Smart meters, such as those being implemented by a number of utilities in Canada, Italy and the United States under the rubric of advanced metering infrastructure (AMI), provide many operational benefits to the utility such as lower meter reading costs, theft detection, faster outage detection and remote customer connect/disconnect.

In addition, they provide a unique platform for the deployment of smart pricing programmes. Among these, dynamic pricing programmes are noteworthy. These represent an advancement of traditional time-of-use (TOU) pricing programmes that have been around for decades. The simplest example is critical-peak pricing (CPP) and the most complex example is real-time pricing (RTP). In CPP, prices are established for various time periods ahead of time.

However, the prices for the critical period, in which the power system is stressed, are called just a day in advance. In some cases, they are called a few hours ahead on the day critical conditions are encountered. Such price signals can be augmented with the provision of smart thermostats that have price sensitive set points, or gateway systems that remotely control multiple end-uses. In RTP, hourly prices are provided to customers on a day-ahead or hour-ahead basis. Unlike CPP, RTP prices reflect varying system conditions and are not set ahead of time.

Dynamic prices provide customers with a chance to lower their energy bills by curtailing peak period usage and/or shifting it to off-peak periods. In so doing, they offset the need for expensive peaking capacity. They can also help to lower prices in wholesale markets and to mitigate market power being exercised by a few generators. Finally, by reducing emissions they help to protect the environment.

Despite these many benefits, less than 10% of the customers are on a dynamic pricing rate in the US and most of these are commercial and industrial customers in the southeastern US. The potential impact of dynamic pricing programmes is large. Over the long haul, as much as 5% of US peak demand may be eliminated through dynamic pricing. Impacts may be even higher if standard tariffs are converted to dynamic prices.

Will customers respond?

One of the big questions on the minds of regulators and utilities is whether customers will respond to dynamic pricing. Uncertainty on this front is holding back the wider scale deployment of dynamic pricing. However, new experimental evidence emerging from several pilot programmes may help change this hesitation. For example, a large scale pilot carried out by Puget Sound Energy a few years back showed that even a mild TOU rate can reduce peak loads by 5%. California has just completed a large-scale pilot with 2,500 customers to estimate dynamic pricing impacts.

These customers were chosen to be statistically representative of the state’s 10 million residential and small commercial and industrial customers and were located in four climate zones. The experiment featured multiple rates or treatments and customers were randomly assigned to treatment and control groups.

Analysis of experimental data has shown that, on average, residential customers dropped peak loads on critical-peak days by 13%. Rates during those critical days were more than five times higher than standard rates. Customers with central air conditioning (CAC) systems dropped peak loads by 16% while those without CAC dropped peak loads by half as much. Impacts were boosted substantially by the presence of enabling technologies.

For example, customers with smart thermostats dropped loads by almost twice as much as the average residential customer. And those on gateway systems dropped loads by almost twice as much as customers with smart thermostats, i.e. by about 50%. These load drops held steady during simulated heat wave environments, when several critical peak days are likely to be called in a row.

They also held steady across the two summers in the experiment. Thus, they were found to satisfy the regulatory requirements for resource adequacy that now exist in most jurisdictions. Based on these experimental results, California’s utilities are developing business cases for AMI. Pacific Gas & Electric Company has been authorised to roll out 5 million electric and 4 million gas meters to its customers in northern California. It expects to reduce its peak demand in 2011 by about 500 MW, based on an expected adoption rate of about 16% for its dynamic pricing rates.

San Diego Gas & Electric Company’s application is under review while Southern California Edison expects to file its application shortly. The experimental results can be used outside of California once the underlying conditions have been adapted to conditions elsewhere. Among those conditions that modellers will need to modify are the initial load shape of customers, the saturation of CAC systems and weather conditions. In addition, the modeller will have to provide existing and dynamic rate designs.

