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Article Excerpt
Policymakers often seek to limit energy prices following market shocks, and instead issue public appeals to reduce demand. This article presents new evidence on how price changes and conservation appeals affect energy consumption, using household-level data from California's energy crisis during 2000 and 2001. The evidence indicates that when policymakers cap energy prices following market shocks, they preclude substantial--and quite rapid--reductions in energy use. The data also reveal that conservation appeals and informational programs can produce sustained reductions in energy demand.
1. Introduction
* Markets for energy often experience shocks that require rapid changes in consumption or prices. Examples abound, from the 1970s oil shocks to California's electricity crisis and recent supply disruptions in gasoline markets. Efficiency requires that consumers quickly respond to higher prices with attenuated demand, thereby averting shortages or rationing. In practice, however, political decision makers are reluctant to let the price mechanism run its course. Instead, they will often hold prices below new market-cleating levels when laws and regulations enable it, and issue public appeals for voluntary conservation in order to mediate demand. (1)
Do these political responses to market shocks exacerbate shortages, or are they a useful strategy to help avoid them? To answer this question requires evidence on whether--and how promptly--consumers react to (i) price shocks and (ii) public pressures. Recent surveys have drawn attention to the fact that, despite more than 30 years of market interventions in response to energy price shocks, policymakers still possess limited information regarding their consequences (IEA, 2005a, 2005b). The lack of compelling evidence makes it difficult to weigh the effects of restraining prices and issuing public appeals when market shocks occur.
This article provides unique evidence on how energy consumption responds to both price shocks and public appeals. The analysis is based on seldom-available utility billing data containing the energy consumption histories for tens of thousands of households in the San Diego region during California's energy crisis. This population experienced an unprecedented increase in electricity prices during 2000, and mass public appeals for energy conservation the following year after prices were (legislatively) rolled back. (2)
The data reveal striking changes in households' consumption habits. After electricity prices unexpectedly (and rapidly) increased in 2000, the average household's electricity use fell more than 13% in about 60 days. As we explain, this requires the typical household to invest in new appliances or make substantial behavioral changes in how often they are used. The latter was especially widespread: after the legislature imposed a (binding) cap on residential electricity prices, consumption rapidly rebounded toward former levels. We infer that when policymakers limit price increases following supply shocks, they preclude substantial and fairly rapid changes in energy consumption behavior.
We then consider the effectiveness of public appeals. To curb excess demand under the new price cap and avoid mandatory rationing (or "rolling blackouts"), California initiated a media campaign to promote voluntary conservation. In essence, this amounted to a massive public appeal to forgo consumption. The typical San Diegan's energy use declined steadily by 7% over this six-month period--absent any pecuniary incentive to do so. The magnitude of this response indicates that well-orchestrated mass public appeals can be an effective means to avert rationing when the price mechanism is unable (or, in this instance, not permitted) to equilibrate the market.
These findings provide new and useful information along three lines. First, although the literature on energy demand is voluminous, little work examines how quickly consumption adjusts to price shocks. This gap in the literature makes it difficult to refute conventional wisdom in regulatory and policy arenas, which have long regarded prices as a minimally effective instrument for influencing energy use. (3) The use of accurate (metered) energy consumption data at the household level is invaluable in this regard, as it enables stark conclusions about the speed and magnitude of demand changes by individual consumers.
Second, public appeals by government officials have a long history in times of energy crises and for other social objectives. President Jimmy Carter urged Americans to reduce oil use with Oval Office broadcasts, California issues "Spare the Air" declarations on smoggy days that encourage people to refrain from driving, municipalities ask citizens to conserve water during droughts (yet often leave water prices unchanged), and local utilities broadcast appeals for consumers to shut off air conditioners in hot weather when electricity supplies are tight. Issuing public appeals like these is like soliciting anonymous contributions to a public good: respondents incur private costs individually, yet achieve tangible benefits only if aggregate participation is high. Despite considerable experimental research on public goods problems, there remains little direct evidence on whether public appeals such as these are effective in practice. (4)
Finally, establishing that households can quickly change their consumption habits for electricity is useful because it is harder for consumers to adjust consumption for this service than for most other goods (electricity is considered the most inelastically demanded form of energy, for example). Thus, our findings are suggestive that consumers could do at least as much following market shocks for other goods (such as gasoline, where substitutes such as carpooling and public transportation exist), but where persistent measurement limitations preclude results as precise as the findings documented here (IEA, 2005b).
