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Economic Currents

Keep up to date with the latest UHERO news.

Why are Hawai’i’s Electricity Prices So High?

Excluding rooftop solar, Hawai’i residential consumers pay an average of about 37 cents for a kilowatt-hour of electricity. Taking refrigerators, water heaters, stoves, air conditioning and other uses into account, the average Hawai’i household uses about 18.5 kWh each day, for a monthly bill of about $205.

That’s a lot, between three and four times the average price on the mainland, and by far the highest price of any state. Thankfully, high electricity prices hurt a little less here than on the mainland, because our mild climate means we don’t have heating bills and we can usually get by without air conditioning.

But keep in mind that well over two thirds of the state’s generated electricity is used by commercial businesses and industry, which factor into the prices we pay for everything else. Businesses tend to pay less for electricity than households do, but the price is still high, so it’s easy to see how high prices are a burden on Hawai’i’s economy.

Electricity prices can be roughly boiled down to the price of oil, which is used to generate most of our electricity, plus price we pay for fixed costs like power plants, the grid and its management. These costs are fixed in the sense that they don’t vary with the amount of electricity generated and consumed. We have record high electricity prices because oil prices remain high, and because the fixed price of our infrastructure, averaged over the amount of electricity we use, is very high and rapidly growing.

Besides oil, there is one coal power plant on Oahu, which produces electricity much less expensively. Hawaiian Electric also buys electricity through a series purchasing power agreements (PPAs). Prices paid on PPAs vary across contracts and timing (peak or off-peak). These comprise a small share of total generation and the prices, on average, are roughly similar to the cost Hawaiian Electric’s reported cost for oil-generated electricity. Some new lower-cost PPAs should be coming online soon, and some older higher-cost PPAs expire relatively soon.

The Public Utilities Commission (PUC) allows Hawaiian Electric to adjust prices as oil prices change, but there is a bit of a lag between change in oil prices and changes in electricity prices. Every three years the PUC performs a rate case to evaluate costs more thoroughly. The three utilities, HECO, MECO and HELCO have rate cases performed on a rotating schedule. Some of the details remain confidential, and what is available can be difficult to discern from publicly available documents.

Historically, a good predictor of electricity prices in the current month is the average Brent crude oil price over the previous four months (figure 2). In our analysis we found Brent crude oil prices predicted Hawai’i’s average electricity price even better than prices reportedly paid by HECO.

Recently, however, we’ve seen prices drift up from the historical relationship. Statistically, a clear break occurred around November 2008, during the height of the financial crisis and the deepening recession. In the graph, we show months since this break in blue, and the historical relationship in black.

From the pre-November, 2008 relationship between electricity prices and crude oil prices, we can approximate the fixed-cost component of price at about 10.7 cents per kWh, which roughly equals the number reported by Hawaiian Electric. This margin covers cost maintaining the grid, infrastructure, billing and Hawaiian Electric’s profits. This fixed cost roughly equals the average retail price of electricity on the mainland. High fixed costs are partly a testament to the smaller scale and geographical constraints of an island economy. It’s hard to know whether or how much competition could reduce these costs.

We can calculate the portion of electricity price left over after we have accounted for estimated variable (fuel) costs by adding 10.7 to the difference between each month’s price and the fitted line in figure 2. We’ll call this the “estimated price per kWh towards fixed costs” shown in figure 3. Since the break in November 2008, prices have drifted upward from the historical relationship, which suggests the fixed cost share of price has risen to around 15 cents per kWh, or about $83 dollars per household per month.

Fixed costs have drifted up due to a number of factors. A 2009 rate case granted Hawaiian Electric permission to raise Oahu prices 5.7 percent to finance new infrastructure and meet rate-of-return requirements. A $1/barrel tax was also implemented in 2010 to fund renewable energy and food security initiatives. But this tax amounts to only 0.2 cents per kWh. The spread between Hawaiian Electric’s oil costs and world Brent crude oil prices has also increased slightly since 2011 (figure 4).

 

 

Finally, there’s the revenue decoupling rule, which allows HECO to increase prices each year between rate cases to compensate for revenues lost due to energy efficiency and distributed generation (i.e., new solar installations). The intent of decoupling is to align HECO’s interests with those of competing solar providers, as described in my last post. With revenues stable, and generation costs falling, HECO can profit from this policy between rate cases. So far, revenue decoupling adds 1.3 cents per kWh, and a leaked document from the Public Utilities Commission suggests this will soon rise to 2.2 cents per kWh.

