Evaluating Increasing Block Pricing as a Subsidization Scheme in the Electricity Retail Sector: The Colombian Case

Open Access
Mina Carbonero, Roger
Graduate Program:
Energy and Mineral Engineering
Master of Science
Document Type:
Master Thesis
Date of Defense:
April 22, 2013
Committee Members:
  • Anastasia Scherbakova, Thesis Advisor
  • Subsidies
  • Block Pricing
  • Electricity
  • Colombia
Targeting of subsidies has been used by many policy makers in different countries as an attempt to ensure universal access to public utility services. This amounts to nonlinear pricing to achieve particular performance goals. Different subsidization schemes have been developed, and have also been augmented with cross-subsidies among customer classes i.e. residential, commercial and industrial. A variety of targeting mechanisms have been used to allocate the subsidies; the most popular ones being increasing block pricing (IBP), means-tested and geographically targeted subsidies. The Colombian subsidization scheme is particularly interesting because it combines cross-subsidization among customer classes with IBP and geographically targeted subsidies. Under this scheme, residential customers are classified in one of six categories. Customers classified as part of the lower three categories received a subsidy on the first 200kWh of electricity consumed per month, while users in the upper two categories, along with industrial and commercial customers, pay a 20 percent tax on their monthly electricity consumption. Customers classified as part of class four pay the marginal price of electricity for all levels of consumption. In theory, this household classification process is made such that the lower the household’s income, the lower its assigned category. However, in practice, households are being classified according to the neighborhood in which they are located and/or the observable characteristics of the household. The use of neighborhood characteristics results in the creation of subsidized zones, which can constitute an incentive for the migration of high income households to subsidized neighborhoods. Using households’ observable characteristics to identify high income households in poor neighborhoods can result in homeowners changing the observable characteristics of their properties to make them look like those of poorer ones. Hence, the current subsidization scheme as it is being applied may result in subsidizing high income households at the expense of poorer ones, reducing the transfer to those at the bottom of the income distribution, and undermining the policy’s objective of universal access and wealth redistribution. The objective of this study is to evaluate the effectiveness of this subsidization mechanism on targeting low income households. The importance of this study lies in the diagnosis of the problems associated with the currently used targeting method, and therefore constitutes an input for the improvement of the subsidization scheme. Evidence regarding the subsidization of high income households was obtained. I find that up to 50 percent of households were misclassified as part of class one when they actually belonged to the upper three quintiles of the income distribution. 61 percent of class two and 76 percent of class three households were misclassified. Additionally, I find that households classified as part of class one have a higher probability of exceeding the subsidized consumption level than households from classes two and three. The resulting probabilities of exceeding the subsidized consumption with respect to class four were 17.48 percent for class one, 12.71 percent for class two and 7.78% for class three. Household level income data is necessary to perform a better evaluation of the policy.