Generating Revenue for Generating Green Electricity

Generating Revenue for Generating Green Electricity: Evidence from Laboratory Experiments on Three Subscription Mechanisms for Green Electricity Programs

Michael R. Moore SNRE University of Michigan

Arnab Mitra Erb Institute University of Michigan

A proposal for faculty fellow funding submitted to the Erb Institute on Global Sustainable Enterprise

June 14, 2012

Generating Revenue for Generating Green Electricity: Evidence from Laboratory Experiments on Three Subscription Mechanisms for Green Electricity Programs The first generation of green electricity programs were established over the last fifteen years.

Green electricity programs are utility-sponsored, subscription-based programs in which households or commercial businesses participate voluntarily and pay a premium in support of new capacity for renewable generation. As of 2009, 860 such programs were operating in the United States (Bird and Sumner, 2010). These programs collectively resulted in about 5.15 billion kilowatt-hour (kwh) of green-electricity sales in 2009.

Research Question: What is the relative revenue-generating ability of the three main mechanisms for enrolling consumers in green electricity programs?

We are investigating the three subscription mechanisms commonly employed in green electricity programs: the voluntary contribution mechanism, the green tariff mechanism, and the all-ornothing green tariff mechanism. [These mechanisms will be described momentarily.] In the U.S., subscription revenue from these programs is a major vehicle for financing new generation capacity in renewable-based electricity. In light of the large number of programs, evaluating the relative performance of the mechanisms is important as a basis for recommending programmatic reforms to the electric utility industry and, potentially, for increasing the ability of green electricity programs to finance additional generation capacity.

Kotchen and Moore (2007)1 developed a theoretical framework to study the voluntary contribution mechanism (VCM), the green tariff mechanism (GTM), and the all-or-nothing green tariff mechanism (A/NGTM). The VCM is modeled after green electricity programs in which a subscriber’s green payment is independent of her electricity consumption. For example, many programs offer subscriptions in 100 kwh/month blocks. The program sets a price premium, say 2¢/kwh, and the subscriber can choose an integer number of blocks (1, 2, 3, and so on). Block subscriptions result in fixed payments per month. In addition, other programs simply allow a subscriber to specify the dollar amount of a monthly contribution. Block subscriptions and openended subscriptions are VCMs: they result in constant payments per month.

The GTM is modeled after a second type of program design in which the subscriber pays a premium per kilowatt-hour and decides the fraction of monthly electricity consumption to which the premium applies. The type of program commonly uses fractions of 25%, 50%, 75%, and 100%, although some programs allow fractions as low as 10% (Bird and Sumner, 2010). With the GTM design, individual payments vary with monthly consumption regardless of the fraction chosen.

1

The article by Kotchen and Moore ranks sixth on the list of most cited articles in the Journal of Environmental Economics and Management among articles published since 2007 (see http://www.journals.elsevier.com/journal-ofenvironmental-economics-and-management/most-cited-articles/, accessed 06/13/12). JEEM is the leading journal in the field of environmental economics.

A special case of the GTM is the all-or-nothing GTM, or A/NGTM. With this design, the program specifies 100% as the only possible subscription fraction, i.e., the premium applies to all of the consumer’s electricity consumption, or none. By definition, then, the defining characteristic of GTMs is a green payment that varies with monthly consumption.

We build on the research by Kotchen and Moore (2007). They characterize the three mechanisms in game-theoretic terms in a framework of private provision of public goods.

(Avoided air pollution from fossil-fuel-generated electricity is the environmental public good provided by subscriptions to a green electricity program.) In addition, they apply the models empirically using household data from subscribers to two green electricity programs in Michigan (Detroit Edison and Traverse City Power & Light). A limitation of their study, however, is that it does not examine the effect of alternative mechanisms on the level of public-good provision (i.e., revenue generation). Kotchen and Moore write (p. 14), “This would be possible with …experimental data on participation in hypothetical programs with different participation mechanisms. This is a task for future research.” This is exactly the research that we are undertaking in our laboratory experiments at University of Michigan.

The proposal is organized into three sections: 1. Work to Date; 2. Preliminary Results; and 3.

Future Work. The first two sections are relevant since much of the budget request relates to conducting additional laboratory experiments as a basis for a set of publishable final results. The third section poses a new Research Question based on our preliminary results.

1. Work to Date We have included, as an appendix, a first draft of a research paper on this topic. It includes: Section 2: Theoretical Setup Section 3: Experimental Game Section 4: Experimental Procedure Section 5: Results.