Looking forward, we might hope for electricity prices to come down. The cost of generating electricity from wind and solar is less than oil, and falling rapidly. Natural gas, a cheaper, cleaner and less expensive fuel, might be brought in to substitute for oil. But the intermittent nature of renewables and our antiquated grid will limit renewables, and rapidly growing fixed costs may limit how much residents and businesses will ultimately gain from lower generation costs.

An over arching concern is that fixed costs of the grid are approaching levels that could make battery backup to “unplugged” distributed systems a viable substitute for the grid. With PV solar and battery costs falling, and fixed costs rising, we may be setting up an unavoidable “death spiral” that makes the whole grid obsolete. We will navigate this issue in more detail in later post.

In the next post of the series we’ll review the costs and benefits of solar, net metering, the rapid growth of solar installations, and how this growth can stress the current grid infrastructure.

--- Michael Roberts


Is Monopoly a Barrier to Hawai’i’s Ascent?

In 2012 Joseph Stiglitz, a Nobel Prize winning economist and Columbia University Business School Professor visited Hawaii to give the Stephen and Marylyn Pauley Seminar in Sustainability. Stiglitz discussed sustainability within the context of our depressed national economy and ongoing struggles with debt and unemployment. For our economy to fully recover, we need more investment, and Stiglitz argued that investments ought to be in education, technology, and green infrastructure, with solar, wind and an improved electricity grid being obvious choices.

Stiglitz then discussed Hawai'i’s local economy (around the 50 minute mark in the linked video). He saw monopolies in inter-island transfer, electricity, and shipping as key obstacles to Hawai’i’s sustainable growth. Of the three, he pointed to the second, Hawaiian Electric Industries electricity monopoly (HECO, MECO and HELCO) as the most important.

To be fair, Stiglitz has no unique insight into Hawai’i’s circumstances. Our unique geography makes it difficult to tell how much unavoidable costs or market control factor into our unusually high prices for electricity and other goods and services. What’s clear is that, at least in the case of electricity, the old regulatory model is being challenged by the rapid growth of renewable energy.

 

Regulatory Challenges

Historically, for electricity and many other utilities, there can be economies of scale, meaning it can be less costly for one company to produce than many companies. Think of large power plants and the impracticality of having many different electric lines running to each house. Similar situations arise for water, cable TV and phone services. The obvious problem with monopolies is that, left to their own devices, they'll maximize profits by charging prices that far exceed costs. As a result, local governments typically regulate utility prices, as they do here in Hawaii.

Regulation is tricky, however. Monopolies have no incentive to be forthcoming about their actual costs. And they have little incentive to innovate or find creative cost-cutting measures, if lower costs simply cause the public utility commission to commensurately lower regulated prices. Some argue that regulators, starved of resources or the right incentives, might serve the monopoly's interest instead of the public's. 

 

Green Energy Challenges the Status Quo

Today, rapidly improving technology and a push toward green energy are challenging our electric utility monopoly. Economies of scale in generation no longer exist. Even without state and federal subsidies, rooftop solar and wind are becoming competitive with traditional carbon-based fuels, even on the mainland where electricity prices are less than one third those in Hawai'i. And Hawai’i’s geography suits renewables better than most places on the mainland.

A key technical challenge for renewables is their intermittency, which makes it more difficult to match demand with naturally varying supply. Another is our existing grid, which is designed for centralized generation, not a distributed network with tens or hundreds of thousands of rooftop power sources.

Engineers are working hard on the technical challenges, and so far have managed to accommodate more solar and wind power than many had thought possible on our antiquated grid. Experiments with variable time-of-day pricing might help match intermittent supply and demand. Others are dreaming up new ways to store energy or distribute it further, like the costly and controversial inter-island cable

The political and regulatory challenge is facilitating access by these competing energy sources to a monopoly-controlled grid. Competition is good for consumers and economic efficiency. But, as Stiglitz noted, competition kills profits, so Hawaiian Electric has no incentive to facilitate grid access.

