Tariff Regulation with Energy Efficiency Goals

by Laura Abrardi and Carlo Cambini

We study the optimal tariff structure that could induce a regulated utility to adopt energy efficiency activities given that it is privately informed about the effectiveness of its effort on demand reduction. The regulator should optimally offer
a menu of incentive compatible two-part tariffs. If the firm's energy efficiency activities have a high impact on demand reduction, the consumer should pay a high fixed fee but a low per unit price, approximating the tariff structure to a decoupling policy, which strenghtens the firm's incentives to pursue energy conservation. Instead, if the firm's effort to adopt energy efficiency actions is scarcely effective, the tariff is characterized by a low fixed fee but a high price per unit of energy consumed, thus shifting the incentives for energy conservation on consumers. The optimal tariff structure also depends on the cost of the consumer's effort (in case the consumer can also adopt energy efficiency measures) and on the degree of substitutability between the consumer's and the firm's efforts.