Who should foot the huge bill to switch California homes to heat pumps?

When SoCal Edison first announced its plan to spend hundreds of millions of dollars to help 250,000 customers install heat pumps back in 2021, some building-electrification advocates saw it as the kind of proactive step utilities need to be taking to transition their customers off of fossil fuels and help California meet its ambitious climate targets.

Others saw it as an unproven building-electrification strategy that could add new charges to already-expensive electric bills, without clear evidence of long-term cost reductions and climate benefits.

In January, the California Public Utilities Commission sided with the latter group, rejecting SCE’s proposal on the grounds that it doesn’t ​“sufficiently show clear…benefits in the face of certain costs” for its customers at large.

SCE’s plan to spend up to $744 million on a combination of heat-pump installations, electrical-panel upgrades and associated grid improvements would have mostly targeted residential customers, as well as a smaller number of commercial customers.

SCE CEO and President Steven Powell called the proposal a ​“vital opportunity to reduce GHG emissions” in an ​“area of the California economy where the least amount of progress has been made.” But that laudable goal ran up against a big hurdle: the fear of increasing utility bills.

California has some of the highest and fastest-rising electricity rates in the country, putting regulators under pressure to nix any plan that might further increase costs. A preoccupation with short-term rate impacts has been evident in a number of CPUC decisions in the past year, including several that have clawed back rooftop solar incentives for customers of California’s three big investor-owned utilities.

Groups that advocate for protecting utility customers from rate increases have largely supported these decisions. In response to the CPUC’s rejection of SCE’s building-electrification plan, Mark Toney, executive director of nonprofit The Utility Reform Network, said, ​“This is one of the best decisions, when it comes to being ratepayer-focused, that the PUC has made in a long time.”

The Sierra Club and Natural Resources Defense Council don’t agree, however. In a filing protesting the CPUC’s SCE decision before it was finalized, the environmental groups accused the agency of pursuing ​“a narrow view of affordability, one that does not consider the long-term impacts of failing to invest in decarbonization now or the risks of leaving low-income and environmental and social justice customers behind.”

Sierra Club and NRDC had not wholeheartedly supported SCE’s plan. They had proposed an alternative plan that would have limited SCE’s ability to charge its entire customer base for the electrical improvements it made to specific homes. Their alternative plan also focused more funding on lower-income customers in disadvantaged communities.

Nor are Sierra Club and NRDC unaware of the ​“issues of rising electric rates,” said Nihal Shrinath, an associate attorney with the Sierra Club. The higher electric rates go, the harder it will be to convince customers to ditch fossil fuels and transition to 100% electricity, he said.

But the CPUC didn’t consider Sierra Club and NRDC’s alternative plan, or other proposals from ratepayer advocacy groups to launch new pilot programs, he said. Instead, it denied ​“two and a half years of testimony and work put into trying to make a better program” and sent SCE back to the drawing board.

Shrinath sees that as an unfortunate outcome, given that ​“it’s so rare that you get a utility doing the right thing. We’ve been pushing utilities for a long time to consider electrification programs. They don’t make a lot of money off them because rebates and incentives can’t be ​‘rate-based,’” that is, treated as ​“regulated assets” such as power grid investments for which utilities can earn a steady rate of return.

Furthermore, SCE’s proposed rate increases were not unreasonable, he said. California’s rising utility bills are primarily the result of investments utilities are making to harden their power grids against wildfires and expand them to support the state’s clean energy and electrification goals. In comparison, Sierra Club and NRDC estimated that their alternative plan would have raised most residents’ electricity bills by about $1 each month from 2024 to 2027 — a fraction of average electricity bills.

Spending money now to help people switch gas furnaces and water heaters for more efficient heat pumps will save money in the long term, Shrinath said. The Sierra Club and NRDC’s alternative plan estimated an average savings of $7 per year for SCE customers for decades into the future.

By focusing solely on the criteria of not raising near-term rates, the CPUC risks hobbling progress on California’s pressing electrification goals, Shrinath said. ​“The state is very actively pushing for electrification through all sorts of different rules and policies,” which will put utilities and their customers under pressure to switch to electric vehicles and appliances, he noted.

“At the same time, you need upfront capital to electrify — and not everyone has that upfront capital,” he added. ​“Even if electrification is a positive step for folks” who can expect to reduce their total heating bills, ​“if your electric appliance is more costly upfront than your gas appliance, you’re going to have trouble replacing it.”

Who should pay for electrifying California’s buildings? 

Toney of The Utility Reform Network agrees with the Sierra Club and NRDC that California needs to find ways to help its residents meet the state’s aggressive electrification goals. ​“We’re absolutely joined at the hip when it comes to leadership on climate policy,” he said. ​“Where we differ is on the revenue streams to pay for that.”

So far, ratepayers have largely borne the costs of the gigawatts of solar power the state’s major utilities have signed contracts for over the past decade and a half, as well as for the roughly $1.5 billion in utility electric-vehicle charging programs launched in the past half-decade. Toney says he’d like to see state lawmakers direct more taxpayer dollars to fund these programs instead.

Nor does Toney think that SCE should be allowed to add new building-electrification costs to its customers’ bills until it can explain how that doesn’t just duplicate other sources of funding. The CPUC agreed with that assessment, stating that SCE failed to show how its electrification plan is necessary on top of the various state-approved heat-pump programs that have already provided SCE with more than $100 million. Incentives created by the Inflation Reduction Act will potentially bring hundreds of millions of dollars of federal funding into the utility’s service territory, CPUC pointed out in the decision.