 

Revenue Decoupling

Thus far, the political solution to the grid-access problem is revenue decoupling. The idea, implemented in Hawaii over four years ago, is to allow the regulated monopoly to raise prices to compensate for sales lost to competing generation like solar. Revenue decoupling is the key reason electricity prices have continued to rise in Hawai’i over the last four years, even as generation costs have stabilized. Those higher prices have compensated Hawaiian Electric for roughly 200 megawatts of PV solar that have been installed on Oahu since decoupling in 2010.

Decoupling aligns the financial interests of Hawaiian Electric and competing solar interests, allowing both to profit from expansion of solar, wind and improved efficiency. The losers are commercial, industrial and residential consumers of generated electricity, who, for one reason or another, haven't installed solar. For a number of reasons we will discuss in subsequent posts, decoupling may not be a sustainable model over the long run.

 

Continuing Dialogue

On April 15, 2014 Vice President Al Gore will deliver another Stephen and Marylyn Pauley Seminar in Sustainability. Surrounding the Seminar will be a larger event with many local and national experts that will consider various sustainability issues in Hawai'i, including one session dedicated to our ongoing challenges and opportunities with electricity.

In anticipation of this event, UHERO will develop a number of posts that dig into some of the economic issues surrounding Hawai'i's push toward renewable energy, and over-arching challenges with managing the grid and regulating prices.

If you're confused by a lot of the jargon and complex details, you're not alone. Our hope is to add some clarity to the debate, aided with lots of nifty graphs and charts of available data. On issues that still confuse us, we'll use this blog to highlight key questions and ambiguities. We'll do our best to answer your questions, too.

---Michael Roberts

 

UHERO blog posts are intended to stimulate discussion and critical comment. They views expressed are those of the individual authors. 


Changing climate conditions threaten groundwater recharge. The potential benefits of conserving it are substantial.

Results from a recent statistical exercise suggest that by the end of the 21st century, Hawaii will likely see a 5-10% reduction in precipitation during the wet season and a 5% increase during the dry season (Timm and Diaz 2009). Given that approximately 70% of normal precipitation falls during the wet season, Hawaii is facing an overall decline in annual precipitation, and thus a decline in groundwater-recharge (how much water goes toward refilling our critical aquifers*). Meanwhile, water tables and streamflow have already been declining as a result of both increased groundwater withdrawals and the warming climate (Bassiouni and Oki 2012). 

Drawdown of existing groundwater stocks is likely still decades away, meaning there's still time to do something about it. One option is watershed conservation. Watershed conservation, of course, has costs and those costs can appear quite high in the near-term. For example, the construction of pig fencing -- one tactic for achieving watershed conservation -- can cost between $92,000 and $159,000 per mile, not including helicopter time and materials. Conservation activities, however, can generate much larger benefits over the long run. Estimating these benefits is the topic of our new working paper: Optimal groundwater management when recharge is declining: A method for valuing the recharge benefits of watershed conservation.

To arrive at these estimates, streamflow and evapotranspiration projections (Safeeq and Fares 2012) and rainfall projections (Timm Diaz 2010) were used to construct two potential climate change scenarios:

(i) a precipitation decline of 5.3% and subsequent recharge decline of 8.5% by 2100 (baseline) and

(ii) a precipitation decline of 1.9% and a subsequent recharge decline of 3.7% by 2100 (conservative)

Using a dynamic economic-hydrologic optimization model (read the working paper here for more on the model) and based on these scenarios, we looked at the Pearl Harbor aquifer and calculated a net present value (NPV) based on the stream of future benefits (expressed in dollars) derived from having this water resource available at current recharge rates. We then calculated NPV for the aquifer in each of the two climate change scenarios. The amount of value "lost" (the difference between the NPV at current recharge rates and the NPV at lower recharge rates) represents the potential benefit of conservation.

The net present value (NPV) of the Pearl Harbor aquifer is approximately $7.886 billion at the current rate of natural recharge. Our two climate change scenarios reduce the value:

(i) If a decline in precipitation reduces recharge by 3.7% the value drops to $7.722 billion. (potential benefit of $163.9 million)

(ii) If recharge is reduced by 8.5% the value drops even further to $7.538 billion. (potential benefit of $347.7 million)

We conducted a sensitivity analysis on several of the model’s parameters (see results in figure above and explanation of parameters below). We found that maintaining the current level of recharge in the aquifer represented a value of anywhere between $31.1 million and $1.5 billion. In addition to increasing welfare by lowering the scarcity value of water in both the near term and the future, enhancing recharge delays the need for costly alternatives like desalination.