Misperceptions about dynamic pricing

Other barriers to the faster adoption of dynamic pricing include economic and technological considerations. For example, will the benefits of avoided capacity outweigh metering costs? Will customers understand the new rates? Can dynamic prices be conveyed easily to customers in near real-time conditions? But a bigger barrier is based on a misperception.

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Regulators and utility executives fear that dynamic pricing will lead to rate shock and exacerbate price volatility, which ironically are the very conditions that dynamic pricing is supposed to alleviate. Legislators are concerned that a move toward dynamic pricing will eliminate existing rate subsidies between customers with flatter-than-average load shapes and those with peakier-than-average load shapes.

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They do not want to unleash a voter backlash by taking away these subsidies. Utilities are equally concerned about being able to recover their AMI investments and about any customer backlash that may occur when prices begin to fluctuate by time of day on a dynamic basis. What British utility analyst D. J. Bolton wrote in 1938 is still very true: “There is general agreement that appropriate tariffs are essential to any rapid deployment of electricity supply, and there is complete disagreement as to what constitutes an appropriate tariff.” Rate making is as vexing an endeavour today as it was back in Bolton’s time.

However, fears about dynamic pricing can be addressed by building ‘consumer protection’ into rate designs. For example:

  • Utilities can provide customers on dynamic pricing rates a bill guarantee for the first year.
  • They can make dynamic pricing rates revenue neutral for individual customers, e.g. by offering two-part rate designs.
  • They can make the rates revenue neutral for the peakiest customer.
  •  They can give customers a credit equal to the amount of the insurance premium that is implicit in existing (nondynamic) rates.

 Regulators can address utility fears about creating a new type of stranded cost in their AMI investments. They can do this by:

  • Establishing a cost-benefit framework for evaluating AMI investments and by adhering to the criteria embodied in the framework through the duration of the project.
  • Pre-approving some utility expenses for getting started with smart pricing programmes, such as implementing pilots and field tests. This will allow activities to be placed on a fast-track.
  • Creating a regulatory process for approving full-scale deployment of smart metering and smart pricing programmes. This should be done in the beginning so everyone has a clear vision of the path to follow from Day One.
  • By making sure that utilities are made whole on their fixed costs, regardless of how much the load shape is changed by these programmes. It is important not to place utility earnings at risk by introducing such programmes, since that will raise the cost of raising capital for the utilities and ultimately have an adverse affect on their customers.

Creating an action plan

Now is the best time to harness the opportunity created by smart pricing. This is largely because utilities across the globe are facing an unprecedented wave of new investments in generation, transmission and distribution capacity. Welldesigned dynamic pricing programmes can help mitigate the rate impact of these investments, give customers choices and improve environmental quality.

To make the most of these opportunities, utility executives need to begin the journey by asking the right questions. Among the questions on any executive’s list the following should figure prominently:

  • What do I hope to achieve with dynamic pricing? Lower capacity costs? Higher customer satisfaction? A cleaner environment?
  • Which dynamic pricing options are best suited for my customers? Is CPP sufficient or would it be useful to also deploy RTP, maybe to the larger customers?
  • How should I evaluate the costs and benefits of dynamic pricing? Are the tests that have long been used to evaluate other demand side programmes sufficient or should they be modified, e.g. by including the concept of consumer surplus in the net benefits equation?
  • How should I market smart pricing so I attract those customers who stand to gain the most from it and who would also give me the most benefits? It would not be a good situation if the only customers who joined the programme are the ones who would get lower bills simply by switching over to dynamic pricing rates and not making any reductions in their peak loads.
  • How do I get the best regulatory treatment for my AMI investments?

The best way to address these questions is to hold brainstorming sessions with all the key utility staff who will play a role in designing, implementing and evaluating dynamic pricing programmes.

After the internal sessions have been held, the utility should develop a long-term plan for dynamic pricing and convey it in simple language to all its employees, customers, regulators and other publics. It may be useful to hold brainstorming sessions and perhaps focus groups with representatives of these groups too.