The heart of our work is the set of laboratory experiments that apply the three subscription mechanisms. We completed six sessions of experiments during Winter Semester 2012 using the Zajonc Experimental Laboratories in the Institute for Social Research at the University of Michigan. Subjects were recruited from undergraduate and graduate courses at the university.

The mechanisms were implemented as four-person games. Between eight and sixteen subjects participated in each session.

The experiments create the basis to compare the two of the three mechanisms, the VCM and the GTM. The theoretical analysis finds that individual subscriptions and aggregate revenue are identical across the two mechanisms (for a particular utility function and income in a symmetric game with four players). The experiments test these findings empirically.

Three sessions were conducted for the VCM, and two sessions were conducted for the GTM with the green tariff equal to one. An additional session was conducted for the GTM with the green tariff equal to 1.5 to analyze whether a change in the green tariff results in a change in total provision of green electricity, as opposed to what theory predicts. The number of subjects in each

of the VCM sessions was 12. The numbers of subjects in the GTM sessions were 8 and 16 (for ) and 12 (for ). Subjects were not allowed to participate in more than one session.

On average, each session lasted about 70 minutes. The subjects were given sufficient time to comprehend the experimental instructions and, in addition, all questions were answered before the decision-making began. As such, the subjects did not need to play a practice round.

In each session, the same game was played for 12 decision rounds.2 At the beginning of each decision round, the subjects were randomly matched to form groups of four subjects. We employed a stranger matching protocol for the sessions. Under this protocol, each subject was randomly matched with three other subjects in each decision round. The four matched subjects formed a group; however, the subject-composition of each group kept changing randomly in each decision round. For a session with 12 subjects, there were three groups in each decision round. At the end of each decision round, each subject was apprised of the subject’s consumption of the private good (the endowment income, 120, minus the voluntary contribution to green electricity), total provision of green electricity by the subject’s group, points the subject earned in that decision round, and total points the subject had earned through that decision round.

In each decision round, each subject earned points according to his/her utility-payoff in that round.3 At the end of each session, all points earned by a subject were added and converted to US Dollar at the rate of $1 per 15 points. Note that if each decision round in a session were played according to the symmetric Nash equilibrium strategy, each subject would earn $15.68 in that session. In addition, each subject was given a show-up fee of $5.

The experimental sessions were computerized with the ZTREE software for laboratory experiments (Fischbacher, 2007). Each subject received a sheet with the experimental instructions upon arriving for a session. To maintain perfect anonymity, we did not identify the subjects by a registration number and, instead, let the computers identify each subject internally.

In each decision round for the VCM sessions, each subject chose a contribution to green electricity by entering a number (up to two decimal digits) from the set [0, 120] on the computer screen. Likewise, for the GTM sessions, each subject recorded the percentage of private consumption to contribute to green electricity by selecting a whole number from the set {0, 1, …., 99, 100}.4 The same procedure was repeated for all 12 decision rounds. At the end of the 12th round, each subject was notified about his/her individual earnings during the session.

The choice of our experimental design was motivated by what has been established as the standard practice for the experimental public goods game. Following Andreoni (1995a, 1995b) we adopted the stranger matching protocol in the sessions. The stranger matching protocol – which is known to the subjects – retains the one-shot nature of a game, yet also allows for game specific learning over the decision rounds. The absence of an identifying registration number in 2

Note that despite a finite repetition of the game, application of the backward induction principle will lead to the unique subgame perfect Nash equilibrium in each game, and this is identical to the unique Nash equilibrium in the one-shot game.

3 Individual utility-payoff of consumer i is determined by private consumption yi and the total provision of green electricity g, according to the particular utility function where gi is consumer i’s provision of green electricity and g-i is provision by the rest of the group.

4 We let the subjects choose numbers with decimal digits under the VCM because a corresponding percentage choice with a whole number under the flexible GTM may actually result in a contribution with decimal digits.

the sessions eliminated any possibility of reputation formation for a subject. Since we were interested in the behavior of experienced subjects allowing for game specific learning, each game was repeated for 12 decision rounds. After each decision round, each subject was notified of the Total contribution to green electricity by the subject’s own group. Information was not provided about any other group. Experimental literature on oligopolistic markets has shown that own group feedback induces competitive behavior (Dufwenberg and Gneezy, 2002; Bruttel, 2009).

To minimize the chance of a subject making decisions in any round based on individual (or others’) decisions in earlier rounds, the history of decisions was not made available to the subjects. This made each subject focus on the current decision round. As such, unless the subjects had a preference for green electricity, our design was aimed at providing a fair chance for the Nash outcome to emerge.

