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Dynamic pricing: the facts are in, Part II

Say you're a regulator and dynamic pricing conjures fears of high prices on the consumers you're charged with protecting and treating fairly.

That topic and emotion might well have been on your mind in Portland two weeks ago when the National Association of Regulatory Utility Commissioners (NARUC) met for summer committee meetings. Enter Ahmad Faruqui, a principal at The Brattle Group and pricing expert, who addressed the gathering on the topic of dynamic pricing and advocated facts over fears. (Faruqui's presentation to NARUC is here.)

For the initial installment in this three-part series, please read "Dynamic Pricing: The Facts Are In," which ran yesterday. In that article, Faruqui explained the implications of the power industry's low load factor and how dynamic pricing could improve it. The third installment will run tomorrow. 

Faruqui presented calculations to his NARUC audience that document that the nation's electricity customers collectively are currently over-paying by about $7 billion each year. (That estimate is based on a Federal Energy Regulatory Commission staff estimate that 92 gigawatts would be saved under universal dynamic pricing, plus demand response valued at $75 kW-year.) 

Also consider that customers with flat loads subsidize those with "peaky" loads to the tune of $3 billion each year. And that 80 percent of low-income customers would actually save on their bills under dynamic pricing. 

Those are the facts. And those numbers do not take into account potential changes in customer behavior to actively take advantage of dynamic rates. 

Of course, the burning question remains: "But will customers respond?" 

A decade of experiments (more than 134) have tested dynamic or TOU pricing in the U.S., Canada, Europe and New Zealand, according to Faruqui. He plotted more than half of those studies, which have been published. 

You'll need to examine the data for yourself. But Faruqui found that customers do react to price signals and that the advantage of in-home, enabling technology is measurable but relatively slim. Price is the fundamental driver.

"You can get a lot (of response) with price alone," Faruqui told me in a recent interview. "That is not commonly recognized."

"Some argue that the only way dynamic pricing will work is to provide customers with enabling technology inside the home, that customers cannot respond without a smart thermostat, smart appliance or in-home display," Faruqui added. "The data reveal that you get most of the response based on price alone. But you do get a boost from adding enabling technology."

This is a critical point, he argued, because many regulators and utilities consider enabling technology too expensive for customers to purchase or for the utility to subsidize.  

"People say we have to do `prices to devices,'" Faruqui said. "Those devices remain expensive. So regulators and others say `we can't do it then.' Because enabling technology costs would be on top of smart meter costs."

On the other hand, dynamic pricing cannot be accomplished without smart meters, because their load profile must be measured on an hourly basis to see how much to charge them during the different hours and rates, Faruqui said. 

New billing systems are needed as well, but in most cases, those come with advanced metering infrastructure (AMI) systems, according to Faruqui.

Faruqui even looked back to studies from 30 years ago and concluded that several decades have elapsed, but "consumer behavior is remarkably consistent."

"The upshot is that people in the utility industry have remained skeptical for 30 years about a scientific fact that consumers respond to price," Faruqui said. "Some look at newer experiments and say that's just a `flash in the pan.' It won't last. In reality, we've measured consumer response over three decades and found similar results. It's a robust finding."  

The good news, in this view, is that smart meters on residential customer premises will cover half the nation by 2017, he said. Dynamic pricing has been a success in Arizona. Arizona Public Service has 51 percent of its customers on various time-of-use rates and Salt River Project has about 30 percent. And dynamic pricing is expected to rollout in the Mid-Atlantic region with Baltimore Gas & Electric and Pepco Maryland, followed by the Midwest (Illinois) and California. 

"There is some momentum building," Faruqui observed. "But 33 percent of all meters today are smart. How many of the prices are smart? One percent. That's a huge gap. That's the regulatory hesitation, with consumer advocates raising the fear factor. That's causing the momentum to stop. Those perceptions, those fears, carry more weight than they should."

So where's the sweet spot for balancing risk and reward among dynamic rate programs? 

Faruqui plotted eight types of pricing programs, from a flat rate to an inclining block rate, a seasonal rate, TOU, "super peak" TOU (2-3 hour peak), critical peak pricing (CPP), variable peak pricing (VPP) and real-time pricing (RTP). That's the gamut from low risk/low reward to high risk/high reward. (A separate category to itself is peak time rebate (PTR), which carries zero risk and a pays a rebate for load reductions relative to a baseline .) 

Faruqui's conclusion: "CPP represents a good hybrid, a sweet spot between a flat rate and a real-time price."

"Let's aim towards a future in which we change the paradigm," