The link between retail pricing, peaking generation: analysis

Platts

By Tom Tiernan
October, 16 2013

The use of dynamic pricing at the retail level is often touted as a solution to having fewer peaking power plants run for only 100 hours in a year, with customers adjusting their usage when they're paying peak demand prices, but it has not taken hold in the utility sector beyond a very limited segment.
    

A Federal Energy Regulatory Commission survey found that only 1% of residential customers are on time-of-use rates, with an even smaller number on dynamic pricing, where rates vary based on wholesale market prices and power grid conditions. Proponents of dynamic pricing generally do not include TOU rates as dynamic, since they are set and do not change, though TOU rates often reflect a peak, off-peak and shoulder price for a 24-hour period.
    

The point that retail prices reflecting the different values of electricity would reduce the use of peaking generation facilities has been around for decades. Many large utility customers are on some form of dynamic pricing, but the number of residential or small commercial customers is miniscule.
    

Among the benefits of dynamic prices are that they will motivate customers to shift their usage from high-priced hours to low-priced hours on a given day, so they have the potential to lower a market clearing price for an independent system operator, along with reducing the need for peaking generation units. The use of dynamic pricing to send market signals to retail customers based on grid supply and demand fundamentals has plenty of support, but progress to change retail prices toward dynamic pricing has been a tough climb for utilities and regulators.
    

Unlike dynamic pricing for airline tickets, toll roads or sports event tickets, which have become or are becoming the norm for US consumers, such pricing for electricity presents some challenges, though a few proponents have ideas to address those challenges.
    

The idea of paying $1.30/kWh under a critical peak pricing program for just a few hours of the year when the grid is stressed and demand is through the roof, even when it is offset by off-peak prices that can be 5 cents/kWh or so, is too much of a political risk for some utilities and regulators to take. Even though plenty of utilities in California, Maryland, Illinois and some other states have demonstrated that customers on dynamic pricing plans adjust their usage, the thought of having a grandmother pay exhorbitant prices for electricity on a hot summer day is among the factors that dynamic pricing supporters need to address.
    

Oklahoma Gas & Electric, which has a time-based pricing plan that is attracting interest among customers and saved the utility from building a peaking power plant, gained support from all parties for its program that has been a success, said Lisa Wood, executive director of IEE, a collection of investor-owned utilities focusing on efficiency and innovation.
    

Coming up with pricing plans that nudge utility customers toward dynamic pricing, eventually, is one approach, and increased use of distributed generation resources could be another driver for dynamic pricing, said Ron Binz, former chairman of the Colorado Public Utilities Commission. In an article that appeared in EnergyBiz Magazine and in comments at a Washington conference this week, Binz said time-of-use rates could be a good bridge to help customers become familiar with the concept of paying different prices for electricity during different time periods.
    

Making TOU rates voluntary "is never going to work," because the only customers who will sign up for such plans are those who understand them and are willing to shift their usage to save money, Binz said at the National Summit on Integrating Energy Efficiency and Smart Grid. The larger residential customers account for a bigger chunk of power sales among that class of customers, and TOU rates will not likely trigger consumer resistance, Binz said in the magazine article.
    

A peak-time rebate plan, where customers are exposed to wholesale market prices but not penalized if they do not shift their usage, also can be a transition mechanism toward dynamic pricing, Wood said in an interview Wednesday. That type of plan, which includes a critical peak pricing component where residents may pay 10 times the off-peak price during critical peak events, has been successful at Baltimore Gas & Electric, Wood said.
    

To say adoption of dynamic pricing has been slow would be an understatement, and recent research by economists and a consulting firm takes quite a conservative view on the gains possible in the next five to 10 years.
    

Regulatory inertia was mentioned as a barrier by Dan Delurey, executive director of the Association for Demand Response and Smart Grid. With a handful of utilities showing that consumers respond to dynamic pricing and change their power usage habits to reflect peak and off-peak prices, "no more evidence is needed to prove that it is OK to introduce time-based rates," Delurey said in an email Wednesday.
    

Yet even as advanced meters are more prevalent, eliminating some of the meter reading and technology barriers to dynamic pricing, other obstacles include consumer hesitancy and regulatory or economic concerns -- generally stemming from having consumers pay peak power prices rather than the constant price they are accustomed to, Navigant Consulting said in a report issued last week. Report authors Cameron Brooks and Eric Woods concluded that dynamic pricing will remain elusive for most customers in the US.
    

By 2020, less than 1% of residential customers in the US will be on dynamic pricing plans unless the industry acts aggressively to counter consumer hesitancy and regulatory barriers, the Navigant report said. If dynamic pricing is to become more widely available, "there will need to be a significant shift in regulatory momentum and customer acceptance. If that happens, the level of adoption could reach 5%, or 7.7 million customers," Navigant said.
    

An August report from IEE noted that 46 million households have advanced meters, roughly 40% of the households in the US.
    

The Navigant report "argues that we can't take dynamic pricing to be an inevitable development from smart meters," Woods said in response to a question on the report.
    

A dated adage in the power industry is that it does not make sense to have smart meters and dumb rates, with flat retail prices that do not send market signals analogous to dumb rates. Navigant maintains that the situation will not change much, with little widespread offering or adoption of new pricing plans for some time, Woods said.
    

A similar conclusion was reached by Paul Joskow and Catherine Wolfram, professors at the Massachusetts Institute of Technology and University of California Berkeley, respectively, in a 2012 paper on dynamic pricing. "It is most likely that dynamic pricing programs will evolve slowly, and that most utilities will begin by allowing volunteers to opt on to alternative tariffs while leaving flat-rate pricing the default option," said Wolfram and Joskow, who also is president of the Alfred P. Sloan Foundation.
    

If consumers face retail prices that do not reflect variations in marginal generation costs or supply and demand fundamentals, "they will consume too much when marginal costs are higher than retail rates, likely during peak periods, and too little when marginal costs are lower than retail rates, likely during off-peak periods. Distortions in consumption lead to distorted investment in and utilization of generating capacity," Wolfram and Joskow said.
    

Lowering demand by pricing electricity differently at the retail level is simple in concept, but can become complex in practice for utilities, regulators and consumer advocates. That is why Binz and others advocate simple plans such as TOU rates to help consumers understand the idea that the price of electricity changes.
    

"Some people don't ever want to think about electricity prices," so how utilities and regulators present new pricing options to them will be important, and several utilities are improving their consumer engagement practices in this area, Wood said.
    

Another factor that can drive more adoption of dynamic pricing is increased use of distributed generation, she added. For customers with their own generation covering a portion of their usage, they can reduce their utility usage and be on some form of dynamic pricing plan to save money, Wood said.
    

While the percentage of customers overall in the US on dynamic pricing may not be large, Wood said that those on advanced meters should be the denominator in any percentage calculation, since advanced meters make dynamic pricing easier to achieve. She agreed with the Navigant conclusion that dynamic pricing may not be prevalent overall, but if the percent of customers is applied only to the 46 million or so with advanced meters, the 7.7 million customers on dynamic pricing by 2020 would be about 17% of customers in that segment.
    

Rather than viewing dynamic pricing as an individual solution bringing enhanced grid operations and the potential to reduce consumer utility bills, it should be viewed as a part of a package of offerings brought about by improved technologies and changes in the industry, Wood said. Demand response programs, energy efficiency efforts, retail pricing and DG make up a bundle of services that utilities and other companies can bring to customers, she said.

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