Our study design is based on five years of disaggregate billing data for a random sample of 70,000 households. We compare within-household changes in average daily electricity consumption during a 2 1/2-year pre-crisis period to consumption changes during the price shock in 2000 and the voluntary conservation campaign in 2001. To disentangle the confounding effects of weather, we carefully matched each sample household to daily weather data using 21 weather stations in the region. The within-household analysis allows us to identify, net of weather-related effects, the variation in consumption behavior that followed changes in prices and public appeals. Because of the staggered design of households' billing periods in the San Diego region, the data reveal a great deal of information about the timing of consumers' responses to these events.
The next section provides background information describing the events we analyze. Sections 3 and 4 summarize the data and our methods, respectively. The main results are presented and discussed in Sections 5 and 6. A brief conclusion closes.
2. Background: prices and policy responses
* The one million households in the greater San Diego metropolitan area receive electric service from a single utility, the San Diego Gas and Electric Company (SDG&E). Figure 1 shows the average electricity price paid by these households from 1998 to 2002. (5) There is little variation in this price series across households, except that low-income (poverty-level) households are eligible for slightly subsidized rates. The dashed line in the figure shows the average price that households would have paid if a (binding) price cap had not been imposed in September 2000. From the figure, we can distinguish three pricing regimes: (i) a period of basically stable prices, from January 1998 to May 2000; (ii) the price spike in summer 2000; and (iii) the period under the price cap beginning September 2000. These changes, along with the policy interventions under the price cap, are the subjects of our analysis.
[] The stable price period. Until July 1999, electricity prices in San Diego were regulated in much the same way that they had been for decades. Other than a slight downward adjustment in January 1998 (visible at the far left in Figure 1), average prices were essentially flat during the 1990s. In July 1999, however, the regulatory system determining these prices changed substantially. Rather than set prices through periodic regulatory hearings, the tariffs determining retail electricity prices were formally indexed to the price of power on regional wholesale markets. Thus, if wholesale market prices increased from one week to the next, this increase would appear in consumers' bills that month.
The shift to this system of indexing residential electricity prices was part of California's long-term vision for reorganizing its electricity industry. (6) The anticipated effect was that competition in wholesale markets would, over time, drive down retail prices below their previously regulated levels (see White, 1996; Joskow, 2001). San Diego Gas & Electric was the first of California's utilities to implement this "floating prices" system; the state's other regulated utilities were slated to do so later, had the state's electricity crisis not intervened.
[FIGURE 1 OMITTED]
During its first year, the change to this new system of electricity pricing was immaterial to the residential consumer. Although the wholesale price index was printed on households' monthly statements, its use resulted in little change in electric bills. As Figure 1 shows, average prices continued at basically the same level over the year starting July 1999 as the year prior, except for two minor "blips" at the peaks of the 1999 summer cooling and winter heating seasons. The 2 1/2 years period from January 1998 to May 2000 was thus one of stable electricity prices, although the regulatory and market system determining these prices changed dramatically in the interim.
[] The price spike and cap. In June 2000, California and western U.S. wholesale electricity markets experienced an unprecedented run-up in prices. (7) Because San Diego residential electricity prices were now indexed to the wholesale market, these price increases promptly appeared in households' monthly bills. San Diego households' prices increased from their historical average of approximately 10 cents per kilowatt-hour (KWh) to over 23 cents per KWh in a span of about three months.