2. Preliminary Results Summary of Experimental Sessions: We begin with a summary of the sessions as an overview of the results. Table 1 describes how group level green electricity provision, group level private consumption, individual percentage choice, and individual earning vary across the experimental sessions. On average, a group of four subjects contributed 266.53 (monetary units) in a given decision round under the VCM sessions, as opposed to 177.23 under the GTM (π = 1) sessions.

Statistical test is unnecessary to claim that the average contribution under the VCM sessions is significantly higher. On the flipside, average group level private consumption (conventional electricity) is significantly higher under the GTM (π = 1) sessions than under the VCM sessions.

Under the GTM sessions, when the green tariff rises from 1 to 1.5, the average of individual percentage choice falls from 67.06% to 64.94%. As the green tariff rises, individuals lower their consumption of green electricity as a percentage of conventional electricity, only partially offsetting the green-tariff increase, which ultimately raises the total provision of green electricity.

Table 1 also shows that individual payoff is invariant to the treatments. In a nutshell, table 1 points to the broader environmental implication of the superiority of the VCM over the GTM. Without affecting individual welfare, the VCM would result in more revenue for green electricity and a significantly lower pollution, in comparison to the GTM.

Table 1: Summary of Experimental Sessions VCM Sessions

GTM Sessions (Green Tariff = 1)

GTM Session (Green Tariff = 1.5)

Average Group Level Provision

266.53

177.23

211.90

Average Group Level Private Consumption

213.47

302.77

268.10

67.06%

64.94%

$23.39

$23.95

Average Individual Percentage Choice Average Individual Earning

$23.82

First Round Play: The set of decisions made in a first round is often regarded as the purest basis of comparison between two or more treatments, as it precludes the effect of prior learning. Any statistical difference between the set of first round decisions across treatments is therefore attributable to the difference(s) in the treatments, provided the sample size is large. In the first decision round, the average group (individual) level provision is 289 (72.25) under the VCM sessions (number of independent groups = 9, number of independent subjects = 36). Under the GTM (π = 1) sessions, the corresponding average group (individual) level provision is 167.07 (41.77) (number of independent groups = 6, number of independent subjects = 24). The null hypothesis of equality of the average group level provision under the VCM and the GTM (against the alternative that the former is higher than the latter) is rejected at a 1% level of significance (t = 4.33). The corresponding null hypothesis of equality of individual provision is also rejected at a 1% level of significance (t = 4.05).

Average Play in the Sessions: Figures 1-3 show the evolution of the average group level provision for each session, by treatment. Focusing on the first two VCM sessions (S1 and S2), we observe that the level of provision showed greater fluctuation from decision round six onwards. However, the level of provision does not diverge far away from an approximate level of 260 for VCM S1 and 230 for VCM S2. The average provision for the third session under the VCM has approximately stayed at a level close to 300 from decision round six onwards, with the only exception of a sudden drop in decision round 12. This drop can perhaps be explained by the subjects’ selfish free riding behavior in the last decision round.

The average provision for the two GTM sessions has, by and large, stayed at a (stabilized) level of 180 (Figure 2). A similar stabilized trend is observed for the GTM session with a green tariff of 1.5 (Figure 3). The average provision stayed at a level close to 210 from the beginning to the end of the session.

3. Future Work We describe three categories of research activity going forward: 1) Conduct additional replicates of the existing experimental sessions to consolidate a complete and convincing set of results; 2) Introduce experimental sessions for the A/NGTM (the all-or-nothing mechanism); and 3) Conduct further theorizing on motives for green electricity purchases, and test alternative theories using additional experimental sessions.

Additional Replicates of VCM and GTM Experiments. The existing results from six sessions suggest a clear pattern of the VCM generating substantially more revenue than the GTM. Five more experimental sessions with these two mechanisms should produce a conclusive analysis.

Experimental Sessions for the A/NGTM. Analysis of the theoretical model (in the Appendix) shows that, under fairly general conditions, consumers should not purchase green electricity in the equilibrium of the A/NGTM. This result changes – and consumers make positive purchases of green electricity – when the preference structure is changed from purely altruistic preferences

to impure altruism with warm-glow preferences (Andreoni, 1990). We plan to design and implement five experimental sessions to understand the role of warm-glow preferences in explaining green electricity purchases under the A/NGTM. Theorizing on Motives for Green Electricity Purchases. The pattern in the preliminary results – of the VCM generating substantially more revenue than the GTM – is a phenomenon that deserves further research should it continue to hold in the additional experimental sessions.

