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Turning off the gas: Stronger and coherent EU policy to accelerate the fossil gas phaseout

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Rapidly phasing out fossil gas demand has become a top priority in Europe. Existing European legislation is expected to achieve only moderate reductions by 2030. The ongoing energy crisis has provided an opportunity to aim for even more extensive decreases in fossil gas demand. Legislation under negotiation, informed by the European Commission’s REPowerEU plan, is expected to go further, yet more ambitious targets and a unified policy approach could achieve potential reductions currently left on the table.  

RAP’s analysis finds that even with full implementation of the REPowerEU plan, by 2030 natural gas demand in Europe will remain roughly equivalent to Russian gas imports in 2021. A stronger energy efficiency target in the Energy Efficiency Directive (EED) and a higher renewable energy target in the Renewable Energy Directive (RED) could reduce gas demand and eliminate Russian gas imports. 

Furthermore, the Hydrogen and Decarbonised Gas Market package should emphasize integrated planning and targeted applications of alternative gases to ensure its consistent with a fossil gas phaseout. 

A joint, coherent policy approach — addressing more ambitious targets for the EED and the RED and complementary metrics applied to the Hydrogen and Decarbonised Gas Market package — would guarantee that fossil gas use is rapidly reduced and the infrastructure is in place to meet the remaining demand equitably and efficiently.

How the European Union incentivises inefficient renewable heating

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The EU’s renewables directives count what fuel is burned for heating, as opposed to the amount of heat produced.

Never has the spotlight shone so brightly on Europe’s heating and cooling sector. And for a good reason. Fossil gas makes up around 39% of the energy used to heat buildings and much of Europe wants to rapidly phase it out.

To help do so, the European Parliament recently voted in favour of a key amendment to the Renewable Energy Directive (RED): raising the annual target for the share of renewable energy in heating and cooling.

The new goal—a 2.3 percentage-point increase each year until 2030—is roughly double the one proposed in the Fit-for-55 package unveiled in 2021.

The clear signal has been set, yet there is something off with the way the metric is measured. By counting fuel burned instead of heat produced and not including electricity used for heating or cooling, the RED favours inefficient technologies.

Ignoring the mushy peas on the floor

Imagine a toddler having lunch. Her father has prepared a bowl of 300 grams of mushy peas and figures that this meal should meet half of the two-year-old’s nutrient needs for the day. She is a messy eater though and jettisons around half of her food on the ground. Once her dad sees the empty plate, he pats himself on the back, thinking that he filled her belly. He should look at the floor.

Measuring the renewable share of heating and cooling in the RED is simple. It tallies all the energy used to heat and cool from renewable sources, then divides it by the total. The key question is: which energy counts as renewable?

Unfortunately, the RED’s answer to this is flawed. It only counts final energy use or, in other words, the fuel that is delivered to the customer to use in their heating appliance. That means if someone burns a log in a fireplace at 50% efficiency and it produces 100 kilowatt-hours (kWh) of heat, how much “renewable heat” does that account for?

If you were thinking “100 kWh” you would be wrong. The RED counts that as 200 kWh, since that is the energy content of the biomass that was combusted at 50% efficiency.

That is a big problem because heating systems have different efficiencies. An electric heat pump typically produces 100 kWh of heat with 33 kWh of input electricity. The remaining 67 kWh is drawn from the ambient air for free. An 85% efficient pellet boiler needs 117 kWh.

The point: Less efficient technologies need more input energy for the same useful heat outcome. The RED discourages switching to more efficient heating appliances and electrification. It counts the full weight of the mushy peas, not just those that were eaten.

Anti-electrification policy

The other problem with the RED methodology is its scope. It does not consider the renewable electricity used for heating and cooling at all. Whether it is used to drive a heat pump or just an electrical resistance heater, it does not count toward the renewable heating and cooling target. Even for cooling, which is virtually only based on electricity.

This is an effort to avoid double-counting. The data wranglers do not want to count renewable electricity in both the power sector and the heating and cooling sector. As a data wrangler myself, I appreciate their commitment to neat allocation. But in this case, neatness has its downside.

Electricity providing a heating or cooling service should be considered towards the renewable heating and cooling target. Otherwise, heat pumps could be undervalued in terms of their contributions. If the methodology does not even consider where the electricity comes from, the heat output of the heat pump can never be fully renewable.

If the renewable share of electricity would be considered in the RED’s methodology as a heating and cooling service, the incentive to promote heat pumps would even be stronger. Member States will thus be encouraged to implement policies that aim to achieve the heating and cooling target, with the ancillary benefit of growing the deployment of efficient heat pumps to do so.

As it stands, the least efficient and least electric technologies are those that have the most potential to meet the goals under the RED. More efficient and electricity-based heating appliances risk falling behind.

The way forward

Getting metrics right is crucial to ensuring a rapid and balanced transition to clean heating and cooling. The Renewable Energy Directive’s goal should be to promote efficient heating and cooling technologies that maximise useful energy while minimising input energy.

This means counting the useful heat that is produced by a heating system, not the input energy needed. It also means including the electricity used for renewable heating and cooling.

Since electricity realistically contributes to both the headline renewable energy target (32% in the RED II and voted to increase to 45% by the European Parliament), as well as the renewable heating and cooling target. Both calculations should factor it in so that the statistics are accurate.

Double-counting can be avoided by ignoring the electricity used in the heating and cooling sector when calculating the headline target.

Metrics matter. Only by counting the useful heat produced can the Renewable Energy Directive provide the right incentives for phasing out fossil gas and spurring the clean electrification of heat.

 

A version of this article originally appeared on Foresight Climate & Energy.

Photo: Holger Schué from Pexels.

Metrics matter: Efficient renewable heating and cooling in the Renewable Energy Directive

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The Renewable Energy Directive (RED), designed to help meet the EU’s ambitious 2030 and 2050 climate targets, sets targets for growing renewables usage for heating and cooling in the building sector. As currently written, however, the RED encourages inefficient uses of renewables in buildings to meet these goals.

In this paper, we suggest reforms to the RED would ensure a more efficient and balanced approach to renewable heating and cooling in the EU. It shows that the RED’s metric for determining the contribution of renewable heating and cooling tends to favour less efficient technologies. The paper also discusses how the use of electricity for heating and cooling is not accounted for in the RED definition of renewable heating and cooling, nor in the methodology for the renewable contribution of heat pumps.

By adapting the definition of renewable heating and cooling and updating the definition of renewable heat from heat pumps, the RED can provide a more comprehensive overview of the status of decarbonising the sector. We recommend the following policy adjustments:

  • Amend Article 7 (3) of the RED to calculate the useful energy produced instead of fuels consumed to produce it.
  • Mandate Eurostat to develop a consistent method for counting the amount of (renewable) electricity used for different services including heating and cooling, both in general and from heat pumps. To avoid double counting, remove this electricity from the heating and cooling sector when calculating the headline renewable share.
  • Amend Annex VII of the RED to include the electricity used to drive heat pumps so that it accounts for the full contribution of heat pumps.

‘Game on’ for Germany’s heat pump transformation

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Time is of the essence if Germany hopes to meet its ambitious net-zero emissions target by 2045. To achieve this goal, the country will have to rapidly transform how it heats its buildings while ridding itself of Russian gas. Alongside increasing the renovation rate of buildings and rolling out clean district heating, heat pumps are one of the key technologies that can phase out fossil fuels and bring renewable heat to German buildings.

The situation has become even more urgent following Russia’s invasion of Ukraine and the ongoing fossil gas crisis. About two-thirds of German gas imports came from Russia in 2020 and the building sector is the country’s largest consumer of gas for heating. In the five years leading to 2020, gas boilers made up more than half of the market for space heating, while oil boilers made up another 12%. Heat pumps came in at only 16%.

Germany will need to install around 6 million heat pumps by 2030 to be on track for the 2045 target. That translates to a massive increase in annual heat pump uptake — from 154,000 installations in 2021 to 500,000 yearly by 2023. Up until now, most of these units have been installed in new buildings. The existing building stock will need to bear most of the load and, crucially, low-income households must receive enough support to make the transformation equitable as well.

The challenge is enormous. Despite generous subsidies during the past few years to encourage the replacement of fossil fuel boilers with heat pumps, the market has been stubborn. The year 2021 saw more than 920,000 heating appliances installed in Germany – 700,000 were still oil and gas boilers.

Germany has discovered first-hand that generous subsidies from the country’s federal subsidy program (previously the Market Incentive Program and now the Federal Support Program for Efficient Buildings) are not enough to spur a rapid heat transition in buildings. Recently, Agora Energiewende and RAP released new analysis prepared by the Öko-Institut and Fraunhofer ISE that looks at how to trigger this market transformation.

Germany’s 65% rule: Russian gas out, heat pumps in

To achieve its net-zero target and reduce gas consumption, Germany needs to end fossil fuel boiler installations as soon as possible. Financial incentives for clean alternatives did not trigger the necessary market shifts in the past. Regardless of much higher gas prices, subsidies are unlikely to be enough for the required transition. This is in part because German households pay more than six-times higher taxes and levies per kilowatt-hour of electricity than for fossil gas.

What else can be done? The federal government’s answer was announced in March 2022. Starting in January 2024, all new heating systems will need to run on 65% renewables. This political agreement should apply to heating system installations in new buildings as well as replacements in existing ones.

The 65% threshold must be implemented via laws, but the agreed wording leaves the door open to hybrid heat pumps where, typically, a heat pump is combined with a fossil boiler. That would be the bare minimum — standalone oil or gas boilers are de facto ruled out and even solar thermal systems combined with gas boilers would not meet the 65% baseline.

Hybrid heat pumps are cost-advantageous only in the rarest cases. According to the new analysis, standalone heat pumps hold the economic upper hand until the outside temperature falls to -7°C, at which point it is cheaper to heat with a gas boiler. For comparison, from 1991-2020, January temperatures in Germany averaged 1.7°C.

The plan is ambitious, but Germany is in good company. This policy attention towards heating systems is consistent with efforts at the EU-level, such as the Fit for 55 package, REPowerEU plan and Ecodesign performance standard regulation, and in various Member States, several of which have announced bans for new oil and gas boilers with diverse years of implementation.

Key actions for a swift transformation

Transforming a heating market based on 700,000 fossil fuel heating systems to a market predominately centered around heat pumps in only 18 months is a daunting task. Once implemented, the ‘65% rule’ will become the regulatory instrument that draws the borders of the field on which the game will take place. And in January 2024, it will blow the whistle to kick it off. Before that happens, a massive and swift industrial transformation will be required that sweeps along all members of the supply chain, from manufacturers to installers to households. Targeted support for low-income households will be crucial so they are not disadvantaged.

The total cost of owning a heat pump could slow down their future uptake or significantly increase the cost burden on homeowners. Without considering existing subsidies, the upfront cost of a first time, fossil-fuel-to-heat-pump switch in Germany is still around two- to three-times higher than a gas boiler replacement, though much of this is associated with radiator and pipe upgrades. Upfront costs, however, have risen significantly due to a shortage of skilled craftspeople. Installers say they can reduce costs by shortening the installation time from three to two days, while manufacturers have a 40% cost reduction potential in view based on new production methods as well as economies of scale.

To help reduce operating costs, the government has shifted its famous renewable energy surcharge away from electricity bills onto general taxation. On top of that, it is gradually phasing in a carbon price on heating fuels that should reduce this imbalance in the coming years. The new analysis recommends lowering the electricity price for heat pumps by exempting them from certain levies, reducing the VAT to the EU-minimum, and enabling the use of heat pump tariffs that maximize the contribution of heat pump flexibility to meeting power system needs.

To achieve the Germany’s ambitious net-zero target and provide transparent and predictable market conditions, the whistle is in the hand of the government. Kicking off the heat pump transition in a transparent, equitable and suitably ambitious manner means tabling a draft law to implement the 65% rule as soon as possible.

Read the analysis here (in German).

Navigating towards net-zero power system: it is not the ‘heading’ but the ‘course’

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The energy price and supply risks we are facing today are making the decarbonisation of the power sector by 2035 an even more significant challenge. But if we deviate the heading of our ship from the course for longer than necessary, we will lose the course we set for ourselves: cost-efficient power sector decarbonisation writes Zsuzsanna Pató.

The energy price crisis and the war in Ukraine opened a whole new dimension for the need to get off fossil fuels, alleviate energy poverty and assure reliable energy service for consumers. Pursuing these multiple objectives has always been challenging, but the urgency of action adds another facet: we need to accelerate power system decarbonisation and achieve a 75% renewable share by 2030.

We must ensure that the responsive, short-term actions taken to meet today’s security and price challenges are directionally correct for the long-term vision: a decarbonised and well-functioning economy by 2050. Building soon-to-be abandoned fossil infrastructure now is costly.

