The Power of Prices: Why Raising Prices on Electricity Can Save People Money
By Landon Stevens
We are all familiar with our power bill. When it comes in the mail or electronically we don’t pay it too much mind, we don’t know how it is priced, if we should move some of our consumption to different times of the day or night, or if prices actually relate to demand. Advances in technology, paired with innovative rate designs, can provide all that information to utilities and consumers. They can limit costly infrastructure investments by utilities resulting in cost savings for customers.
On a normal electric bill, customers pay a small fixed charge and a set low rate per kilowatt-hour (kWh) of electricity used. The problem with this billing structure, which is approved by state regulators, is that it does not usually match a utility’s cost to serve customers. Utilities argue that 70 percent of their expenses are from fixed costs, like infrastructure, and only 30 percent from variable costs, like fuel. Customers’ fixed charges, however, make up only 10 percent of their bill. This difference shows that current utility pricing models are not sending the right signals to consumers to help them manage power use and save money.
A University of California Berkeley study explains well why this is a problem, especially during peak hours of high energy demand:
“Supplying electricity during periods of peak demand is expensive. Because electricity storage is not cost effective, sufficient generation capacity must exist to satisfy demand at all moments in time. To avoid blackouts, electricity providers regularly invest in power plants that operate only on the few highest demand days of the year. Electricity prices, however, do not reflect the high cost of meeting peak demand. Most retail prices reflect the average cost of providing power and do not vary based on when this power is consumed. As a result, retail electricity customers are undercharged for their electricity at peak times, leading to inefficiently high consumption.”1
Alternative Pricing Models
There are multiple options for addressing these pricing problems. The two main proposals are for the use of either demand charges or time-of-use rates. The idea behind each of these proposals is to get customers to use less electricity when utilities experience peak demand.
Demand charges are based on a customer’s maximum electricity usage over a certain time frame each month, usually their highest 15 minutes or one hour of usage. These charges provide less incentive for a customer to shift their usage throughout the month and instead put the focus on using less electricity all at once.2
Time-of-use (TOU) charges use more direct pricing signals to get customers to shift their consumption. The idea is to make a ‘peak’ block of hours – usually 3 to 5 hours a day depending on the season – priced significantly higher than the rest of the day. This, in theory, would prompt consumers to use electricity during off-peak hours rather than times of highest demand.
Technology is Facilitating New Rate Designs
In the past, technology has limited the effective implementation of these plans. Electricity meters had no way to monitor exactly when customers were using power throughout the day. The introduction of Advanced Metering Infrastructure, more commonly referred to as ‘smart meters’, has made it possible to capture much more granular data. If the goal is to limit peak electricity, it is important for utilities to access this usage data via smart meters. Perhaps more importantly, consumers need to understand their usage as well. Smart meters allow for this knowledge sharing among all parties.
Smart meters arm consumers with daily and even hourly usage data supplied in near-real time, which has allowed for greater use of basing prices on demand. These pricing changes, combined with new control technologies like smart home functions and programmable thermostats, make it easier for customers to reduce the kWhs they use during peak demand time. They can, for example, program appliances to shut down part of the peak demand time, do laundry at off-peak hours, and ration their air conditioning.
Moving into the Future
This year, California will be the first state to implement default TOU rates for customers. A two-year pilot study by the Sacramento Municipal Utility District (SMUD) showed that its users on TOU plans reduced peak usage by up to 12 percent.3 Another study of over 50 TOU pilots from around the globe shows that peak demand was reduced anywhere from 0 to 25 percent based on the peak to off-peak pricing ratio. 4
While less than half of electric utilities in the US give the option for TOU rates, some experts are already arguing that those rate designs are not enough. “TOU rates solve yesterday’s problem,” said Ahmad Faruqui of the Brattle Group, “California needs dynamic pricing.”
Dynamic pricing takes TOU rates one step further so that instead of a set block of peak hours each day seeing an increased charge, customers can be notified in real time that prices will be changing because of increased demand and they can use technology to immediately adjust their consumption. According to Faruqui, “The future is dynamic pricing enabled by smart technology that brings variable renewables…onto the grid at the right time and the right price.”5
According to Stephen Sunderhauf of Pepco Holdings Inc., dynamic pricing could play a much larger role in future rate designs. “Market conditions, technology, and policy will dictate much of what happens, but some form of dynamic pricing is likely to be around for a long time,” he added.6
With technology evolving and advanced metering becoming commonplace, utilities should capitalize on the opportunity to increase consumer access to information and leverage the power of real-time pricing in the markets. The best way to change consumer behavior is to arm them with adequate data and incentivize them with proper price signals. Implementing new rate designs will allow utilities to eliminate waste and idle resources while running their power generators more efficiently which will put money back in their customer’s pockets.
Blonz, Joshua A. “Making the Best of the Second-Best: Welfare Consequences of Time-Varying Electricity Prices.” Working Paper 275. Energy Institute at Haas, Berkeley, California, 2016. http://ei.haas.berkeley.edu/research/papers/WP275.pdf ↩
Fields, Spencer. “How Do Demand Charges Work.” EnergySage. https://news.energysage.com/how-do-demand-charges-work/ ↩
Sacramento Municipal Utility District. “SmartPricing Options Final Evaluation.” https://www.smartgrid.gov/files/SMUD-CBS_Final_Evaluation_Submitted_DOE_9_9_2014.pdf ↩
Lessem, Neil., Faruqui, Ahmad., Sergici, Sanem., and Mountain, Dean. “The Impact of Time of Use Rates in Ontario.” Public Utilities Fortnightly, 2017. http://files.brattle.com/files/7305_the_impact_of_time_of_use_rates_in_ontario.pdf ↩
Trabish, Herman K. “Beyond TOU: Is more dynamic pricing the future of rate design?” Utility Dive, 2017. https://www.utilitydive.com/news/beyond-tou-is-more-dynamic-pricing-the-future-of-rate-design/447171/ ↩