Response to Extreme Energy Price Changes: Evidence from Ukraine.

AuthorAlberini, Anna
PositionReport - Statistical table
  1. INTRODUCTION

    The response to energy price changes--summarized into the price elasticity of demand--is key to understanding the effectiveness of a number of policies meant to moderate demand, shed peak load, encourage consumers to adopt energy efficiency equipment, and hence reduce emissions of C[O.sub.2] and other pollutants. Estimating the price elasticity of demand requires datasets with sufficient cross-sectional or longitudinal variation in prices, and generally presumes that users know the prices they are faced with.

    In earlier literature, extreme price changes have been studied, for example, in Herter and Wayland (2010), Wolak (2011), Jessoe and Rapson (2014) and Bell and Blundell (2016). In these cases, however, the extreme price changes were temporary and infrequent (5-15 times a summer), and were experienced during either pilot or broad-based critical peak pricing programs.

    But what happens when the extreme price changes are permanent? This is what we set out to explore using residential energy consumption records from a sample of households in Ukraine. In our analysis, we examine whether the response to such changes is complicated or otherwise altered by consumers' imperfect knowledge of their consumption level, energy expenditure, or prices.

    That consumers may find it onerous to process complicated pricing systems or kinked budget constraints has been observed in other utilities-related contexts (e.g., Hortacsu et al., 2017) and in the taxation literature (Liebman and Zeckhauser, 2004), where this may lead to inertia or to the development of simplifying heuristics ("schmeduling"). Shin (1985) argues that consumers may have limited ability to process block tariff schemes and/or seasonal tariff changes, and for that reason may rely on the average price paid instead of basing consumption decisions on the marginal price. Borenstein (2009) derives the consumption patterns that can be expected under block pricing and Ito (2014) finds empirical evidence that households in California respond to average price rather than marginal block price.

    McRae and Meeks (2016) document households' difficulty with computing bills and recognizing the correct marginal price at large levels of consumption after a tariff reform in Kyrgyzstan that replaced uniform pricing with increasing block rates. Consumption adjustment after the reform was more pronounced for households with a better understanding of the price schedule, with the effect being the strongest for low-tier consumers who were "inattentive" (i.e., did not correctly perceive the block that their usage levels fell in).

    Kahn and Wolak (2013) conduct an experiment where residential electricity customers in California receive an on-line education course about the nature of increasing block pricing, and find that, even with no price changes, the provision of information is sufficient to trigger a behavioral response: Households who learn that high consumption leads to high marginal prices reduce consumption, while those who learn that they face low marginal prices increase consumption. The overall effect is a 1.5-3% reduction in electricity usage.

    In this paper, we seek to estimate the price elasticity of residential energy demand in a setting with extreme price changes--Ukraine over the last 3-4 years. As a consequence of conflict with Russia, its main supplier of natural gas, natural gas prices for residential and manufacturing customers alike increased by almost 300% over a very short period of time. Electricity prices rose quickly too, as coal supplies fell under the control of Russian supporters and the government agreed to meet demands by the International Monetary Fund. The tariff hikes were blamed for impoverishing people, causing loss of competitiveness in the manufacturing sector, and even closing energy-intensive plants. (1) Some observers note that the price increases are implicitly removing the inefficient system of energy subsidies in Ukraine (Rozwalka and Tordengren, 2016), which has one of the highest rates of C[O.sub.2] emissions per unit of GDP in the world (International Energy Agency, 2016).

    We exploit variation in tariffs over time and across customers to estimate the price elasticity of electricity using a panel dataset that documents monthly meter readings from households in the city of Uzhhorod in Ukraine over about three years. (2) We ask three research questions. First, what is the price elasticity of consumption implicit in the response (if any) to electricity price changes? At least in the short run, residential electricity demand is usually thought to be relatively inelastic with respect to price, although a recent review (Miller and Alberini, 2016) uncovers a wide range of empirical estimates. We expect households in Ukraine to use minimal amounts of electricity, since their homes, stock of appliances and incomes are generally smaller than in Western Europe or the US. But since they experienced large tariff increases, might one expect to observe large changes in consumption?

