Should Utilities Compensate Customers for Service Interruptions?

Electricity Journal

Volumn 25, Issue 7, 2012, Pages 45-55

  Costello, Ken ^a  

^a UNIVERSITY OF CHICAGO   (United States)

Author keywords

[No Author keywords available]

Indexed keywords

CONDITION; FINANCIAL COMPENSATION; FINANCIAL PENALTY; SERVICE INTERRUPTION; STATE COMMISSIONS;

SALES;

EID: 84867455432     PISSN: 10406190     EISSN: None     Source Type: Journal    
DOI: 10.1016/j.tej.2012.08.001     Document Type: Article

References (26)

1. See Ronald Coase, The Problem of Social Cost, J. LAW & ECON. 3 (Oct. 1960), at 1-44.
2. Doug N. Jones and Patrick C. Mann, The Fairness Criterion in Public Utility Regulation: Does Fairness Still Matter? J. ECON. ISSUES 35(1) (March 2001), at 153-72.
3. A utility, for example, could be motivated to overspend on reliability to avoid outages. ''Overspending'' means that at an existing level of reliability the marginal benefits from reduced outages are less than the marginal costs.
4. The latter pricing scheme reflects what economists call ''perfect price discrimination.'' Under this extreme form of discrimination, the utility would extract all the value that customers receive from electricity consumption. Although economically efficient, few people would consider this outcome to pass a ''fairness'' test.
5. One interpretation of ''reasonable care'' is that the customer should use the same degree of care that a person of ordinary prudence would exercise in the same or a similar situation.
6. As pointed out elsewhere in this article, it could also be inefficient in the sense that customers would tend to be more careless in controlling the damages from a service interruption.
7. In restoring service, a utility incurs costs that it might never recover. Exceptions include a special rider that allows a utility to recover its costs from a major storm and deferred recovery of the costs during the next rate case.
8. Penalties for substandard reliability should exceed in dollars the higher costs for a utility to improve its reliability. Otherwise, the utility would prefer to pay the penalty and continue to have substandard reliability.
9. Customers would differ as to the additional amount they would be willing to pay because of the varying effect of outages on individual customers.
10. The outcome is also economically efficient in that the increased value of electricity to customers is greater than the additional costs to the utility. The assumption is that customers have an estimate of the decrease in the value of lost load from more reliable service.
11. ''Pareto optimality'' is an economically efficient world in which no person becomes better off without another person becoming worse off.
12. See, for example, American Society of Civil Engineers, Failure to Act: The Economic Impact of Current Investment Trends in Electricity Infrastructure (Reston, VA: American Society of Civil Engineers, April 2012). The report warns that if the country fails to make the necessary investments (which involves hundreds of billions of dollars) to upgrade its generation, transmission, and distribution systems, businesses and other power consumers will suffer more frequent blackouts and brownouts, motivating them to develop secondary or backup sources of power. The report estimated that power interruptions could cost an industrial firm between $2,000 and $5,000 and a commercial business between $700 and $1,300.
13. From the author's observation, typically electric utilities apologize for a prolonged outage but then defend it as an uncontrollable event and refuse to offer any compensation to customers.
14. See Pacific Economics Group, Service Quality Regulation for Detroit Edison: A Critical Assessment, March 2007; and Pacific Economics Group Research, System Reliability Regulation: A Jurisdictional Survey. The latter study identified several states where regulators require utilities to report on their service-reliability metrics and monitor the utilities' performance for the metrics: In the U.S., eight States and the District of Columbia have system reliability targets for some of the utilities in the State, while 12 States have penalty/reward mechanisms for at least some utilities in the State. Seventeen U.S. States have system reliability monitoring regimes (at 52).
15. See also Serena Hesmondhalgh et al., Approaches to Setting Electric Distribution Reliability Standards and Outcomes.
16. This argument assumes that a utility compensates customers based on their actual losses. It does not apply when a utility pays customers a fixed amount for outages no matter what the effect is on an individual customer.
17. This argument is dubious because studies have shown definitely that customer losses from power outages are much greater than any reduction they may receive on their bills.
18. The author is aware of only four utilities that pay compensation based on actual damages, subject to a cap and other specified conditions. They are Ameren and Commonwealth Edison in Illinois, Southern California Edison, and Consolidated Edison inNewYork.
19. A counterargument is that compensation by itself could motivate a utility to upgrade its system. The motivation depends on the size of the compensation (assuming that the utility is unable to recover it from ratepayers) relative to the incremental cost of upgrades. If, for example, compensation were greater than the incremental cost, the utility would tend to upgrade its system. This outcome is efficient when customers value the increased reliability more than the additional costs for upgrading.
20. See, for example, Hung-Po Chao and Robert Wilson, Priority Service: Pricing, Investment, and Market Organization, AMER. ECON. REV. 77(5) (Dec. 1987) at 899-916.
21. This problem also would arise if customers file a false claim.
22. In the United Kingdom, for example, the regulator, the Office of the Gas and Electricity Markets (OFGEM), has what it calls Guaranteed Standards in place that require distribution companies to compensate customers, subject to certain exemptions, if the companies fail to restore service within a specified time period. The standards cover 12 areas, including service restoration, connections, and voltage quality. OFGEM expressed that the objective is to compensate customers for the inconvenience caused by an outage, and not for subsequent financial losses. The mechanism also gives distribution companies incentives to restore service as soon as practicable within a specified time period to avoid paying compensation. See http://www.ofgem.gov.uk/Networks/ ElecDist/QualofServ/GuarStandds/Pages/GuarStandds.aspx.
23. ''Consumer surplus'' measures the difference between the value of consumed electricity and the outlays required by a customer to pay for the electricity.
24. Empirical evidence is lacking as to whether utilities are the lowest-cost damage mitigator. This evidence would be important in identifying which party, from an efficiency perspective based on the Coase theorem, should be liable for outage damages.
25. As stated elsewhere in this article, however, customers do have some control over the damages they suffer from an outage.
26. A customer would have to show that the utility was negligent, resulting in damages, for example, in the formof spoiled food, water damage to a home, equipment failure, and repair costs.