Electricity Tariff Rebalancing in Emerging Countries: The Efficiency-equity Tradeof and Its Impact on Photovoltaic Distributed Generation.

AuthorHancevic, Pedro I.
  1. INTRODUCTION

Utilities such as electricity, natural gas, water, and sewage, present certain tensions in terms of economic efficiency, cost recovery requirements, distributional objectives (including access), and most recently, environmental and resource conservation goals. In most cases, multiple objectives need to be fulfilled using a reduced number of imperfect policy instruments and limited resources. From the point of view of economic efficiency, the marginal price that a user pays for one extra unit of the service must be equal to the marginal cost of supplying it. This simple theoretical precept may not be followed in practice when other objectives, such as better (re-)distribution of income or resource conservation, have a preponderant role in the consideration of policymakers and the society. This consideration goes beyond the natural monopoly characteristics of these markets. Hence, it is not surprising that residential rates typically distort consumption and investment choices. In addition, residential tariffs are sometimes subsidized--representing a heavy burden to the fiscal budget--and do not necessarily reflect well-targeted mechanisms to alleviate the less favored segments of the population.

In this study we examine the case of the residential electricity pricing in Mexico, but the empirical strategy used and the qualitative and, to some extent, quantitative results obtained are likely to be useful in other contexts, especially in emerging economies with a similar background.

Residential electricity users in Mexico afford an intricate increasing block tariff (IBT) that is based on the geographical location of households. Only a fraction of the system costs is recovered through volumetric charges--i.e., charges based on quantity consumed. No fixed charge exists even though a sizeable part of the system costs is fixed, at least in the short- to medium-run. Hence, residential users are highly subsidized and pay, on average, 46% of the total cost of the service--i.e., generation, transmission, distribution, and commercialization costs. (1) In practice, the Mexican IBT scheme constitutes a consumption subsidy that is received by approximately 98% of residential users across the country. As a result, the current financial situation of the state-owned utility, Comision Federal de Electricidad (CFE), represents a critical problem for the federal administration since the residential subsidy amounts to more than 0.4% of GDP. (2)

The IBT scheme set marginal prices that either exceed or fall short the social marginal costs, generating wrong consumption decisions and sizeable deadweight losses. In addition, artificially low or high energy rates distort long-run choices. It is therefore not surprising that the investment in energy efficiency, appliance replacement, and the adoption of green technologies such as distributed PV generation and storage systems, have moved slowly and in a suboptimal fashion (Davis et al., 2014; Hancevic et al., 2017; Hancevic and Lopez-Aguilar, 2019). The latter is remarkable since Mexico has an enormous potential for the development of PV technologies and only 0.6% of households have adopted rooftop solar panels according to the National Survey on Energy Consumption in Private Homes (ENCEVI-2018), conducted by INEGI. (3)

From an equity perspective, the use of consumption-based subsidies embedded in the IBT scheme is quite inefficient as an income redistribution device. Instead, well-targeted means tested mechanisms are always preferable, as long as administrative costs are reasonable (e.g. Angel-Urdinola and Wodon, 2007; Borenstein, 2012; Dahan and Nisan, 2007; Hancevic and Navajas, 2009; Lin and Chen, 2018). As stated before, the Mexican subsidy is received by virtually all households, independently of their wealth, income, or any other objective measure of living conditions. As a reference, total subsidy represented 18% of the total government expenditures in education, more than 40% of the resources allocated to public health, and 47% of those channeled to reduce poverty in 2018. This situation happens in a country where poverty represents approximately 44% according to the National Council for the Evaluation of Social Development Policy (CONEVAL).