Because price changes under this system were not announced (or even known) in advance, they comprised a true "price shock" when consumers received their June 2000 bills. Continuing increases the next month generated a storm of public protest and, ultimately, legislative intervention. By the end of August, the California state legislature responded by imposing a retail price cap on residential and small-commercial electricity rates in the San Diego region. (8)
We know a great deal about when information regarding these price changes became available to San Diegans. There is no reason to believe that a typical consumer anticipated the June 2000 price spike. In the third week of June, local media began reporting in business news segments the rapid escalation in wholesale market prices (which now determine monthly bills). By the first week of July, media coverage of the price spike appeared prominently on front pages of regional newspapers and in local newscasts. By then, the increase in prices would have been evident to most any consumer through his or her last utility bill. The legislative price cap first received general media coverage in the third week of August 2000. Its enactment on September 6, 2000 was highly publicized.
Consequently, a household could learn that prices were changing either through its utility bill or through the media. From a research standpoint, we will quantify when households react to price shocks given this concurrent media coverage. That is, we do not attempt to identify what the impact of a large energy price change would be in a "media vacuum" that did not report on it at the time. (9)
[] Post-cap interventions. Although imposing a binding price cap quickly dissipated consumer uproar over the price spike, maintaining the cap created other problems. Chief among these was the fact that prices on regional wholesale markets, over which California policymakers had no authority, now exceeded the capped retail price by a considerable margin (see Figure 1). This same situation affected the state's other regulated utilities, who had not yet moved to the floating prices system and sold electricity at regulated rates similar to SDG&E's now-capped price. Essentially, the state's utilities were buying high and obligated to sell low, losing money with each kilowatt-hour consumed. This unstable situation quickly pushed the utilities toward insolvency, turning a financial crisis into one that threatened the state with shortages and electricity rationing (via periodic rotating power outages) by the winter of 2000-2001.
Rather than increase retail prices and face the same political uproar again, state leaders attempted to prevent such rationing by reducing energy consumption with other means. Starting in February 2001, state agencies and utilities undertook a major campaign to urge conservation and educate people about how to reduce energy use (we summarize its implementation in Section 6). These mass public appeals for voluntary energy conservation, and the deepening electricity crisis, received prominent media coverage throughout the spring and early summer of 2001.
California's effort to alter individual consumption behavior through its conservation campaign provoked considerable attention and initial skepticism. On the one hand, strategies that successfully reduce energy use without directly taxing it (or otherwise raising price) are of great interest to energy and environmental policymakers. Yet it is an open question whether promoting (voluntary) electricity conservation has much of an effect if consumers' economic incentives to modify their behavior remain unchanged.
To summarize, our agenda is to assess how household electricity consumption responded to three successive events: the price increase during the summer of 2000, the price cap in early fall 2000, and the state's public appeals for conservation and concurrent crisis attention during the spring and early summer of 2001.
3. Data
* We examine these events using the Household Electricity Research Billing Sample (HERB S), a large, five year panel of San Diego Gas and Electric Company residential utility bills. Each observation in the HERBS is a consumer's monthly bill, including total electricity consumption, exact billing-period dates, the total electricity bill, line-item charges, taxes, any special discounts or rebates, and so on. The data also include information on the location of the residence served, tariff schedule parameters, the billing cohort (described below), and the total bill the household would have paid absent the price cap. We constructed the HERBS with permission of SDG&E from their billing system data archives.
Our sampling design selected 70,000 accounts, at random, from the population of all residential accounts served by SDG&E in March 2001. The number of accounts in this population is the same as the number of households in San Diego County and we therefore use the two terms synonymously. We follow each sample household's account history backward 3 1/2 years to October 1997 (or to the date it established service, if later) and forward one year to April 2002 (or to the date it ended service, if earlier). Slightly less than 1000 households enter the HERBS each month prior to March 2001, and a similar number exit each month...
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