We all understand that distributed generation and CHP systems can be more efficient than conventional, centrally generated power as delivered by utilities. So why don’t more US customers generate their own power? In this issue’s second feature article on distributed generation in the US, Joshua M. Pearce says it is largely to do with the way utilities charge for power.

Until recently most distributed generation technologies were used on a relatively large scale and thus represented a relatively small threat to electric utility dominance. Today, however, an armada of home-scale distributed generation and cogeneration systems is available to the public. These technologies include wind turbines, solar photovoltaic cells, fuel cells, microturbines, Stirling engines, combustion turbines and reciprocating engines.

Historically, electric utilities have used many methods to discourage the use of these technologies, such as double metering (e.g. one meter measures the electricity they sell you at the retail price of 10 cents per kWh and the other measures the electricity they buy from you at their avoidable costs of around 2 cents per kWh). Today, as net metering laws have come into force in a growing number of states, electric utilities have resorted to more insidious attacks, such as quietly increasing unavoidable customer charges to allow for lower avoidable electric rates to compete with distributed generation technologies.

A recent study1 published in Energy Policy found that removing unavoidable electric utility charges by folding them into electric rates would eliminate 44.3 million metric tonnes of carbon dioxide and save the entire US residential sector over US $8 billion per year. These reductions would come from increased avoidable costs thus leveraging an increased rate of return on investments in energy efficiency, cogeneration and distributed generation. If the customer charge were eliminated, this could have far-reaching effects on small-scale (home scale) cogeneration and on-site power production.


Based on regulations from the public utility commissions in all 50 US states, the electric utilities may break monthly electrical charges into two parts:

  • Part 1 – the customer charge – a fixed charge ($/bill)
  • Part 2 – charge based on actual consumption of electricity ($/kWh).

The unavoidable customer charge (part 1) is a fixed, recurring (monthly or daily) charge that all customers pay whether or not they use any electricity. One variant of the standard customer charge is the ‘minimum bill’, which requires payment of a monthly charge, but with it also comes a specified number of ‘free’ kilowatt hours before being billed on a per unit basis. This unavoidable charge is the same, independent of electricity consumption. This method of billing has created an incentive to use electricity less efficiently. For any electricity consumers who pay fixed customer charges, the more electricity they use the less per unit energy they pay for it.

Customer charges initially gained acceptability on the grounds that metering and billing costs are not related to usage at all. Initially, the customer charges were generally low, although this is changing for the worse as distribution charges are being treated as fixed charges, and utilities fold additional equipment costs of time-of-use billing into customer charges. Electric utilities favour fixed charges like the customer charge because, like many businesses, they derive their revenue by charging for their variable services (electricity consumed on a monthly basis) even though many of their costs are fixed and do not vary strongly with the amount of electricity consumed2.

This is a similar circumstance to restaurant owners who must pay fixed costs, such as rent, while only profiting on variable services such as meals served. Although the ingredients and labour involved in the production of a meal are dependent on the number of meals, a large fraction of the restaurant costs are independent of the number of meals served. So, if no one is eating at the restaurant, the restaurant owner is losing money. Unlike the restaurant owner, the electric utility has managed to force customers to pay a growing portion of their bills based on a fixed charge regardless of how much electricity they ‘eat’.

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Imagine if your favourite restaurant worked out your bill using the customer charge model (see box). This model would work well if you wanted to eat a big Italian dinner at the restaurant every night, but very poorly for someone on a diet. For the restaurant owner, however, this model works very well if she can force her customers into it, because her fixed costs are now covered by the monthly customer charge, so she is assured a profit. Not only do customer charges decrease risk by ensuring revenue stability, such rate schedules limit the perceived competition and threat to electric utility profits from energy efficiency and distributed generation.

Any unavoidable charge creates an ‘efficiency penalty’. Figure 1 illustrates this point using the customer charge for New Hampshire Electric customers ($20.00/month) with its concomitant avoidable rate cost per kWh of $0.14953. As can be seen in Figure 1, the disparity between the actual and avoidable cost is substantial until over 1000 kWh per month is consumed. The percentage of the bill made up by the customer charge can be seen in the inset in Figure 1 as a function of kWh/month. What this means in practice is that a small family using 130 kWh/month is essentially paying double the avoidable billing rate because of the customer charge.

Figure 1. Actual total rate and avoidable rate [$/kWh] as a function of electricity consumption for NH Electric customers. The inset shows the percent of the total electric bill due to the consumer charge as a function of kWh/month
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Efficient users illustrate the small user or ‘efficiency penalty’ of fixed customer charges even more clearly. For example, consider a small user – a single person living in an apartment that is individually sub-metered. This user only consumes 1 kWh per day primarily to run an Energy Star refrigerator and some energy efficient lights, and is thus effectively paying 82 cents/kWh rather than 15 cents/kWh. For this efficient user, 84% of her bill is taken via the customer charge. New Hampshire is not unique. The efficiency penalty is directly proportional to the customer charge and occurs in every state.

