizon with affected facilities submitting their updated emissions reductions plan and the DOH updating and developing GHG inventories and projections. As we move forward, we should consider not only working towards compliance in one year but in perpetuity. This blog post has highlighted the critical link between our broader energy goals and how climate change policy and its policy instruments can enable us to reach those objectives. Maybe Act 32 (2017), which commits Hawaii to meeting some of the principles and goals laid out in the Paris Accord, will be a way to keep us on track. But without any specifics as to how we are to achieve such reductions—through a carbon tax or otherwise—it is largely symbolic. It’s time for a comeback in energy and GHG policymaking.

- Sherilyn Wee 
UHERO Affiliated Researcher

UHERO BLOGS ARE CIRCULATED TO STIMULATE DISCUSSION AND CRITICAL COMMENT. THE VIEWS EXPRESSED ARE THOSE OF THE INDIVIDUAL AUTHORS.


1Though the composition of fossil fuels differs; in the U.S., natural gas and coal comprise roughly 30% each and nuclear, 20% in 2016 (EIA, 2017).

2Yet with technological advances and the discovery of new reserves, it could also be argued that the supply of fossil fuels are “nearly limitless.” In either case, without correcting for the market failure, the transition would be to slow to mitigate the impacts of climate change (Covert et al., 2016).

3For instance, the Regional Greenhouse Gas Initiative, is an electric sector cap-and-trade program between nine Northeastern States.

4See Act 73 (2010), Act 107 (2014), and Act 185 (2015).

5Emissions reduction depends on the generation source displaced and on increased consumption due to reduced prices. Murray et al. (2014) show tax credits have a small impact on GHG emissions, and in some cases, emissions increase. Palmer and Burtraw (2005) show that neither a production tax credit or an RPS leads to as high of and as cost-effective a reduction as a cap-and-trade program.

6Note low cost and renewable energy is often incorrectly regarded as synonymous; such treatment depends on context (e.g. PV versus non-PV customers) and the procurement of renewable energy sources (benefit from low-cost utility-scale renewables is shared amongst all customers). Also, if Oahu’s coal plant—the cheapest source of energy at around 3 cents/kWh—were to go offline (power purchase agreement to expire in 2022), energy costs would increase dramatically.

7See HB1464 (2009) and HB623 (2015).

8The Department of Health (DOH) is in the process of updating prior GHG inventories and developing new GHG inventories for 2015, 2016, and 2017.

9There are 6,490 EVs statewide, comprising less than 0.01% of all registered passenger vehicles as of October 2017 (DBEDT, 2017).

10Contrary to the Department of Health’s (2014) statement that “these rules will ensure that the state returns to 1990 GHG emission levels by 2020 as required under Act 234, 2007.”

11GHG emissions are a global pollutant and therefore global damages should be accounted for.

12See for example David and Knittel (2016) and Levinson (2016) on fuel economy standards.

13In the 2017 legislative session, the Department of Business Economic Development and Tourism (DBEDT) for the second time, proposed to amend the RPS calculation to correct for this error (see SB906, HB1040).

14As a per kWh charge, customers who are able to reduce or offset their energy use through energy efficiency and distributed PV pay a lower dollar amount than customers who do not have access to such technology. The expansion of distributed PV puts a greater burden on these (generally) lower-income customers.


The Role of Policy and Peers in EV Adoption

Electric vehicles (EVs) can be a cleaner means of transportation compared to cars with traditional gasoline engines. They have the added benefit of being able to provide support to the electric power grid—an increasingly important attribute in states like Hawaii with high levels of intermittent renewable energy. To achieve widespread deployment of EVs, we need to know why consumers choose to buy an EV rather than a traditional car. Towards this end, we have conducted two studies that evaluate the effects of state-level policy incentives in the United States and that estimate “spillover effects” from geographic peers in Hawaii who purchase EVs. Preliminary results are presented below.