The enormous dollar values in the Pearl Harbor aquifer example illustrate the kinds of huge benefits conservation can generate. Pig fencing may cost a lot, but it still pales in comparison to the potential tens of millions - or even billions - that can be had from such conservation projects over the long term. When other ecological services provided by forested watersheds are considered (e.g. those related to species habitat, subsistence, hunting, aesthetic value, commercial harvest, protection against flooding and sedimentation, and ecotourism), the value of watershed conservation may be much higher.

--- Kim Burnett and Christopher Wada

 

 

About the Chart: Valuing the Conservation of the Pearl Harbor Aquifer

1. Our baseline assumed demand for water would grow by 1% each year (based on historical data for population and per capita income growth).

2. The high growth scenario assumes demand for water grows at triple that rate (3% each year).

3. Many past studies suggest that demand for water is fairly constant given changes in price, i.e. demand is "inelastic". However, recent research suggests that consumers facing increasing block prices (the pricing structure currently used in Hawaii) may be more responsive to price changes. The high elasticity scenario assumes that the price elasticity** of demand is -0.5, twice the value of the baseline scenario.

4. The discount rate adjusts the value of future benefits or costs to reflect the desire to accrue benefits sooner and costs later. In the low discount rate scenario, the discount rate is one third of its baseline value (0.01), which means that weighting of net benefits accrued to current and future consumers is closer to being equal.

5. Because the price derived from the optimization model used reflects both the extraction cost and the scarcity value of water, with the scarcity value of water being relatively large, the high extraction cost scenario (where the cost coefficient is double its baseline value) does not substantially change the NPV.

 

*Hawaii's groundwater provides nearly 99% of Hawaii's domestic water and roughly 50% of all freshwater used throughout the state (Gingerich and Oki 2000).

**Price Elasticity: The price elasticity of demand measures the percentage change in quantity demanded resulting from a one percent change in price. In other words, it is a measure of consumer responsiveness to price changes. Demand for a good is said to be inelastic when elasticity is less than one and elastic when elasticity is greater than one. In our baseline scenario, for example, the -0.25 value for demand elasticity means that a user consuming 10,000 gallons of water per month at a price of $5 per thousand gallons would reduce consumption by 25 gallons per month if the price of water is increased to $5.05 per thousand gallons.

References

Bassiouni M, Oki DS (2012) Trends and shifts in streamflow in Hawai‘i, 1913–2008. Hydrol Process. doi:10.1002/hyp.9298 Gingerich SB, Oki DS (2000) Ground water in Hawaii, U.S. Geological Survey Fact Sheet 126-00

Safeeq M, Fares A (2012) Hydrologic response of a Hawaiian watershed to future climate change scenarios. Hydrol Process 26:2745–2764

Timm O, Diaz, HF (2009) Synoptic-Statistical Approach to Regional Downscaling of IPCC Twenty-First-Century Climate Projections: Seasonal Rainfall over the Hawaiian Islands. J Climate 22:4261-4280.

This research is forthcoming in the peer-reviewed journal, Environmental Economics and Policy Studies (Burnett and Wada 2014). For more applications of economic principles to natural resource and environmental management problems, visit UHERO’s Project Environment.

WORKING PAPER


Hawai‘i’s Environmental Response, Energy, and Food Security Tax (aka Barrel Tax)

The one-dollar increase in Hawai‘i’s environmental tax from five-cents since its inception in 1993 to $1.05 effective July 1, 2010 was a stepping stone in Hawai‘i’s clean energy progress. While in theory it serves to discourage fossil fuels (internalizing the negative externality), its major impact has been as a funding source for energy and food security initiatives. Act 73 temporarily created three new funds—the Energy Security Special Fund, the Energy Systems Development Special Fund, and the Agricultural Development & Food Security Fund. Providing support for the Hawai‘i Clean Energy Initiative (HCEI) and the Greenhouse Gas Emissions Reduction Task Force (GHGRTF) as well as instrumental research conducted by the Hawai‘i Natural Energy Institute (HNEI) are just several examples of how the barrel tax has contributed to advancing the State’s energy goals.

What does the barrel tax apply to and how much has been collected?

