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The Importance of Marginal Cost Electricity Pricing to the Success of Greenhouse Gas Reduction Programs

Friedman, Lee. Energy Policy, 39, No. 11,  November 2011, pp. 7347-7360.


The efficient reduction of GHG emissions requires appropriate retail pricing of off-peak
electricity. However, off-peak electricity for residential consumers is priced at 331% above its marginal cost
in the United States as a whole (June 2009). Even for the 1% of residences that are on some form of
time-of- use (TOU) rate schedule, the off-peak rate is almost three times higher than the marginal
cost. A barrier to marginal-cost based TOU rates is that less than 9% of U.S. households have the
“smart” meters in place that can measure and record the time of consumption. Policies should be put
in place to achieve full deployment. Another important barrier is consumer concern about TOU rate
design. Two TOU rate designs (baseline and two-part tariff) are described that utilize marginal-cost based rates, ensure appropriate cost recovery, and minimize bill changes from current rate structures. A final barrier is to get residences on to these rates. Should a marginal-cost based TOU rate design remain an alternative for which residences could “opt-in,” or become the default choice, or become mandatory?
Time-invariant rates are a historical anachronism that subsidize very costly peak-period consumption and penalize off-
peak usage to our environmental detriment. They should be phased out.

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