State EV Policies

Though EV battery costs have fallen rapidly in the last several years, the upfront cost of EVs still remain a barrier to rapid adoption. States have implemented a range of policies to encourage consumers to purchase EVs—financial and otherwise—but it is unclear how effective these policies are at achieving additional EV uptake. We estimate the effect of policy on EV adoption using semi-annual new vehicle registrations by EV model from 2010 to 2015 and a rich dataset of consumer-oriented state-level policies designed to promote EV purchases. We focus our policy analysis on EV vehicle purchase incentives and a range of other policies like home charge subsidies, reduced vehicle license taxes or registration fees, time-of-use rates, emissions inspection exemptions, high occupancy vehicle lane exemptions, designated and free parking, and an annual EV fee (that discourages EV purchase). As a rough indicator capturing the overall number of policies that states have used to incentivize consumer EV adoption, we add the number of policies up by state, illustrated in Figure 1. We separate the “policy index” (ranging from 0 to 9) by battery electric vehicles (BEVs) and plug-in hybrid electric vehicles (PHEVs) and show how it has changed over time (as shown in Figure 1 for the second half of 2011, 2013, 2015). Overall, there are more BEV policies, where California and Arizona are leaders in the number of EV policies adopted.

Figure 1. State Policy Index: BEVs (top) and PHEVs (bottom)


Our econometric estimates show that state policies positively impact EV adoption for both BEVs and PHEVs. The vehicle purchase incentive has a pronounced effect on BEV uptake. A $1,000 increase in the purchase incentive leads to an approximately 15% increase in sales of BEVs. We test these results by examining states that have ended large purchase subsidies, and find that BEV adoption declines. Other policies—aggregated together into a policy index—likewise increase EV uptake, though more so for PHEVs. This suggests that policies related to usage are perhaps more relevant for PHEVs. Each additional policy increases PHEV sales by 18%. The contrast between the effectiveness of different types of incentives for BEVs and PHEVs offers some guidance for policymakers evaluating current state policies or considering adopting new state EV policies. In sum, we find that state policies have driven additional EV uptake—extending EV purchases to consumers who would not have otherwise entered the market.

Geographic Peer Effects for Teslas

We also examine the role of geographic peers in EV uptake in Hawaii. Hawaii provides an excellent case for studying peer effects because it has strong EV adoption, the second highest amongst U.S. states in EVs per capita (IHS Markit, U.S. Census Bureau, 2010 – 2015). Although federal and state governments offer a variety of consumer incentives, the decision to adopt EVs may also extend beyond economic and policy motivations to include behavioral and social components. Social networks, also called “peer effects,” could have a potentially large influence on vehicle choice if people are influenced in their decision to adopt an EV by peer decisions to adopt EVs. Our second study examines peer effects defined by geographic networks, i.e., by visual observations of EVs registered in one’s neighborhood. Using zip code-level EV registration data from 2013-2016 for Hawaii, we exploit a three-month gap between adoption decisions and deliveries of Teslas to estimate presence and size of peer effects. Tesla EVs were important for reigniting interest in EVs more generally and amount to 13% of registered EVs on Maui, Oahu, and Hawaii Island. Our econometric analysis identifies statistically significant neighborhood effects. Figures 2 and 3 illustrate EV and Tesla uptake, respectively, by zipcode on Oahu, Maui, and Hawaii Island; Kauai is omitted due to data limitations.

Figure 2. EV Adoption on Oahu, Maui and Hawaii Island

 

Figure 3. Tesla Adoption on Oahu, Maui and Hawaii Island

We find that geographic-based peer effects generate one additional Tesla sale for every 26 Teslas sold in a zip code. How meaningful the magnitude of these peer effects may be is likely contextual. If for example policy focused specifically on marketing to peers and social networks, this may not provide much gain. However, as a pure spillover effect, peer effects can be meaningful. If, for example, Hawaii were to offer a second round of vehicle purchase subsidies, the peer multiplier effect estimated in our analysis would increase the additional Teslas purchased by 4-5% over each year of the vehicle’s life. As a lower bound, this amounts to roughly 1 additional Tesla per zipcode as a result of peer effects. One note of caution: whether the peer multiplier for Teslas—a very high-end vehicle—will translate as the peer multiplier for other lower-priced EVs, such as the Nissan Leaf or Chevy Volt, remains an open question.

