Inflation - Energy - Utilities

I am writing this article to evoke thoughts and opinions about rising electricity bills and their impact on the economically disadvantaged (particularly during inflationary periods). Given electricity is a core-need in our daily lives, it can be argued that it becomes “Giffen-Goods” (“price-inelastic”) to the economically disadvantaged. With the push towards “electrification of everything”, this problem will only grow in the coming years.

There is a focus on inflation and interest rates these days. Inflation is the annual rate of price rise measured against a fixed basket of goods and services (retail, wholesale, commodity, energy, housing, etc.). Since it is an annualized percentage, its measure is an up-down trajectory. I have always viewed inflation only through the lens of a few key “human pain-points” (food, energy, housing) i.e. those if corrected, can enable a return to a normal daily life.

Governments manage inflation in a narrow band to provide economic stability. Developed countries aim for under 2% while developing countries aim for 4-5%. There are a variety of reasons for this differing approach, but a primary set of objectives is around price stability and fiscal balance. High inflation leads to erosion of purchasing power and to manage this price rise, a rise in wages often follows. Any imbalance in price vs. wage rise creates its own unstable secondary cycles. The irony is that inflation control rarely reverts prices to their pre-levels and establishes a new permanent higher-cost baseline. Hence in the long term, sustained inflation is harmful.

Interest rate (borrowing cost) is a policy instrument used to manage inflation. The interest rate determines a financial headwind (or tailwind) imposed to slow down (or accelerate) the borrowing of money. So, when inflation is high, interest rates rise to slowdown growth and vice versa. As governments wrestle inflation, the stickiness of higher prices remains. This stickiness is what hits the economically disadvantaged very disproportionately as they have no avenues to increase their wages (often the reverse as job loss occurs).?

Energy is a crucial contributor to overall inflation due to its pervasiveness in all aspects of our economy (electricity, transport-fuels, heating-fuels). Due to this, the entire value chain in each of our daily procurement streams (from raw materials-manufacture-transport-wholesale-retail) is affected by energy price rise. While most governments try their best to ensure energy prices are kept in check, it is not always possible due to international markets and hard-currency fuel imports. Herein lies the crux of the problem.

Electricity being a part of the energy bundle has a high economic impact. High electricity prices have a wide-ranging inflationary effect on all goods and services. It is said that a 1% increase in electricity price has a 3-5% inflationary effect on procured goods and services. Thus, electricity prices are an area of public contention. In such times, the public looks to its regulator as a “compassionate savior”. While higher retail electricity prices may be contributed by increased generation fuel costs, the public expects an offsetting “temporary reprieve” in the regulated T&D value chain to deal with affordability.

The question is whether such an “Economic Duress Rate Relief” (EDRR) can be enabled during difficult times. It would need a clear policy direction and an acceptable regulatory framework. The current Cost-of-Service regulation allows all legitimate and approved T&D costs to be rate based. So, any tinkering with this will create a long-term imbalance in revenue recognition and the financial structure for the utilities. Nevertheless, as a moot point, the following approaches could be considered:

1.?????? Temporarily seek appropriate O&M cost reductions (during such times) commensurate with retail price rise. For example, a 5% inflation would seek a similar temporary cost reduction.

2.?????? Recognizing capex has a long-term impact on rates, temporarily limit, delay or apportion investments into regulatory assets, commensurate with a price cap formula.

3.?????? Limit all elements of rates (kWh tariff, TOU, demand charges and T&D delivery charges) to below inflation to safeguard public affordability (much like rent-control). Once established, utilities would self-regulate their pace of investments and costs appropriately.

4.?????? Allow cost-of-service pass-through into rates but enable a temporary bill payment relief (subsidy) framework for the government to compensate the economically disadvantaged ratepayers.

All the above are retrograde to the progress made towards a market-oriented electricity regulation (TOU, dynamic pricing, demand charges, etc.). However, a counter argument can be made that similar price/rate cap frameworks do exist in other regulated areas such as residential property tax, rent control, college tuitions and income tax. Secondly, it could be argued that the rate base (being only second to tax base) must enable economic distress relief. Thirdly, many utilities are government owned and should be directed to voluntarily offer such rate-relief. Lastly, rising electricity rates lose their price-elasticity for the economically disadvantaged segment and begin to mimic a Giffen Good (minimum “survival” consumption despite price rise).

Currently, electricity regulation has no “rate-payer affordability test” nor jurisdiction. Such qualifications and power only rest with the policy makers. A hasty broad-based rate-relief will have a disproportionate benefit to the rich. There are no easy answers, but the problem is a real and a growing one. With climate change temperature rise and the push for electrification, we are forcing ourselves for introspection into an alternative rate setting mechanism. An economic rate-payer classification would now be needed along with the different residential tariff classifications.

In many developing countries, the residential rates are designed with escalating tariffs on rising consumption levels. Often the lowest consumption slab is heavily subsidized or made free. However, this subsidy gets reduced with the separation of ‘carriage and content’ as the energy component is only a part of the overall bill. The recent years have seen a steep rise in T&D delivery charges and a consumption-oriented tariff (or bill subsidy) does not address this delivery charge inflation.

Electricity inflation across the entire value chain (generation, T&D delivery and retail energy) needs to be looked at as an overall “core-inflation” bundle, not merely consumption only. All areas of O&M and Capex must meet this stress test to keep rates in check. It impacts the economically disadvantaged rate payer the most.

I am writing this article not to conclude my views but to show that this is a burgeoning problem as electricity costs trend higher and higher. Policy makers and regulators need to start discussions now, sooner rather than later. Your views and comments are welcome.