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Jonathan G. Koomey, Staff Scientist 1 Cyclotron Road, MS 90-4000
Berkeley, California 94720

Energy Analysis Program Tel: 510/486-5974 Fax: 510/486- 4247 e-mail:
JGKoomey@lbl.gov

July 16, 1998

Professor Darwin Hall (562/985-5804 fax)

Contemporary Economic Policy

1250 Bellflower Blvd

Long Beach, CA 90840-4607

Dear Darwin,

You asked me to respond to Professor Hirshleifer\'s letter to you of
April 1, 1998, regarding Ballanoff\'s critique of my article,[^1] in
hopes of beginning a discussion on this issue. I read the materials in
question, examined commercial sector utility rates from many utilities,
and spoke with a utility rates expert at PG&E. I summarize my
conclusions below.

Ballanoff is correct that IF part of the commercial sector rates are
fixed with respect to kilowatt-hour (kWh) usage then the correct bill
savings number to use in my calculations is lower than the simple
average over all kWh would suggest. He is incorrect to assert that this
fixed part of the rates is significant. He reached his erroneous
conclusion by referring to Table 11 in a publication from the Energy
Information Administration (attached). This table presents utility
operating expenses (in other words, utility *costs*) broken out by
various subcategories. It also presents total utility operating
revenues.

Ballanoff divides the total costs of electricity production (\$68.8B),
which he asserts is the relevant variable component of the rates, and
divides by total electric utility revenue (\$176.4B) to get 39%, the
factor by which he multiplies my average rate of 7.5 cents per kWh. This
calculation yields 2.93 cents/kWh, which is the electricity \"rate\" he
proceeds to use in his follow up calculations (in fact, this is the
short-run *average* *cost* across all sectors). It is clear from this
table that he is using *cost* data, not *billing* data to calculate the
fraction of total bills that are avoidable. This mistake is a
fundamental one, and it leads Ballanoff to his incorrect conclusions.

During the rate design process, regulators allocate the costs identified
in the EIA\'s table to the four main components of commercial sector
rates: energy (\$/kWh), demand (\$/kW), metering (\$/meter), and
customer (\$/customer). While the capital charges are \"fixed\" parts of
the *costs*, a large fraction of these capital costs are lumped into the
demand charge for purposes of ratemaking. The rationale for this
allocation is complicated, but it boils down to the following: power
plants are constructed to meet peak demand and preserve reliability, and
a customer who reduces peak demand increases the reliability of the
utility system and reduces the need for constructing new capacity in the
long run.

The energy savings from the ballasts will occur during peak times and
therefore will reduce demand charges also, an assumption that is a
robust one since lights tend to be on during the daytime peak
periods.[^2] The energy and demand charges are therefore both reduced by
the energy savings resulting from the more efficient ballasts, so the
only parts of the rates that are fixed with respect to the efficiency of
a fluorescent ballast are customer and metering charges.

A colleague at PG&E\'s rates department estimated for me PG&E\'s
customer and meter charge revenues as a fraction of total revenues for
Commercial/Industrial customers, which are shown in the Table below:

+------------------+-----------------+---------------+----------------+
|                  | \% of Total     | \% of Total   | FIXED          |
|                  | Commer          | Commerci      | COMPONENT      |
|                  | cial/Industrial | al/Industrial | Customer &     |
|                  |                 |               | Meter Charge   |
|                  | Electricity use | Revenues      | Revenues as %  |
|                  |                 |               | of Total       |
|                  |                 |               | Revenues       |
+------------------+-----------------+---------------+----------------+

  ------------------- ----------------- ---------------- -----------------
  Small Light & Power 17%               23%              5.2%

  ------------------- ----------------- ---------------- -----------------

  ------------------- ----------------- ---------------- -----------------
  Medium Light &      48%               51%              3.0%
  Power                                                  

  ------------------- ----------------- ---------------- -----------------

  ------------------- ----------------- ---------------- -----------------
  Large Light & Power 35%               27%              0.6%

  ------------------- ----------------- ---------------- -----------------

  ------------------- ----------------- ---------------- -----------------
  Total               100%              100%             2.9%

  ------------------- ----------------- ---------------- -----------------

The table shows that on average, only about 3% of Commercial/Industrial
rate revenues are fixed with respect to energy use. This level of fixed
charges would affect my conclusions only slightly, and is certainly
offset by the various assumptions incorporated into the analysis that
work against my ultimate conclusions (such as dropping the 80 buildings
with excessively high average electricity rates).

I used the average electricity rates for each building in the CBECS
survey sample because I knew that the fixed component of the rates is
negligibly small for commercial buildings. These fixed charges are much
smaller in percentage terms than for residential customers because the
cost per customer of metering and billing doesn\'t vary much with the
number of kilowatt-hours used by the customer, but the number of
kilowatt-hours used per customer is much higher for commercial customers
than for residential ones.[^3]

Ballanoff thus made a crucial mistake in his comment, which is why I
believe it should not be published. It is incorrect to use the EIA\'s
*cost* data to estimate the variable part of commercial sector *bills*,
and when the correct data are used, we see that the fraction of utility
bills that are fixed with respect to energy and demand savings is
negligible for the buildings in question. This conclusion is consistent
with the dozens of actual utility rates structures I reviewed in the
process of investigating Ballanoff\'s comment.[^4] The main point
contained in his comment is therefore invalidated.

I stand by my conclusions, but am happy to discuss these issues by
phone, to resolve any lingering misunderstandings.

> Regards,
>
> Jonathan G. Koomey, Ph.D.
>
> Staff Scientist

CC: Professor Jack Hirshleifer

Economics Dept., UCLA

Los Angeles, CA 90095

310/825-9528 fax

[^1]: Koomey, Jonathan, Alan H. Sanstad, and Leslie J. Shown. 1996.
    \"Energy-Efficient Lighting: Market Data, Market Imperfections, and
    Policy Success.\" *Contemporary Economic Policy*. vol. XIV, no. 3.
    July (Also LBL-37702.REV). p. 98-111.

[^2]: Lighting tends to be MORE coincident with peak demand than the
    average commercial sector end-use, which means that using the
    average bills actually understates the actual savings from the
    ballast standards, as the reviewer points out.

[^3]: Of course, it costs more to keep track of both demand and energy
    charges than to just track energy charges (as is usually done for
    residential customers) but typically demand meters are only used for
    the larger commercial customers for which the additional expense is
    offset by the significantly larger electricity consumption per
    customer. For commercial customers without demand meters, the per
    kWh rate is much higher than the energy charge for customers with
    demand meters, because it includes the costs that otherwise would be
    allocated to demand charges.

[^4]: CSA Energy Consultants. 1995. *CSA Electric Rate Database: User
    Guide*. Arlington, VA: Casazza, Schultz, & Associates, Inc. January.
    This database contains electric rate structures for dozens of
    investor-owned utilities. It shows demand charges, energy charges,
    and customer/meter charges by rate structure, and includes
    residential, commercial, and industrial rates. It was compiled for
    the Utility Data Institute.