Ahmad Faruqui, Principal
Ryan Hledik, Associate
Sanem Sergici, Associate

They embody subsidies between customers within a class
They do not promote economic efficiency
All they do is recover the revenue requirement
March   22   – 25,    2009   Miami,   FL,   USA

Under current rate designs, customers with higher load factors subsidize those with lower load factors (since the former are less costly to serve than the latter)
This is one of the worst kept secrets of uniform pricing
March   22   – 25,    2009   Miami,   FL,   USA

In a state with 10 million customers, the subsidy may amount to $3.9 billion
Load Shapes by Customer Type
(10 million customers total)
600
500
400
300
200
100
Peak
Off-Peak
Peak
Off-Peak
Peak
Off-Peak
Rates
Flat = $0.10/kWh
Peak = $0.20/kWh
Off-Peak =
$0.067/kWh
0
Flat Average Peaky
Amount of Cross-Subsidy
Per customer = $10/month (20% of bill)
Total per month = $33.3 million
NPV (10 years) = $3.9 billion
March   22   – 25,    2009   Miami,   FL,   USA

Uniform pricing promotes poor load factors since customers do not pay the full cost of power during the most expensive hours of the year
Sixteen experiments with more than 15,000 customers have shown that customers lower their peak usage by several percentage points if they are charged the full cost of peaking power
March   22   – 25,    2009   Miami,   FL,   USA

Customers respond to dynamic pricing even without technology
Non-Technology Enabled Impacts of Pricing Pilots
30%
25%
20%
15%
10%
5%
0%
TOU PTR CPP
Pricing Pilot
March   22   – 25,    2009   Miami,   FL,   USA

Enabling technologies facilitate even greater demand response
Role of Technology on Pilot Program Impacts
40%
35%
No Technology
Technology
30%
25%
20%
15%
10%
5%
0%
PSE&G (TOU) PSE&G (CPP) CA SPP (CPP)
Pilot Program
AmerenUE-2004
(CPP)
AmerenUE-2005
(CPP)
March   22   – 25,    2009   Miami,   FL,   USA

Quantifying the benefits of dynamic pricing
March   22   – 25,    2009   Miami,   FL,   USA

• If it leads to a 5% drop in peak demand, the national benefits will be $35 billion over the next two decades
• If capacity prices rise to $104/kW-year, the benefits rise to $66.2 billion
• Even higher benefits would accrue if dynamic pricing leads to a 10% or 15% drop in peak demand
March   22   – 25,    2009   Miami,   FL,   USA

So what is keeping us from harnessing those billions in value?
The cost of advanced metering infrastructure
(AMI)
Disagreement on what constitutes a smart rate
Fear of a customer backlash
March   22   – 25,    2009   Miami,   FL,   USA

Distribution of Bill Impacts
20%
15%
10%
5%
0%
0%
-5%
-10%
-15%
-20%
-25%
10% 20% 30% 40% 50% 60% 70% 80% 90% 100%
Customers with Flatter Consumption Customers with Peakier Consumption
Percentile of Customer Base
March   22   – 25,    2009   Miami,   FL,   USA

1. Educating customers
2. Offering them tools
3. Creating two-part rates
4. Providing temporary bill protection
5. Crediting the hedging premium
6. Offering a menu of dynamic pricing rates
March   22   – 25,    2009   Miami,   FL,   USA

Get them to buy-into dynamic pricing by showing them it can lower energy costs for society as a whole, lower their monthly utility bill, prevent energy crises, improve system reliability, and lead to a cleaner environment
March   22   – 25,    2009   Miami,   FL,   USA

At the simplest level, provided them information on where their utility dollar goes and what actions will help them lower their bill
At the next level, provide them real-time in-home displays which disaggregate their power consumption and tells them how much they are paying by the hour
Eleven pilots with 11,000 customers have shown that feedback mechanisms can lower usage by
6% on average, with a range from 2% to 18%
March   22   – 25,    2009   Miami,   FL,   USA

Customers would buy a predetermined amount of power at a known rate (analogous to how they buy all their consumption today) and buy the remainder (the second part) at dynamic pricing rates
Customers would pick their own predetermined amount or it could be based on consumption during a baseline period
March   22   – 25,    2009   Miami,   FL,   USA