    Second, is there evidence of heterogeneity in the price elasticity of electricity demand driven by dwelling or household characteristics, or by consumer recall of own bills and/or consumption levels? Third, how quickly do households adjust their consumption after a price change?

    Briefly, histograms of the monthly usage records suggest that our Ukrainian consumers were aware of the increasing block pricing system and responded to marginal prices, with bunching observed at the current as well as future block cutoffs.

    We find that the short-run price elasticity of electricity consumption is approximately -0.2 to -0.5, depending on the subsample of households included in the estimation sample, with the bulk of our estimates around -0.3. The elasticity becomes up to 50% more pronounced over the first few months since a price change.

    Persons who are quantity-attentive (have a good grasp of their consumption in physical units) appear to have somewhat a more elastic demand for electricity, even though they don't differ from the rest of the sample in terms of most dwelling and household characteristics and mode of bill payment, and even if they actually use less electricity than the others to start with. Those who are bill-attentive (recall their recent bills correctly) are similar in their responsiveness to price to those are not bill-attentive. Persons who are both quantity- and bill-attentive display a price elasticity of -0.56, but this finding should be interpreted with caution due to the small number of respondents in this group. Only about 15% of the respondents indicated that they did not know the tariffs they were currently paying; dropping them from the sample or, conversely, limiting the sample exclusively to this group has little effect on the price elasticity. In sum, even accounting for attentiveness and awareness of tariffs, the estimated price elasticity remains within a narrow range. This is in sharp contrast with McRae and Meeks (2016), who report price elasticities ranging from -1.20 to -0.24, and likely due to the options available to consumers: Electric heat is used by only 16% of the sample, and no one appears to have switched away from it during our study period, presumably because of the constraints imposed by the existing infrastructure (e.g., no connection to the gas lines).

    The remainder of this paper is organized as follows. We provide background information in section 2. Section 3 presents the data collection and section 4 the econometric models. Section 5 describes the data and section 6 the results. Section 7 concludes.

  2. BACKGROUND

    As in many other former Soviet Republics, in Ukraine electricity is generated and supplied to industrial, commercial and residential customers by state-owned companies. Tariffs are set by an independent regulator (INOGATE, 2015).

    From 2006 to the end of January 2011, residential electricity customers paid a uniform price of 24.36 UAH cents for each kWh consumed. Increasing block rates (IBR) were first introduced on February 1, 2011, in part to help cover the increasing costs of generation, which had been adversely impacted by the 2006 natural gas supply disruption from Russia. The early IBR system was comprised of only two blocks. Within the first 150 kWh/month, residential customers paid the same price per unit as before (24.36 UAH cents/kWh), and for every kWh in excess of 150 kWh the price was 31.48 UAH cents/kWh (raised to 28.02 and 36.68 UAH cents/kWh, respectively, in April 2011).

    The three-block system was first introduced in May 2012. The marginal block rates were the same as before, but for each unit in excess of 800 kWh/month customers would pay 54.72 UAH cents/kWh. The price in the third tier was almost doubled to 96.76 UAH cents/kWh in July 2012.

    By the beginning of our study period, which spans from January 2013 to April 2016, residential customers had thus had plenty of time to get accustomed to the IBR system, and some experience with large price increases, although the most pronounced one (that of July 2012) was presumably experienced only by a small share of the households.

    Table 1 displays the electricity tariffs for the Uzhhorod region from 2012 to 2016. (3) Ukraine has one-part tariffs for gas and electricity, with no fixed fee and increasing block pricing. The tariffs are set by a government agency and the same tariff scheme applies to everyone. In other words, consumer do not select into supply plans as they might in the US or other countries, and the tariffs are exogenous to the single consumer.

    During our study period (January 2013 to April 2016), electricity prices rose several times: In the lowest tier, for example, the nominal tariffs doubled over this period. The most significant price increases took place in 2015-16. The structure of the blocks was also changed during this period, with the cutoff between the first and the second tier lowered from 150 to 100 kWh per...

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