But Shrinath noted that the roughly $9.5 billion in federal home electrification and efficiency funding ​“has to be split up between 50 states,” with no guarantee of any set amount being made available to customers in SCE territory. As for state funding, that’s dependent on the state budget — and recently proposed cuts to building-decarbonization programs in the face of California’s current budget shortfall indicate the risk of relying on those funds alone.

“Even if we had secured federal and state funding, there will always be a larger gap there,” he said. Governor Gavin Newsom has set a target of deploying 6 million heat pumps by 2030. But SCE’s analysis indicates that with existing state and federal funding, it will fall short of its share of that goal by 1.4 million homes across its service territory. Closing that gap will take more aggressive measures — ​“and there’s a role for utilities to play,” he said.

To be clear, SCE’s proposal to ​“rate-base” investments like electrical panel upgrades in customers’ homes is a controversial one.

Regulators have approved ​“on-bill repayment” structures that allow utilities to cover the upfront costs of appliances or efficiency upgrades for individual customers and then charge them incrementally in monthly bills over the course of years to pay back the costs. But that differs from charging a utility’s entire customer base for investments that directly help only a subset of customers.

Utility programs to assist low-income customers with their bills do charge all customers to help disadvantaged groups. But ratepayer advocates have fought against the idea of applying the same approach to programs that could end up directing money to wealthier customers who otherwise may have chosen to pay for the entire cost of electrification upgrades on their own — what’s known in the industry as the ​“free-rider” problem. Sierra Club and NRDC proposed that SCE’s program target only lower-income customers to avoid this risk.

At the same time, utility programs can take part in spurring HVAC contractors, heat-pump manufacturers and other players in home electrification to ramp up investments and hiring to meet the state’s aggressive targets, Shrinath said. ​“Getting the market ready to install 250,000 electric appliances in Southern California Edison” territory would only help to accelerate electrification across all of society, he argues.

Toney pointed out that the CPUC’s decision gave SCE the option of proposing a new building-electrification plan. ​“I think the CPUC was being responsible in the way they made the decision, but also saying, ​‘We haven’t closed the door here — come back with a proposal that explains how other programs will interact, where else you’re going to look for money [and how you’ll] minimize the cost and maximize the benefits.’”

But Shrinath said the CPUC offered little concrete guidance for how SCE or other investor-owned utilities should structure programs that are more likely to be approved.

Southern California Edison has no immediate plans to refile an electrification plan, utility spokesperson Jeff Monford told Canary Media. ​“To do so, we’d need specific guidance from state agencies on what they would like to see included in utility customer-funded building electrification programs,” he said. ​“Before we invest time and effort in such a large-scale application, we’d want to ensure the CPUC is open to it.”

How to make the gas-to-electric switch work for utilities and customers

In the absence of clear guidance on what kind of electrification plan will pass muster with CPUC, Shrinath fears that California’s other utilities will settle for the status quo. And today, that status quo continues to reward them for making capital investments in fossil gas infrastructure, even as fossil gas use must shrink rather than expand over the coming decades to meet California’s decarbonization goals.

“I think the upshot is, you’re going to have a lot of folks staying on the gas system because they can’t afford to electrify,” he said.

As an electricity-only utility, SCE doesn’t have to deal with the complexities of shifting customers from its own fossil gas network. But it does foresee a looming crunch in providing its customers with the electricity they’ll need to adopt EVs and heat pumps at the pace and scale that California policy envisions.

The CPUC’s decision comes at a time when other California utilities are exploring a range of ideas for how to move customers from fossil gas to electricity. Pacific Gas & Electric, the state’s largest utility, is planning numerous pilot projects that would combine incentives for customers to switch from gas to electric heating and appliances with investments in retiring gas distribution networks and beefing up electric grid service across entire neighborhoods, for example.

But utilities have a hard time paying for these projects under standard regulatory processes, Rachel Kuykendall, principal strategic analyst on PG&E’s decarbonization strategies team, said during a January webinar hosted by the nonprofit Building Decarbonization Coalition.

Traditional grid and gas-pipeline upgrades are treated as capital expenses, with costs that can be recovered through increases to customers’ bills over decades. Nontraditional electrification investments, by contrast, have to be paid for through shorter-term cost-recovery mechanisms — and ​“what that looks like for our ratepayers is really big spikes in rates in year one, which can be really challenging for doing this work, at some significant scale,” she said.

The Sierra Club highlighted this regulatory gap in a blog post critiquing the CPUC’s decision to deny SCE’s building electrification plan. ​“The CPUC has a double standard right now where they just approve gas upgrades as a default,” Shrinath said, while ​“applying this heavy scrutiny to electrification. It’s not providing long-term affordability.”

California isn’t alone in dealing with this conundrum. Colorado, Illinois, Massachusetts, New York and other states with decarbonization mandates are struggling to come up with regulatory structures that shift incentives for utilities to keep building and repairing gas pipelines to ones that help customers switch to electricity.

Utilities and regulators need to solve these kinds of regulatory disconnects to manage the transition from fossil gas, Panama Bartholomy, executive director of the Building Decarbonization Coalition, said during January’s webinar. Leaving it up to individual customers ​“really leads to an inequitable future, where lower-income families, renters and industries that are hard to electrify are left on an increasingly expensive gas system,” he said. ​“From a ratepayer perspective, this is actually the most expensive way that we can decarbonize our buildings.”

Shrinath pointed to some work underway at the CPUC that could lay the groundwork for this shift, including a wide-ranging building decarbonization proceeding meant to align utility regulations with the state’s electrification and emissions mandates.

But, he said, ​“I have a hard time seeing PG&E or other utilities pursuing this path unless the CPUC says, ​‘Here’s how you can offer an electrification program to your customers that we will actually accept.’”

Correction: A previous version of this article misstated the dollar amount of SCE’s building electrification proposal. We regret the error.