As of the end of fiscal year 2013, the $1.05 per barrel tax on petroleum products—excluding jet fuel (aviation fuel) and any fuel sold to a refiner—totaled $80 million dollars statewide; on an annual basis this translates to approximately $27 million dollars. The petroleum products taxed represents roughly 2/3 of the barrels of oil imported each year.

Ongoing/Current Issues

Originally, of the $1.05 tax, forty-five cents was allocated to supporting environmental response, energy, and food security, while the remaining sixty-cents was apportioned to the general fund. During the 2013 Legislative session, though unsuccessful, it was proposed that the tax be distributed according to its intended purpose, rather than given to the general fund. As such, increasing the amount allocated to environmental response, energy and food security funds, along with re-establishing the energy systems development special fund, and extending the barrel tax to 2030 have been proposed under SB2196 in the current Legislative Session.1 The barrel tax is set to sunset in 2015, and Hawai‘i’s energy industry hopes to extend the repeal of the barrel tax to 2030, the same year as Hawai‘i’s ultimate renewable portfolio standards (RPS) target.

 

Table 1 below shows the original breakdown under Act 73, SLH 2010, and the allocation as of July 1, 2013.

 

-- Sherilyn Wee and Makena Coffman

 

 

1  The bill text and status can be found here: http://www.capitol.hawaii.gov/measure_indiv.aspx?billtype=SB&billnumber=2196&year=2014


Is inequality actually lower in Honolulu?

Posted February 5, 2014 | Categories: Hawaii's People, Blog

The outlook for inequality and poverty in Honolulu is not as rosy as it might seem at first glance.

On the 50th anniversary of the ‘War on Poverty’, poverty and income inequality are major policy issues facing President Obama’s administration and driving public policy analysis and debate. The Business Journals, parent of Pacific Business News (PBN), took a look at several measures of inequality and PBN followed up with a Honolulu specific look at the findings.

The PBN story characterizes Honolulu as among the most “equal” cities of the 102 examined in the study.1

However, several inequality measures used in The Business Journals’ analysis are not ideal for cross-city comparisons. The measures are constructed using data from the American Community Survey, making them available for all cities, but not necessarily appropriate for cross-city comparison.

A major concern is that the inequality measures use dollar amounts as cutoffs. One measure looks at the ratio of the number of households earning less than $50,000 to the number of those earning more than $200,000. These data for Hawaii are certainly interesting. To see them for your neighborhood or county, visit our new income distribution map to see how these income groups are situated geographically. However, while these dollar cutoffs can help us identify differences in economic fortune across our state where the prices for goods are relatively constant, they are much less useful for comparing differences across the country where prices can vary dramatically.

The cost of housing, food, transportation, etc. is not equal across all cities. Differences in regional prices, and the need for regional price parity to make proper comparisons makes any comparison using a fixed-dollar poverty line substantially less meaningful.

In an analysis of regional prices by the BEA, the state of Hawaii had the highest price level among states, and Honolulu had the second-highest price level among cities.2 The Business Journals analysis does not take these price differences into account. Honolulu’s high prices mean that a household earning $50,000 in Honolulu will be worse off than a household earning $50,000 in most other cities. Also, a household earning $200,000 in Honolulu is not as wealthy as households earning $200,000 in most other cities. Both of these effects mean The Business Journals’ ratio of low-income households to high-income households in Honolulu is too low.

Regional price differences also mean that estimates of the number of poor households in Honolulu using a single poverty line for the entire US are deceptively low.

Comparisons of inequality across the US are made difficult by regional price differences. We’ll do our best here to keep you informed. Watch for more updates, data, and visualizations from UHERO on issues of poverty and income inequality.

---Jonathan Page and Tim Halliday

 

 

1  In such markets, competition between firms does exist as firms try to attract more customers, but it is realized via incentives rather than changes (decreases) in prices. Instead, prices are kept relatively constant, but firms engage in fierce advertising highlighting the differences across products to attract customers.

However, G. Scott Thomas, author of The Business Journals post, does mention the nationwide trend towards greater inequality found by this Congressional Budget Office (CBO) study. But there is no city-level analysis of the trends in inequality in either the CBO study or The Business Journals post.

 

2  See http://uhero.hawaii.edu/news/view/235 for a summary of this report as it applies to Hawaii.


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