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Price Discrimination and the Adoption of the Electricity Demand Charge

Published online by Cambridge University Press:  03 March 2009

John L. Neufeld
John L. Neufeld
Affiliation:
Associate Professor of Economics at the University of North Carolina at Greensboro, Greensboro, NC 27412.
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Abstract

Between 1905 and 1915, as state price regulation became widespread, electric utilities in the United States faced severe competition. The primary source of electricity for industry then was not utilities but self-generation by the user in an “isolated plant.” The demand-charge rate structure first became widespread during this period. The demand-charge rate structure has been interpreted as a misapplication of the peak-load pricing principle, a view which has made its popularity a puzzle. Instead it was adopted as a sophisticated mechanism which institutionalized profit-maximizing price discrimination given the competition from isolated plants.

Type
Articles
Information
The Journal of Economic History , Volume 47 , Issue 3 , September 1987 , pp. 693 - 709
Copyright
Copyright © The Economic History Association 1987

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References

The author is Associate Professor of Economics at the University of North Carolina at Greensboro, Greensboro, NC 27412. Earlier versions of this paper were presented at the Triangle Area Economic History Workshop and the Rutgers University Advanced Workshop on Regulatory Economics. I am indebted to the participants in those workshops and to others including William Hausman, Barry Hirsch, David Kemme, Albert Link, Wilson Mixon, Kenneth Snowden, and anonymous referees. I gratefully acknowledge the support of the UNCG Research Council.Google Scholar

1 Neil, Charles E., “Entering the Seventh Decade of Electric Power,” Edison Electric Institute (1912), unpaged. Material discussed here appears on the 12th page.Google Scholar

2 As the electrification of industry increased, more energy was purchased from utilities. The enormous impact of electrification on American industry has been shown by Devine, Warren D., “From Shafts to Wires: Historical Perspective on Electrification,” this JOURNAL, 43 (06 1983), pp. 347–72;Google ScholarDuBoff, Richard B., “The Introduction of Electric Power in American Manufacturing,” Economic History Review, 2nd ser., 20 (12 1967), pp. 509–18;Google Scholar and Woolf, Arthur G., “Electricity, Productivity, and Labor Saving in American Manufacturing, 1900–1929,” Exploration in Economic History, 21 (04 1984), pp. 176–91.CrossRefGoogle Scholar

3 The first publication by an American economist in this tradition probably was Clark, J. M., “Rates for Public Utilities,” American Economic Review, 1 (09 1911), pp. 473–87.Google Scholar The usually cited seminal works in the modern literature include Boiteux, M., “La Tarification des Demands en Point: Application de la Theorie de la Vente au Cout Marginal,” Revue Generale de l' Electricite, 58 (08 1949), pp. 321–40,Google Scholar translated as “Peak-Load Pricing” in Journal of Business, 33 (04 1960), pp. 157–79;Google Scholar and Steiner, P., “Peak Loads and Efficient Pricing,” Quarterly Journal of Economics, 71 (11 1957), pp. 585–610.CrossRefGoogle Scholar Econometricians have recently become involved with estimating the benefits from time-of-day rates. See Aigner, Dennis J., “The Welfare Econometrics of Peak-Load Pricing for Electricity,” Journal of Econometrics: Annals 1984–1983, 26 (09/10 1984), pp. 1–15.CrossRefGoogle Scholar

4 Energy has a time dimension and is now commonly measured in kilowatt-hours. Power has no time dimension and is measured in kilowatts. One kilowatt-hour of energy can be consumed by using one kilowatt of power for one hour or by using two kilowatts of power for one-half hour. “Demand” is (and was) usually measured not as the maximum instantaneous power used but as the maximum average power used in any 15-minute (or other short time) period. The specific way in which “demand” is charged usually falls into one of two categories: Hopkinson rates and Wright rates. A Hopkinson rate contains an explicit demand charge, for example: demand charge = $2.50 per month per kilowatt of the maximum demand in the month, plus an energy charge of 5 cents per kilowatt-hour used in the month. A Wright rate achieves the same objective through the use of a declining block structure with the size of the high-priced block a function of “demand”: 10 cents per kilowatt-hour for electricity used equivalent to or less than 50 hours use per month of the maximum demand; 5 cents per kilowatt-hour for electricity used in excess of the equivalent of 50 hours use per month of the maximum demand. Consider an electricity user whose maximum power consumption in one month is 1 kw and whose energy consumption is 300 kwh. Under a Hopkinson rate, the bill would be calculated as: 1 kw x $2.50 per month (= $2.50) + 300 kwh x $0.05 per kwh (= $15.00) = a total charge of $17.50. Under a Wright rate the calculation would be: (1 kw demand × 50 hours) × $0.10 (= $5.00) + (300 kwh - 50 figured above) × $0.05 (= $12.50) = a total charge of $17.50. Given any Hopkinson rate structure, one can always develop a Wright rate structure which will produce identical bills except in the case of an electricity user whose consumption of energy is so low relative to his maximum power usage that it remains wholly in the initial high-priced block. Actual rate structures sometimes combine features of Hopkinson and Wright rate structures and frequently add other complicating features, such as block pricing. The term “demand-charge rate structure” will be used to refer to any rate structure in which a user's bill is partially a function of his maximum power consumption independent of the time in which the maximum power consumption occurred. The term “demand charge” will be used either interchangeably with “demand-charge rate structure,” or, more specifically, to refer to the component of an electricity user's bill which is determined by maximum power consumption. The term “demand” especially in quoted material, will often refer to the engineering concept of maximum power consumption rather than the usual economic concept. The meaning should be clear from the context.Google Scholar

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8 In 1897 and 1898 the Commissioner of Labor surveyed electric power companies and received responses from about 31 percent, responsible for 45 percent of the value of all electricity generation. Of those reporting income by type of service (93 percent of respondents), arc lighting accounted for 39 percent of total income and incandescent lighting accounted for 49 percent. A relatively small number of large stations were responsible for much of the non-lighting income. Lighting was the source of over 90 percent of total income for 75 percent of respondents. Fourteenth Annual Report of the Commissioner of Labor 1899, House of Representatives, 56th Cong., Document No. 713 (Washington, D.C., 1900).Google Scholar

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11 Insull mentioned his financial involvement in the Wright patents in a discussion over the relative merits of demand-charge and time-of-day rate structures, Minutes of the Fourteenth Annual Meeting (19th Convention) of the Association of Edison Illuminating Companies (Sault Sainte Marie, Michigan, 1898), p. 133.Google Scholar

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39 The National Electric Light Association's Report of Rates for Commercial Lighting and Power Service (New York, 1906).Google Scholar

40 Generally the term sliding scale indicated that discounts on energy costs were given those with larger consumption, as would be the case under a declining block rate schedule. Presumably this term might also have been used for a “Wright” demand-charge rate structure, or a similar rate structure. See fn. 4 for an explanation of the Wright rate structure.Google Scholar

41 Rate Research Committee, NELA Rate Book and Supplement (Chicago, 1917).Google Scholar