- Sherilyn Wee, Makena Coffman and Sumner LaCroix


References

IHS Markit. (2016). Dataset of New Vehicle Registrations by state 2010-2015.

U.S. Census Bureau. (2010-2015). 2010-2015 American Community Survey 1-Year Population Estimates.


Michael Roberts Receives Agricultural & Applied Economics Association’s Quality of Research Discovery Award

UHERO congratulates Michael Roberts, recipient of the Agricultural & Applied Economics Association’s Quality of Research Discovery Award for his article, "Who Really Benefits from Agricultural Subsidies? Evidence from Field-level Data." Michael will be recognized during the AAEA 2017 Annual Meeting this summer in Chicago.

Michael Roberts is a UHERO Research Fellow, Professor of Economics and co-founder of UHERO's Energy Policy and Planning Group


Sherilyn Wee recognized as Outstanding Student of the Year by the U.S. Department of Transportation

Sherilyn Wee at the UTC Awards Banquet January 7 in Washington D.C. with keynote speaker, Dr. Beverly Scott, CEO of Beverly Scott and Associates.

UHERO congratulates Sherilyn Wee on receiving an Outstanding Student of the Year award, presented by the U.S. Department of Transportation (DOT). Sherilyn was recognized in Washington D.C. for her contribution to the transportation field through her research and leadership with the Electric Vehicle Transportation Center. For 26 years, the University Transportation Centers (UTC) Program, under the management of the U.S. DOT's Office of the Assistant Secretary for Research and Technology, has advanced U.S. technology and expertise in transportation through education, research, and technology transfer.

Sherilyn Wee is a postdoctoral researcher and former graduate research assistant at UHERO. She holds a Ph.D. in Economics from the University of Hawaii.


What a Difference a Rate Makes

UHERO’s Energy Planning and Policy Group has been writing about how variable pricing of electricity, both wholesale and retail, can lower the cost of intermittent renewables. Get the rates right, and facilitate easy open-access to the grid for both buyers and sellers, and amazing things can happen. The idea is that variable rates will encourage households and businesses to shift electricity demand toward intermittent supply, and facilitate creative, low-cost storage of power, all of which would enable cheaper, faster growth of renewables.

Hawaiian Electric Industries (HEI) seems to be moving in this direction. With the right incentives they might move quicker. Unfortunately, the utility has little incentive to implement variable pricing, except to please the Public Utilities Commission (PUC), since these adjustments might do for free what otherwise requires investment in batteries, new power plants and other grid upgrades. Under current regulations HEI grows its profits by maximizing investment, regardless of whether or not those investments are cost effective.

But here I’d like to focus on another rate that can make a big difference in the cost of renewable energy: the interest rate used to finance capital investment. It’s a good time to write about this little detail as the PUC, Consumer Advocate, legislators and others pour over HEI’s latest, more comprehensive revision of the Power Supply Improvement Plan, or PSIP. While there’s lots to study and think about here—all 1200 pages of it—the interest rate assumptions strike me as, well, high. And I wonder if these could be a key factor underlying some differences between HEI’s plan and our own Matthias Fripp’s plan. The plan also includes off-shore wind, which at a cost of about $4/Watt, may be an economic part of the portfolio—it will be good to incorporate this possibility into Fripp’s planning model.

Table 1. Hawaiian Electric Industries assumed cost of capital in the PSIP (p. J-4)

  Capital Source Weight Rate
  Short Term Debt 3.0% 4.0%
  Long Term Debt 39% 7.0%
  Hybrids 0.0% 6.5%
  Preferred Stock 1.0% 6.5%
  Common Stock 57% 11.0%
  Composite Weighted Average   9.185%
  After-Tax Composite Weighted Average   8.076%

 

Here’s the crux: interest rates have been trending down for the last 35 years, and sit near all time lows today. And there’s little hint in market data that they’re likely to go up much soon. Yet, in the midst of these low rates, HEI’s new PSIP uses rates that were typical for utilities some 20 years ago.