Similarly, distorting the merit order by capping gas prices slows down the replacement of fossil fuel capacities with clean resources. The scale of the challenge and the ‘need for speed’ is unprecedented. Old thinking will not deliver the new energy system we need.

With that in mind, RAP has developed a Blueprint for a decarbonised European power system, including the necessary regulatory solutions to navigate there by 2035.

A new baseline for clean investments

Recent events revealed the actual cost of gas. This is the new baseline for investment decisions into clean energy solutions. Gas and other fossil fuel prices can jump on a rollercoaster at any time and take Europe for a ride.

Decarbonising the energy system means decarbonising power generation first. Renewable-based generation technologies are proven technologies, and their costs continue to decrease steadily. The most efficient way of decarbonising heating and transport is via electrification. Both of these end-uses rely on imported fossil fuels in Europe.

Climate policy is now security policy

Rapidly displacing fossil fuels, including Russian gas, with renewable power generation capacity has its own challenges. It requires the parallel pursuit of the goals of minimising the cost of the transition, maintaining a reliable power system and safeguarding the equitable distribution of cost and benefits among consumers while alleviating existing inequalities. The ‘great energy capacity swap’ rests on a few key tenets explored below.

The basics of a zero-emissions power system

The core coordination mechanisms are markets and prices. Creating an integrated European power market has already delivered large benefits to European consumers. Prices — that are granular in time and space — are key in optimising production and consumption decisions and responses. The core European power market model is not broken and does not need a fix. However, it requires some safeguards and reinforcements to protect customers from extreme price impacts and ramp up the speed of change.

Energy Efficiency First must take its place as a key overarching principle, not just a slogan or a new name for energy efficiency. To minimise total system costs, the most efficient solution needs to be chosen from the pool of supply, storage and demand options when balancing the system, providing grid services and ensuring resource adequacy.

Low-cost management of a renewable-based power system needs a lot of flexibility from all possible sources: generation, storage and demand. Faster and larger markets further facilitate the integration of variable generation.

Consumers must wear two hats. They are the ultimate vendors, so they should be empowered to define what energy services they need. They also offer essential new system resources by their demand, storage and generation capabilities.

More grid and more generation assets will virtually always equal more reliability, but we need to ask if the gains are large enough to justify the costs each time. Optimal resource adequacy means full transparency over the cost of marginal supply-side capacity and full recognition of the value of demand-side flexibility. Thriving forward markets are key in triggering investment based on consumer choice and — unlike capacity mechanisms — without running the risk of supporting non-economic/fossil units.

Europe has ambitious offshore wind development plans. Scaling up requires new thinking: joint grid planning with anticipatory investment, multipurpose grid use (interconnection and linking wind parks onshore) and single system operation.

Power System Blueprint

RAP pulled the essential building blocks of a future zero-emissions power system in Europe by 2035. The Power System Blueprint takes a systems view, sketching out an integrated plan of regulatory solutions essential for a transition that is efficient and equitable. The solutions are designed to galvanise the dirty-for-clean capacity swap, optimise network investment and safeguard efficient spending and consumption decisions through transparent pricing. They are offered up as a toolbox to assist EU and national regulators as they identify the next steps and formulate strategies, each with its own starting points and priorities.

Conclusion

The war in Ukraine drastically changed the public discourse on energy — systems and markets. Calls for stepping back from the transition as planned to reconsider the fundamentals of markets are myopic. At this pivotal moment, it is incumbent on us to accelerate the transition while safeguarding consumers from extreme price impact while needed. Whenever you decide on next steps, you should keep the eyes on the horizon. Always. Not only on the direction of the wind.

This article previously appeared in Euractiv

From laggard to leader: How Poland became Europe’s fastest-growing heat pump market

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With the war in Ukraine compelling everyone to rethink their energy strategies and focus on getting rid of Russian fossil fuel imports, while maintaining what is left from the affordability of energy supply, the go-to tactics are achieving several energy policy goals at the same time. The Polish heat pump sector seems to be doing just that.

It is showing the fastest growth rate for heat pumps in Europe in 2021 with an expansion of the market by 66% overall—more than 90,000 units installed reaching a total of more than 330,000 units. Per capita, more heat pumps were installed last year than in other key emerging heat pump markets, such as Germany and the United Kingdom.

But this has not always been the case. For years Poland prided itself on being one of the most energy independent countries in Europe. Its coal mining sector and coal-fueled power plants provided carbon-intensive, but domestic, energy—both for heating and electricity.

