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Headwinds and Tailwinds: Implications of Inefficient Retail Energy Pricing for Energy Substitution


  • Severin Borenstein
  • James B. Bushnell


Electrification of transportation and buildings to reduce greenhouse gas emissions requires massive switching from natural gas and refined petroleum products. All three end-use energy sources are mispriced due in part to the unpriced pollution they emit. Natural gas and electricity utilities also face the classic natural monopoly challenge of recovering fixed costs while maintaining efficient pricing. We study the magnitude of these distortions for electricity, natural gas, and gasoline purchased by residential customers across the continental United States. We find that the net distortion in pricing electricity is much greater than for natural gas or gasoline. Residential customers in much of the country face electricity prices that are well above social marginal cost (private marginal cost plus unpriced externalities), whereas in some areas with large shares of coal-fired generation, prices are below social marginal cost. Combining our estimates of marginal price and social marginal cost for each of the fuels with a large survey of California households’ energy use, we calculate the distribution of annual fuel costs for space heating, water heating, and electric vehicles under actual pricing versus setting price at social marginal cost. We find that moving prices for all three fuels to equal their social marginal cost would significantly increase the incentive for Californians to switch to electricity for these energy services.

Suggested Citation

  • Severin Borenstein & James B. Bushnell, 2022. "Headwinds and Tailwinds: Implications of Inefficient Retail Energy Pricing for Energy Substitution," Environmental and Energy Policy and the Economy, University of Chicago Press, vol. 3(1), pages 37-70.
  • Handle: RePEc:ucp:epolec:doi:10.1086/717218
    DOI: 10.1086/717218

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    References listed on IDEAS

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    Cited by:

    1. Severin Borenstein & Ryan Kellogg, 2023. "Carbon Pricing, Clean Electricity Standards, and Clean Electricity Subsidies on the Path to Zero Emissions," Environmental and Energy Policy and the Economy, University of Chicago Press, vol. 4(1), pages 125-176.
    2. Aldy, Joseph E. & Burtraw, Dallas & Fischer, Carolyn & Fowlie, Meredith & Williams, Roberton C. & Cropper, Maureen L., 2022. "How is the U.S. Pricing Carbon? How Could We Price Carbon?," Journal of Benefit-Cost Analysis, Cambridge University Press, vol. 13(3), pages 310-334, October.
    3. Willems, Bert & Pollitt, Michael & von der Fehr, Nils-Henrik & Banet, Catherine, 2022. "The European Wholesale Electricty Market: From Crisis to Net Zero," Other publications TiSEM 2f225964-853e-4d30-a46d-0, Tilburg University, School of Economics and Management.
    4. David A. Gautschi & Heidi C. Gautschi & Christopher L. Tucci, 2022. "What If? Electricity as Money," JRFM, MDPI, vol. 15(4), pages 1-24, April.

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    More about this item

    JEL classification:

    • Q41 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Energy - - - Demand and Supply; Prices
    • L97 - Industrial Organization - - Industry Studies: Transportation and Utilities - - - Utilities: General
    • Q50 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - General


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