 

HEI’s assumed cost of capital is comprised of 57% equity, for which they claim a cost of 11%, which exceeds rates that many public utility commissions complained about as early as 2004, when market interest rates were much higher than they are today. Expectations for future rates of return on equities are smaller today than they were ten or twenty years ago, and utilities tend to have lower-than-average rates of return because they are considered safe, since returns are all-but-guaranteed by the government. Rates for debt also appear roughly 20 years old. Today, typical rates on corporate “a” bonds, a conservative rating for utility investments, are less than 3 percent on average, and barely over 4% for long-term issues. HEI assumes 7% for long-term debt, which is assumed to comprise 39% of capital costs. The return rate for equity is a policy decision, but it stands to reason that rates ought to follow market rates, which have come down 3-4 percent since 10% was typical.

Clearly, higher overall interest rates would imply higher overall generation costs and higher rates for customers. But the rate also influences the cost-effectiveness of different generation mixes. For wind and solar, nearly all costs are for up-front capital. Conversely, for traditional power generation (oil, coal, natural gas and biofuels), fuel and operation costs generally comprise a larger share of cost than generating equipment. Higher rates therefore favor traditional generation.

Another more subtle consideration is that solar and wind investments have lower risk premiums than traditional fuel-based generation. The reason is that solar and wind pay a higher dividend if fuel prices spike, which is just the opposite of traditional fuel-based generation. This means solar and wind can do more to reduce risk from the larger investment portfolios of typical equity shareholders, and should therefore have a somewhat lower cost of capital.

The upshot of all this is that the high rates used in the PSIP artificially make natural gas and biofuels more attractive from a cost perspective than solar or wind, and generally cause the projected path of customer rates to be higher than they need to be. Two or three percentage points can make a really big difference, as any homeowner with a mortgage can tell you. You can also get a sense of the magnitudes by playing with our solar calculator (now mostly obsolete due to the end of net metering).

We shouldn’t blame HEI for doing what they can to negotiate rates up, for the rate on equity, and the share of capital they finance with equity, is their main channel for growing profits. HEI has a legal obligation to its shareholders to seek to maximize profits, which the new PSIP does skillfully. It’s even better for them if higher rates causes capital investments better-suited to HEI (like developing a new traditional power plant, or retrofitting an old one) to be more attractive than those best suited to a third-party provider. And making the rate for debt similarly high may help to obscure the fact that the equity rate is so high. The problem with cost-of-capital rates falling much less than market interest rates is not unique to Hawaii, although the PSIP rates still appear higher than typical. 

As I’ve argued earlier, regulatory incentives could be changed such that HEI would have an incentive to find the most inexpensive and cost-appropriate capital possible and implement variable rates. This could also help HEI align its profit-oriented goals with the state’s affordable, renewable energy goals. The trick is to divorce their profits from the size of their own capital investments, and instead link profits to improvements in overall cost efficiency of the system, including distributed energy. Other states are also flirting with different incentives for utilities. Finally, build renewable energy goals directly into the cost structure by taxing fossil fuels and/or subsidizing renewables, regardless of source. This approach is one option for a “new business model” that many vaguely refer to.

Other models could work too. I gather that many see these high rates and conclude that a government municipality or cooperative, which would have considerably lower capital costs, as the answer. But it’s important to keep in mind that these alternative structures have incentive problems too. Another option would be to replace HEI with an Independent Service Operator, or ISO. I’m still learning sbout ISOs, but think the model could hold a lot of promise for Hawaii. I’ll have more on ISOs in another post.

Today’s low interest rates, combined with remarkable technological advance in renewable energy, creates what could be an amazing opportunity for Hawaii. It’s conceivable to me that we could transition toward 100% renewable faster than many currently believe. Maybe not in Dinah Washington’s 24 little hours, but soon enough. But to do it, and do it cost effectively, means getting the rates right.

- Michael Roberts


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