Coal Dependent

Even now, with the recent growth of renewables making quite a dent in Polish coal reliance, the share of coal in electricity production and district heating is around 70%. In individual home heating, it is around 48%. Poles consume as much as 87% of the coal burned by all EU households in their homes for heating. The heating sector is responsible for nearly a quarter of CO2 emissions in Poland.

This reliance, however, has been proving less and less sustainable for a number of reasons — especially in the individual heating sector. First of all, the energy independence narrative no longer holds. Polish coal mines are notoriously labour-inefficient, but a bigger problem is that they become less and less economical to run for sheer geological reasons. The average depth of extraction is now close to 800 metres below ground, which brings immense cost—both economical and human.

Time has seen a steady decline in coal mining output, especially for the coal sorts used by individual boilers are in shorter supply. This has been replaced by imported coal mainly from Russia. Poland is currently buying €0.5-1 billion worth of Russian coal each year to heat its houses.

Even if we put aside the acute air quality problems that burning coal in old individual coal furnaces brings—which we should not as the list of 20 most polluted cities in Europe constantly features at least 10 Polish cities—this should be enough in the current circumstances to warrant a huge public policy shift directed at eliminating coal from individual heating altogether.

The preferable way of doing so would be a massive deployment of heat pumps and energy efficiency programmes whilst continuing to utilise more renewables for electricity generation at the same time. This would check the boxes for so many policy objectives, including increasing energy security, reducing carbon emissions and lowering long-term heating costs.

Long-Term Planning

Given Poland’s reliance on coal for heating, how did the Polish heat pump market achieve such remarkable growth? All signs point towards government policy. Through the ten-year Clean Air Programme that started in 2018, Poland will provide close to €25 billion for replacing old coal heating systems with cleaner alternatives and improve energy efficiency.

In addition to providing subsidies, many regions in Poland have begun to phase out the coal heating systems through regulation. Prior to those bans, heat pump installations rates were modest with limited growth over the years. This shows that policy can make a big difference in steering the market towards clean heating away from polluting fossil fuel heating systems.

Trust Building

The recent success is also a showcase of efficient market development by the heat pump industry association, PORT PC. Building customer and installer trust by developing and introducing industry guidelines, quality standards and certification, as well as conducting extensive training programmes, is now bearing fruit.

Further growth in the heat pump sector in Poland is expected and will need to take place in order to further replace coal heating. This can be achieved by implementing changes to the Clean Air Programme and other similar programmes designed to improve the efficiency of homes and heating systems, like the current tax breaks for investment in buildings insulation as well as the STOP SMOG programme designed to help local governments give targeted support to the poorest households.

Also, the recently announced new programme “My Heat” financed from the sale of EU ETS allowances through the Modernisation Fund and fully directed towards heat pumps, will provide additional sources of funding and hopefully build even more awareness among consumers.

Whilst the Clean Air Programme has so far promoted mostly gas boilers (over 40% of the total), the war in Ukraine has shown that natural gas will be a scarce and costly resource and should be used wisely. Heat electrification, rather than gasification, is surely the way to go.

Challenges Remain

Three challenges remain to be tackled for continued success. Firstly, for heat pumps to be most beneficial in terms of climate protection, electricity generation should continue on the pathway towards (quicker) decarbonisation.

Secondly, heat pumps should be an element of system flexibility, rather than a strain on the peak demand. For this, dynamic tariffs and smart solutions are fairly easy fixes but require regulatory intervention as well as consumer awareness and industry willingness to go the extra mile.

Thirdly, proactive measures should be taken to avoid potential supply chain disruptions and to secure enough of a skilled workforce. Poland is very well positioned in both areas, now being a highly industrialised country with excellent technical education.

Poland’s energy transition is picking up speed, and the growing heat pump market is a prime example of a policy push working with supply pull to deliver excellent results. The prospects are encouraging and there have never been more incentives to continue on this pathway.

This article previously appeared in Foresight.

The perfect fit: Shaping the Fit for 55 package to drive a climate-compatible heat pump market

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Removing fossil fuels from heating is a goal of policy makers around the world in order to decarbonise energy systems and to remove exposure to fossil fuel imports. Alongside efficiency measures, the key technology to replace fossil fuels for heating is heat pumps. In the EU, where fossil fuels — mostly gas — dominate the heating mix, rapid action on heat is needed and the share of heat from heat pumps is expected to grow at lightning speed. Heat networks, which simultaneously need to grow rapidly, are also expected to see much of the heat they transport produced from heat pumps.