If electric distribution rates are collected in fixed charges such as customer charges, regardless of the type of existing space or water heating for a customer, the electricity rate can be made so low (in some cases ‘free’ for a given amount of energy) that it becomes attractive to switch to electricity over gas. Thus, a rate design heavily fortified with customer charges makes it cheaper for the customer to have the electric utility burn gas or coal relatively inefficiently in a power plant (e.g. 35%), transmit (and suffer transmission losses ~6%) that electricity over the whole infrastructure, and deliver it to the customer to use for heating rather than have the customer burn gas directly, at greater efficiency (>80%), in an on-site water heater or furnace.

With the inclusion of a customer charge in current rate structures, large institutions can effectively obtain a higher ROI on energy efficiency improvements. For example, this perverse incentive explains in part why most major hotel chains have already retrofitted antiquated incandescent lamps with compact fluorescent light bulbs, while most small energy consumers have not (e.g. home owners, small business owners, and most ironically those who need to save small amounts of money the most – low income families).


In order to implement a new utility rate that contains no customer charges, while ensuring that electricity providers make the same revenue as under current regulations, the total money going to the utilities should remain the same for a given aggregate electricity use. The customer charge represents on average about 7% of the average electric bill, although it ranges from ~3% to 27%, in New Jersey and Utah respectively.

The average American household customer uses 887 kWh/month and at 10.47 cents/kWh pays $92.96 per month in demand and $99.58 per month in total. If the average electric rate is increased by 7.12% to eliminate the customer charge the average customer still pays $99.58/month so the rate change is revenue neutral. However, now the average electric rate has increased by 0.75 of a cent per kWh. For a more energy efficient customer using only 300 kWh/month (or about 1/3 of the average), the monthly bill under the status quo rate structure is $38.03 and, under the new rates, is $33.69 (decrease of about 13%), even though there is no change in usage. Thus the less electricity a person uses under the new rate structure, the greater their incentive to conserve as compared to the standard rate structure.

In our current society, price increases generally provide a signal to customers to reduce the amount they consume. The price must of course be avoidable if it is to have this effect. By contrast, lower prices or non-avoidable costs may encourage some customers to consume more than they would have at higher prices.


Both energy efficiency retrofits and distributed generation applications in households can provide surprisingly high returns on investment. The Energy Policy study cited earlier found that to eliminate the customer charge, the average electric rate in the US would increase by 7.12%. This increase has a profound effect on the return of investment calculated for energy efficiency projects as well as distributed generation projects. For example, using the same New Hampshire example as above, the difference in avoidable electric rates for the average user consuming 887 kWh/month is 2.25 cents per kWh. This has an enormous effect on the return on investment for distributed generation systems.

Distributed generation and cogeneration systems offer several benefits for the public. First, if distributed generation systems are used during peak electrical times, the expansion rate of the centralized grid power system is slowed and any additional fossil-fuel plants are prevented or pushed into the future. The high efficiencies of cogeneration and the renewable nature of many distributed generation technologies thus offer both reduced costs and significant reductions of carbon dioxide emissions. Some of the reduced costs come from reducing the investment necessary for transport and distribution infrastructures and the postponement of investment decisions on large centralized units.

In sufficient numbers, interconnected distributed generation and cogeneration systems enhance reliability and security of the grid in the face of natural disasters, war and terrorism; reduced need for transmission and distribution upgrades; and easier plant site determination. Simply put, the more generators on the grid, the greater its reliability. Thus the most reliable grid of the future will be one in which every consumer is also a producer, whether it be from a cogeneration furnace, photovoltaic roof, or plug-in hybrid car.

Despite these advantages, cogeneration and other distributed generation systems are currently not very widespread in the US, particularly those on the residential scale. They can, however, be far more widespread.

So, in summary, when distributed generation systems are deployed, the entire electric grid system efficiency is increased, emissions are cut drastically, the grid becomes more reliable and utility customers can save significant energy costs. Clearly, it is in the best interest of the American public to support policies that encourage these technologies to be far more widespread.

Cogeneration systems can be thought of as synonymous with energy efficiency investments and treated similarly. For an initial investment, a decision maker earns a return in primary energy savings and money. Currently, most cogeneration systems are primarily found in industry, government or in university cogeneration facilities, although new technologies such as Climate Energy’s micro-combined heat and power system are scaled for use in the home. By increasing the amount of avoidable costs for the use of cogeneration systems, the deployment rates could increase substantially.

For example, payback analysis for cogeneration installations in government buildings produces impressive results. Economic paybacks were 4.3 years in hospital and industrial settings, 5.5 years for prisons, 8.2 years in research and development facilities, 9.3 years in offices and services buildings, and 11.9 years in schools3. Some of these facilities thus fall on or near decision rules of thumb of five and 10 year paybacks for energy service company contracts.

Elimination of fixed rates, such as customer charges, increase the advantage of customer-side distributed generation by decreasing the payback period and thus boosting the return on investment into regions that either energy service companies or users themselves can finance profitably.