Give them full bill protection in the first year.
Phase this out over time.
For example, in year two, their bill would be no higher than five percent; in year three, no higher than ten percent; in year four, no higher than fifteen percent and in year five, no higher than twenty percent.
In the sixth year and beyond, bill protection would be provided for a fee.
March   22   – 25,    2009   Miami,   FL,   USA

The supplier has to hedge against the price and volume risk embodied in the open-ended fixed price contract which is today’s rate design
Research suggests that this risk premium ranges between 5-30% of the cost of a fixed rate
So customers who move to dynamic pricing rates should be credited for the insurance premium
March   22   – 25,    2009   Miami,   FL,   USA

Distribution of Bill Impacts
20%
15%
10%
5%
0%
-5%
0%
-10%
-15%
-20%
-25%
Revenue neutral
Credit for hedging cost premium
10% 20% 30% 40%
Customers with Flatter Consumption
50% 60% 70% 80% 90% 100%
Customers with Peakier Consumption
Percentile of Customer Base
March   22   – 25,    2009   Miami,   FL,   USA

Distribution of Bill Impacts
20%
15%
10%
5%
0%
-5%
0%
-10%
-15%
-20%
-25%
Revenue Neutral
Credit for Hedging Cost Premium
Demand Response Plus Credit for
Hedging Cost Premium
10% 20% 30% 40%
Customers with Flatter Consumption
50% 60% 70% 80% 90%
Customers with Peakier Consumption
100%
Percentile of Customer Base
March   22   – 25,    2009   Miami,   FL,   USA

Dynamic pricing rates may be too risky for some customers
They should have the option of migrating to other time- varying rates (with varying peak periods and varying number of periods)
If the critical-peak pricing rate (combined with a time-of- use rate) becomes the default rate, risk-averse customers should have the opportunity to migrate to a fixed time-of-use rate and risk-taking customers should have the opportunity to migrate to a one-part or two-part real-time pricing rate
March   22   – 25,    2009   Miami,   FL,   USA

R e w a rd
(D is c o u n t fro m F la t
R a te )
1 0 %
More
Risk Averse
Customers
Less
Risk Averse
Customers
RTP
VPP
5 %
CPP
TOU
Seasonal Rate
Inverted Tier Rate
Flat Rate 0 .5
1
R is k
(V a ria n c e in
P ric e )
March   22   – 25,    2009   Miami,   FL,   USA

The benefits of dynamic pricing are well established and increasingly within reach as AMI and other smart grid technologies are deployed
What stands in the way are concerns by regulators and utilities about price volatility and a fear of customer backlash
There are at least six ways to make the transition to dynamic pricing
These should be considered by commissions and utilities
March   22   – 25,    2009   Miami,   FL,   USA

• Faruqui, Ahmad, “Inclining Toward Efficiency,” Public Utilities Fortnightly, August
2008.
• Faruqui, Ahmad and Ryan Hledik, “Transitioning to Dynamic Pricing,” Public
Utilities Fortnightly , March 2009
• Faruqui, Ahmad and Ryan Hledik, “The Power of Dynamic Pricing,” The Electricity
Journal , April 2009.
• Faruqui, Ahmad, Ryan Hledik, Sam Newell, and Hannes Pfeifenberger, “The
Value of Five Percent,” The Electricity Journal, October 2007 .
• Faruqui, Ahmad and Sanem Sergici, “Household Response to Dynamic Pricing of
Electricity–A Survey of the Experimental Evidence,” Discussion Paper, The Brattle
Group , January 2009.
• Faruqui, Ahmad, Sanem Sergici and Ahmed Sharif, “The Impact of Informational
Feedback on Energy Consumption- A Survey of the Experimental Evidence,”
Discussion Paper, The Brattle Group , January 2009.
• Faruqui, Ahmad and Lisa Wood , “Quantifying the Benefits of Dynamic Pricing in the Mass Market,” Edison Electric Institute, January 2008.
March   22   – 25,    2009   Miami,   FL,   USA