All the issues described above deserve special attention and were not addressed in the celebrated energy reform of 2013. Most importantly, they have been systematically overlooked by policymakers during the last decade. Any policy decision might incur high political costs. In this paper we use an empirical approach to argue that the domestic electricity sector requires deep policy changes, including a complete revision of the tariff scheme towards economic efficiency, a deep cut in the residential subsidy, and a new mechanism to better target it to the less favored households. In doing so, we use micro-data at the household level and hourly industry data to simulate an alternative tariff scheme which combines a two-part tariff with a simulated means-tested mechanism. The proposed variable charges are based on, a priory, more efficient nodal prices and incorporate the externality costs of air pollution. The non-uniform fixed charges are reflective of households' total income--i.e., a valid proxy variable for the true willingness-to-pay. Since the proposed fixed charges do not depend upon observed consumption and because the marginal prices are set equal to the social marginal costs, the differences across users do not distort the electricity consumption choices. Finally, we present a concrete example that shows the undesired effects of electricity price distortions on investment decisions in the medium and long term. Using household data together with our simulated tariff schemes and customized PV system characteristics and prices, we simulate different adoption scenarios using a household optimization model. The simulated outcomes are also used to quantify the subsidy changes and the environmental impacts of the proposed policy reforms.

The remainder of this study is as follows. Section 2 provides an overview of the relevant literature. Section 3 analyzes the current situation of the Mexican residential electricity sector. We specially look at the tariff structure and the subsidy distribution. Section 4 uses microdata at the household level to analyze the effects of a tariff rebalacing policy that enhance economic efficiency and reduces the residential subsidy by 30%. As an example of the effects that distorted energy prices has on medium- to long-run investment choices, Section 5 simulates alternative scenarios of solar PV system adoption. One under the current IBT scheme, and another that incorporates the tariff rebalancing mentioned before. In the simulated scenarios we provide a complete distributional assessment and measure the effects on consumer welfare. We also compute the expected changes in government net revenues and the corresponding environmental impacts. Section 6 concludes the paper.

(2.) RELATED LITERATURE

This work fits in different areas of the literature. We can link all these areas answering the following questions: Why should we think of a two-part tariff combined with a means-testing scheme as a possible solution to the efficiency-equity tradeoff in an emerging country like Mexico? How would consumers react in terms of long-run investment decisions (e.g., adoption of rooftop solar panels and electric vehicles, or electric appliance replacement) if energy tariffs were adjusted in a more efficient way? How could the energy subsidy be reduced in such a way that mitigates the impact on the most disadvantaged groups? Many previous studies have assessed a variety of topics related to the residential energy sector. For instance, topics related to energy access, clean energy penetration, energy efficiency, energy conservation, affordability, and reliability (see, for example, Banal-Estanol et al., 2017; Fuente et al., 2016; Kessides et al., 2009; Winkler et al., 2011). Another branch of the literature deals with the measurement of the impact that changes in electricity rates have on adoption of electric vehicles, rooftop solar panels, appliance replacement, and energy efficiency investments (Hancevic et al., 2017; Hancevic and Lopez-Aguilar, 2019; Muratori et al., 2019, among many others). However, just a few recent works (e.g., Burger et al., 2020; McRae and Wolak, 2020) address several of these questions simultaneously. We build on this literature by proposing a two-part tariff scheme--tailored to an emerging economy like Mexico -- that targets economic efficiency, cost recovery requirements, distributional objectives, and environmental goals.

The first part of the two-part tariff scheme is a fixed charge. The volatility of energy costs during different hours and even minutes of a single day is really significant. It obeys to the fact that electricity is in practice a non-storable commodity so demand and supply must always be matched. Hence, changes in the generation mix, capacity constraints, and congestion in transmission lines and distribution networks play a very important role (see Schweppe et al., 2013). Ideally, electricity rates should follow a marginal pricing rule, but in practice, full cost recovery is not possible only relying on variable (i.e., marginal) charges (Joskow, 2008; Perez-Arriaga et al., 1996). As a result, fixed charges emerge as a solution to cover the residual costs. There are costs related to installing and maintaining the transmission lines and the grid, the metering infrastructure, processing bills, customer service, etc. Many of these costs are fixed with respect to the number of users served or the quantity consumed by them. Therefore, the fixed charge has its own merit to be part of a more efficient pricing scheme.

Historically, there have been many concerns regarding optimal pricing policies for natural monopolies and regulated utilities (e.g., Bohn et al., 1984...

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