Research Question: What set of preferences explain the distinct pattern of higher greenelectricity purchases in the VCM relative to the GTM? Our results may provoke the need for alternative theoretical structures to explain subject decision-making. Recent papers by Deb, Gazzale, and Kotchen (hereafter DGK) (2012) and Krishna and Rajan (2009) provide useful examples to guide our research. DGK develop revealed-preference methods that solve two challenges of charitable giving: externalities among agents and Lancasterian characteristics within utility functions. These challenges apply to our setting of subscription to green-electricity programs. In particular, the GTM involves the characteristics approach of the impure public good model as developed in Kotchen and Moore (2007). We will investigate whether and how to modify the DGK methodology to fit our case of electricity-program subscriptions.

Krishna and Rajan (2009) study “cause marketing” primarily from the perspective of the industrial organization of firms. Cause marketing is the idea of embedding a charitable donation in the price of a conventional good, such as a t-shirt or other item of clothing. Many environmental NGOs sell cause-marketed goods. From the perspective of consumer theory, cause marketing invokes the impure public good model, with the t-shirt providing a private benefit and the embedded donation providing a public-good benefit.

In private conversation with one of the paper’s co-authors, Aradhna Krishna hypothesized that, when exposed to a GTM-type mechanisms, consumers somehow tend to perceive that their donation is operational only on a fraction of their brown consumption. Thus they are guilty for only a fraction of their brown consumption. In contrast, the VCM-type mechanism gives them the impression that their donation applies to their overall brown consumption. This hypothesized difference leads them to donate more under the VCM-type mechanisms. Useful theorizing on this topic might involve extensions to Kotchen (2009), in which consumers purchase environmental offsets to counteract brown consumption.

In our budget, ten experimental sessions are earmarked to understand what set of preferences explain the higher purchases of green electricity in the VCM design relative to the GTM design.

Figure 1: Average Group Level Provision of Green Electricity in VCM Sessions Average Provision 400 350 300

VCM S1 VCM S2 VCM S3

250

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Decision Round

Figure 2: Average Group Level Provision of Green Electricity in GTM Sessions (π = 1) Average Provision 400 350 300

FGTM S1

250

FGTM S2

200 150 100 1

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4

5

6

7

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Decision Round

Figure 3: Average Group Level Provision of Green Electricity in GTM Session (π = 1.5) Average Provision 400 350 300 FGTM S1 250 200 150 100 1

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Decision Round

References Andreoni, J. 1990. “Impure Altruism and Donations to Public Goods: A Theory of Warm-Glow Giving.” Economic Journal, 100:464-477.

Andreoni, J. 1995a. “Cooperation in Public-Goods Experiments: Kindness or Confusion?”

American Economic Review, 85(4): 891-904.

Andreoni, J. 1995b. “Warm-Glow Versus Cold-Prickle: The Effects of Positive and Negative Framing on Cooperation in Experiments,” The Quarterly Journal of Economics, 110(1): 1-21.

Bird, L. and J. Sumner. 2010. Green Power Marketing in the United States: A Status Report (2009 Data). National Renewable Energy Laboratory Technical Report NREL/TP-6A20-49403.

Bruttel, L. 2009. “Group Dynamics in Experimental Studies - The Bertrand Paradox Revisited,” Journal of Economic Behavior and Organization, 69(1): 51-63.

Deb, R., R.S. Gazzale, and M.J. Kotchen. 2012. “Testing Motives for Charitable Giving: A Revealed-Preference Methodology with Experimental Evidence,” National Bureau of Economic Research Working Paper 18029.

Dufwenberg, M., and Gneezy, U. 2002. “Information Disclosure in Auctions: An Experiment,” Journal of Economic Behavior and Organization, 48(4): 431-44.

Fischbacher, U. 2007. “Z-tree: Zurich Toolbox for Ready-made Economic Experiments,” Experimental Economics, 10(2): 171-78.

Kotchen, M.J. 2009. "Voluntary Provision of Public Goods for Bads: A Theory of Environmental Offsets," Economic Journal, 119: 883-899.

Kotchen, M.J. and M.R. Moore. 2007. “Private Provision of Environmental Public Goods: Household Participation in Green Electricity Programs,” Journal of Environmental Economics and Management, 53: 1-16.

Krishna, A., and U. Rajan. 2009. “Cause Marketing: Spillover Effects of Cause-Related Products in a Product Portfolio,” Management Science, 55(9): 1469-1485.

Budget Laboratory Experiments One-time fee to ISR: Ten sessions of experiments: Payments per session: Payment of subjects: 400 Student assistant: 50 Session Subtotal: 450 Data preparation and management (Student assistant) Travel: two trips to professional meetings to present results

1,000 9,000

TOTAL:

$14,000

1,500 2,500