This report — a collaborative effort between RAP, Agora Energiewende, CLASP, and the Global Buildings Performance Network — makes the case that the Fit for 55 package can drive a robust heat pump market in the EU, and that reform of the proposals is needed.

With decades of support given to fossil fuel heating technologies, the rapid deployment of heat pumps will need support. The report identifies the current barriers to making that happen, as well as the six areas where the Fit for 55 package can go further in supporting heat pumps at the scale needed:

  • Development of ETS 2 in the ETS directive, which would include buildings as well as transport sectors.
  • Revisions to Energy Taxation Directive to ensure electricity is always taxed lower than other fuels, which will have tax levels linked to environmental damage.
  • Recast Energy Efficiency Directive in which proposals are set to disallow energy savings from boiler installations, as well as introduce a standard for ‘efficient heating and cooling’ networks.
  • Revised Renewable Energy Directive, which includes higher targets for renewable heat use in buildings.
  • Revisions to the Energy Performance of Buildings Directive, which include the need for Member States to set out policies for fossil fuel heating phaseouts by 2040 and the need for new, zero emission buildings by 2030. Revisions also include uplifts to minimum energy efficiency standards.
  • Modifications to energy labelling and ecodesign regulations for heating appliances are being reviewed and rescaled in parallel to the package.

The report also details how Member State-level policy reforms can move ahead of the Fit for 55 changes in the shorter term. These policies need to be supported by clear government heat pump strategies and joined-up heat and buildings governance. Immediate action is needed to reform heat pump policy across the EU. The Fit for 55 package provides a window of opportunity for policy change that must not be missed.

Read our two-page summary here.

The Complex Landscape of Net Metering Reform in California: Why an Installed Capacity Charge?

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Rooftop solar in California has grown from an infant industry two decades ago to a 10-gigawatt resource that contributes significantly to customer and electric system needs today. The state is blessed with ample sunshine in many regions, and its urgency on this and other clean-energy innovations was born out of the energy crisis in 2000 and 2001, as well as the need to address climate change and improve public health. But a proposed range of reforms to net metering for residential rooftop solar has prompted debate about the future of that important market segment, as well as the broader trajectory of state energy policy.

Full retail rate net energy metering with monthly netting (“traditional NEM”) — the method initially used in nearly every U.S. state, including California — is easy to implement and understand. Traditional NEM, which opted for simplicity over precision and was intended to kick-start an infant industry, might not be ideal from the perspectives of efficiency or fairness, but the extent of those problems depends on the level and design of retail rates, as well as the overall resource mix, load patterns, and customer solar adoption levels.

The maturation of the solar industry and the modernization of the electric grid make an evolution from traditional NEM to more efficient and sophisticated rate designs both possible and desirable. The exact speed of that transition, and exactly which direction to head, is not necessarily obvious and involves tradeoffs that policymakers and stakeholders should understand and debate fully. RAP recently released a report for the Michigan Public Service Commission that seeks to help Michigan regulators and policymakers understand these tradeoffs as they consider improving their rate designs for distributed energy resources (DERs), as well as the broader tariff specifications and DER program structures.

In 2016, California took a substantial step away from traditional NEM to “NEM 2.0.” That step required solar customers to be on a time-of-use (TOU) rate along with other reforms. All else equal, those reforms were designed to reduce the level of compensation for a new solar customer. Residential solar installations dropped modestly in 2017 but the pace of residential installations has grown steadily since then. On Dec. 13, the California Public Utility Commission’s proposed decision on NEM reform signaled a new stage in this debate. The proposed decision found there has been a significant cost shift from new residential solar customers to non-participating customers under NEM 2.0 and includes a wide range of additional reforms to rate design for new solar customers.

These proposed reforms are well intended, and many have substantial merit — including more differentiated time-of-use rates, value-based export credits, encouragement of solar plus storage, and a range of equity measures. More controversially, the proposed decision included a new “grid participation charge,” which is structured as a $/kW monthly fee on installed capacity for new residential solar customers. A new “market transition credit,” structured as a $/kW monthly credit on installed capacity, would partially offset the grid participation charge temporarily for customers of two of the three utilities, at a level designed to achieve a 10-year payback period for new solar installations.