When the customer charge is folded into the electric rate, the effective electric rate increases. The investment and lifetime of the distributed generation technology are fixed, but the value of the avoided electricity purchases has now increased. Combined, these effects decrease the payback times for distributed generation technologies. Again, because the customer charge is not avoidable, if it is used it effectively becomes a sunk cost and actively prevents such systems from being deployed by customers.

New technologies available for small-scale customer-side distributed generation have even more potential. If customer charges were eliminated in favour of slightly higher electric rates to make up for the utility loss of revenue, small-scale customer-side distributed generation could be economically deployed in even more regions. Most homes and businesses are capable of deploying solar photovoltaic arrays on their roofs or replacing older furnaces with cogeneration systems such as the freewatt™ system from Climate Energy, LLC (left), which hit the US market in 2007. The freewatt combines a 93% efficient gas furnace or 95% efficient gas boiler with an over 85% efficient (heat and electric) Honda-powered natural gas engine-generator module. Since Honda’s compact residential-use cogeneration units were first put on the market in 2003 in Japan, over 50,000 have already been installed.

The 1.2 kW freewatt combined heat and power system Source: Climate Energy LLC
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The 85.5% efficient Japanese ECOWILL has been marketed through gas utility companies because it runs on natural gas and generates electricity for home use while utilizing the exhaust heat from the gas engine to provide hot water. Honda estimates that the 50,000 ECOWILL units have potentially reduced carbon dioxide emissions by about 39,000 tonnes per year, equivalent to the amount that would be absorbed by three million trees.

Higher avoidable electric rates make this type of environmentally friendly technology even more profitable in areas where it is economically viable and it increases the size of such geographic regions.

The newer distributed generation technologies are beginning to be hybridized, which provides even more efficient options for home owners. For example, a freewatt ‘plus’ system is expected in the first quarter of 2009. This system includes all of the features of the standard freewatt and also incorporates an automatic transfer switch and sub-panel enabling a backup power mode if the grid goes down. In backup power mode the system will load follow and provide up to 1.8 kWe. The plus system will include black start and heat dump capabilities, allowing the system to operate during a summer-time grid outage. With the on-board internet connection it can also be dispatched by the local utility in a demand response scenario. The plus system is expected to incorporate a two stage furnace with 95% AFUE (Annual Fuel Utilization Efficiency). In addition, the plus system should allow for the future application of a 600 Watt solar photovoltaic module that will plug directly into the existing system inverter and utilize the existing automatic transfer switch.

If even 10% of households in the US installed the 1.2 kW freewatt and 0.6 kW of solar photovoltaic panels (a very modest installation of a few panels), the grid would have an additional 20 GW. These systems would not act as baseload for the grid, but clearly the potential for distributed generation and cogeneration is enormous in the residential market. The realization of this potential would be enhanced by the elimination of the customer charge.

In particular, the value of efficiency, distributed generation and combined heat and power, and fuel choices must be determined for their economic benefits in the context of expanding energy use. This factor can be considerable because any measure that reduces the need for additional construction of transmission and distribution assets will offset on average of over $1300/kW. Thus, the cost of delivered electricity can actually decrease in the long term for all customers due to current forward-thinking policy to encourage efficiency, distributed generation, and decarbonized fuel sources.


Currently there is a penalty of increased costs per kWh for instituting energy efficiency improvements, distributed generation, and improved energy conservation behaviours, because of fixed customer charges. For efficient energy consumers, customer charges can represent a considerable percentage of their monthly bills, making the effective rate of electricity extremely high. These unavoidable costs actually encourage consumers to waste energy and avoid making efficiency investments.

America’s homeowners and small business owners would benefit considerably if the utilities were required to eliminate fixed customer charges. In this way, small energy users could more easily replicate the energy efficiency improvements being made by industry and academia.

If the identical value of the aggregate customer charge is distributed among all customers based on the amount of electricity they use, the following occurs:

  • the rate will increase (cost per kWh) on average for energy consumers while decreasing their total bill
  • this increase in the rate will encourage efficiency by increasing the rate of return on energy efficiency
  • this new rate will increase the rate of return on distributed generation investments
  • the deficiency of the rate system which rewards large energy consumers and less efficient users of energy by having small energy users and energy efficient consumers subsidize their use through customer charges will be corrected
  • greenhouse gas emissions will be reduced by combining all these market signals to energy consumers to reduce energy use, increase energy efficiency and use of distributed energy, and move towards renewable sources of energy.

Joshua M. Pearce is with the Physics Department, Clarion University of Pennsylvania, Clarion, Pennsylvania, US.
e-mail: jpearce@clarion.edu


1. J. M. Pearce and Paul J. Harris. Reducing greenhouse gas emissions by inducing energy conservation and distributed generation from elimination of electric utility customer charges; Energy Policy, 35, pp. 6514–6525, 2007.

2. Only about 1/3 of electrical costs are derived from fuel costs.

3. Hadley, S.W., Kline, K. L., Livengood, S. E., Van Dyke, J. W., 2002. Analysis of CHP Potential at Federal Sites. ORNL/TM-2001/280.