Progressive pricing of energy: a revolution?

Suggested in a previous article and listed among the proposals of the French Socialist Party, works on progressive energy rates have been initiated last month with a bill introduced by Members of Parliament François Brottes and Bruno Le Roux. Although the complexity of this issue would have rather called for an initiative from the government, François Brottes’s background, who has been a member of the National Observatory of Utility Services and co-writer of the Champsaur report on the organization of the electricity market, ensures to the proposal a high level of credibility and seriousness. At the same time – and the authors do not hide it –, the submitted mechanism is not “simple” and some explanations might therefore be useful to foster debates before discussions start at the Parliament.

Progressive energy pricing is, alongside with rent controls and possibly fuel price freezes, one of the aspects of the strategy implemented by the governing Socialist Party since last spring to limit the rise of “constrained expenditure”, i.e. the part of households’ budget which covers basic needs such as housing or heating and can hardly be compressed. This policy is a response to the increasing feeling in the French middle class that their purchasing power is declining, while incomes in real terms have not followed an obvious downward trend and the general level of prices has remained relatively stable (INSEE, 2007).

However, regulating energy prices is a difficult exercise due to the number of variables that enter into the equation. The example of car fuels recalls that energy prices depend, to various degrees, on exogeneous factors such as crude oil prices on world markets. Except by relinquishing significant fiscal revenues through a cut of excise taxes or through subsidies, the state cannot completely absorb these external shocks which in the end affect consumers. A second challenge is to conciliate the social dimension of energy with national objectives set in environmental matters and forecasted investment needs – two imperatives which imply price increases.

The authors of the bill do not deny this state of play and admit that “in the future, households will pay more for energy”, a “ineluctable” phenomenon which must not be impeded but “accompanied”. They also consider it may have a positive effect since higher tariffs should help decreasing energy consumption and thus “accelerating the energy transition”. The key question is therefore how to mitigate the consequences of this increase for the most vulnerable households.

In the lawmakers’ mind, progressive energy pricing is the solution. It would “take the form of a bonus-malus system” in which “big consumers will subsidy virtuous households’ consumption”. For every main house, a “normal” level of energy consumption will be calculated according to three criteria: the number of inhabitants, local climate and type of heating system. Below this threshold, energy will be cheaper than it is now, hence the bonus. Beyond, every additional kilowatt-hour will be charged at an extra rate which aims at discouraging “comfort” consumption and balancing the energy system.

An instrument with contradictory effects?

Several economists like Claude Crampes and Jean-Marie Lozachmeur (Le Monde, 11 September 2012) expressed their doubts about the viability of such a mechanism, arguing that it would not respect the rule of specificity. This principle of economic policy states that an instrument which attemps to solve two problems at the same time is likely to fail on both counts. In the case of progressive pricing, decreasing the price of basic consumption – a social measure – might lead to an increased consumption – in contradiction with the environmental objective. On the contrary, if the maluses work “too” well – in accordance with the goal of reducing consumption -, the system may lack means to finance the subsidised volume.

Nevertheless, a detailed analysis of the bill shows that its authors have integrated this hypothesis, but they have judged that the executive branch should be able to “ensure the financial balance of the plan” and to “adjust” it in case of undesired consequences. One may also question the reality of this so-called “rebound effect” - a concept which claims that energy consumption eventually rises when a household succeeds in saving energy through the acquisition of new equipment or when prices go down. Energy does certainly not belong to the category of pleasure purchases and the link between price and consumption (elasticity, in economic terms) is not as clear as for other goods. Would someone let the light switched on longer just because electricity has become cheaper?

A second objection raised by these economists concerns the relation between energy consumtion and income. While common sense would suggest that they grow in line – a richer household would possess more equipment goods and would hesitate less before turning on the heating, for instance -, Pascal Lorot (Le Figaro, 27 August 2012) claims that “no strong correlation has been found between income and energy consumption”. Claude Crampes and Jean-Marie Lozachmeur mention the case of “large families” and “unemployed people who spend a lot of time at home” and thus consume more energy though they are not always richer. Finally, “energy-wasting domestic appliances and badly insulated houses” hit above all the poorest.

How to finance the fix of energy leaks?

Here again, the lawmakers cannot be accused of neglectance as the text intends to set a “social rate” for families which live in energy-leaking homes. This temporary provision is to make the bridge until works of thermal insulation improvement can be realized. Energy suppliers will play in this regard a major role and will have the obligation to identify badly insulated houses and to alert the National Housing Agency (ANAH). This organism will be made in turn responsible for contacting landlords in order to help them in fixing houses. They will be incentivized to cooperate thanks to a provision of the bill which would allow tenants to “deduce from the rent the part of the bonus-malus caused by the weak insulation of the house”.

Yet all these ideas skip the question of costs. Although it is difficult to find precise data, improving the whole housing stock in France up to the standards set at the “Grenelle de l’environnement” is assessed to require several hundred billion euros. Even if this figure is expressed on an annual basis, it goes far beyond the actual capacities of the National Housing Agency and real estate owners’. Moreover, one must not forget the investments needed to modernize the grid – French power plants are coming to the end of their lifecycles and intermittent supplies coming from renewable energy sources involve changes in the system.

Nevertheless, in the rapporteurs’ mind, progressive energy pricing “is not to become a budgetary instrument”. In other words, it will not provide additional revenue compared with the current tarification mode. This loophole is justified by the authors on the assumption that energy production has attracted “overinvestments” and lower consumption will drive these needs down. They also expect from the government a report on how progressive pricing could be used to better manage consumption peaks and thus maybe reducing production costs – when demand is high, the last kilowatthours are more expensive to generate because they usually come in France from thermal power stations.

Dynamic pricing: an irrealistic solution so far

This is why the economists Claude Crampes et Jean-Marie Lozachmeur advocate a pricing system which would reflect in a more faithful way “the costs of energy supply”. Prices would then become dynamic to signal consumers that each kilowatthour is not produced at the same cost and in consequence, it would be more economical to turn on the washing machine at off-peak times when electricity is cheaper than when consumption is the highest at morning and evening. Certain energy suppliers have already introduced this type of differenciation.

The researchers’ response to the social dimension of this question would rely on “financial support” to poorer households so that they can decide by themselves on income arbitrages – do I let the heating turned on a bit longer tonight or do I go out to watch a movie ? –. This way, the government would lead itself its “income redistribution policy” instead of delegating this task to utilities.

This solution, appealing on the paper, has nonetheless some shortcomings because of the peculiarities of energy. Electricity is very difficult to store on a large scale and does not allow for a wide range of arbitrages in its use. We all need light at the same periods of the day, we turn on the heating system when we go back from work, we all more or less sleep at night… smoothing consumption peaks can therefore have only marginal results, at least for individual consumers. Moreover, in contrary to other goods whose prices are known when they consumed, dynamically-priced energy would not be transparent at all. Only the popularization of smart meters combined with the development of softwares able to communicate with every apparel at home could possibly make dynamic pricing realizable not only from a technical point of view, but also usable for an average citizen who does have the time to check the price of energy when pressing a switch.

Overall, despite an undoubted complexity, progressive pricing seems to be a balanced instrument that takes into account the tight social, economic and environmental constraints connected with energy issues. It is not trivial that China introduced this summer a comparable device and that Germany and Belgium consider the possiblity to do the same. In France, this experiment may in case of success be spread to other fields like water or energy consumption of the service sector. Its result is therefore crucial and this is why it is hoped that Members of Parliament will have very fruitful exchanges.