The basic concept of the grid participation charge is not new. It has been debated before and can be generically described as an installed capacity charge. An installed capacity charge is not tied to any reasonable metric of the size of the customer or their impact on or usage of the grid, but is primarily a way to spread certain categories of costs. The direct incentive provided to customers by an installed capacity charge, all else equal, is to install fewer kW of the resources covered by such a charge. In this case, the market transition credit is attempting to partially counteract this effect by ensuring a reasonable payback period for new customers. In that context, it is important to consider whether such a spreadsheet analysis is reasonably accurate and whether there are more qualitative considerations, such as the complexity of the newly proposed rates, that could further hinder adoption.

New York is implementing a similar rate structure for new residential rooftop customers starting in January 2022, which has been labeled a “customer benefit contribution” charge. This charge is designed to cover a smaller set of program costs, namely energy efficiency and clean energy programs as well as low-income discounts. New York’s situation is different: Without its advanced metering infrastructure fully deployed, more sophisticated rates are difficult to implement. The New York Department of Public Service previously estimated that this new charge will be between $0.69 and $1.09 per kW (direct current) of installed capacity, depending on the utility. Final rates, going into effect next month, were recently filed and range from $0.72/kW to $1.33/kW. This means that the size of California’s proposed $8/kW charge for installed capacity is unprecedented, even if it is effectively reduced to $4 or $6 per kW by the market transition credit in the first year of this new structure for two of the utilities.

Jumping into such unexplored territory comes with risks. History shows that rate designs like this spur customers and vendors to find innovative workarounds. For example, customers may try to avoid this new charge by fully disconnecting from the grid. While unlikely for many customers today, it may become a more popular option if costs for storage continue to fall dramatically. Alternatively, customers may be able to set up their solar and storage systems to avoid exporting to the grid and thus avoid any need to notify the utility and be exposed to the grid participation charge. Solar installers have experience with both of these options in Hawaii. Such behavior is likely suboptimal from the societal perspective, and would likely cause significant cost-shifting to other customers. The CPUC could try to prevent these reactions, but this could just push such behavior further underground. Other unintended consequences will also likely arise.

Of course, the proposal for the grid participation charge cannot be evaluated in a vacuum — without a comparison to the relevant alternatives. Regulators should be guided by this principle for efficient rate design (which takes on increasing importance as customers have more options to invest in generation, storage, and load controls): Rate design should make the choices a customer makes to optimize their own bill consistent with the choices that would minimize system costs. Continued reforms to residential time-varying rates is an important option we will explore more fully in a follow-up blog. For now, we note several other rate design options that can address cost shifts from solar distributed generation in a manner similar to the grid participation charge. These should be considered instead of an installed capacity charge, or in combination with a small installed capacity charge:

  • Reasonably sized customer charges ($5 for low-income customers and multifamily building residents, $10 for everyone else);
  • A distribution flow charge on both inflows and outflows;
  • A demand-based or connected load charge to cover line transformer and other site infrastructure costs (approximately $1-2/kW); or
  • A higher minimum bill.

RAP has long advised against major reliance on large customer charges and demand charges for efficiency and equity reasons. In many states and for many customer classes, these charges are far too high. But within proper limits, these options all have a stronger cost causation argument than an installed capacity charge. The distribution flow charge, defined as a cents-per-kWh rate on both imports from and exports to the grid, has not been implemented by any state utility commission, but is a concept that RAP put forward in our report for the Michigan PSC as well as a 2013 report on distributed generation tariff design. Demand charges can also be more difficult for customers to understand and manage than other types of rates, although this can be mitigated with education efforts and data provision.

Ideally, these options would be considered as part of broader reforms to rate design for residential customers. Not all residential customers need to be exposed to more complex rates, however. Another idea discussed in the Michigan report is segmenting the residential class into an “advanced” category and a “basic” category. That way, a broad swath of the residential class could be moved onto more sophisticated and efficient rates without risking adverse impacts to low-income and low-usage customers. Broader residential rate design reform was not a focus of the current California proceeding, but it should be considered as the full CPUC takes up the proposed decision.

The grid participation charge, and other alternatives to address similar issues, is not the only important public policy concern as California considers reforms to its DER program. RAP will follow up with additional blogs in this area in January, discussing issues such as the structure of time-of-use rates, the newly proposed value-based export credit system, community solar and locational value.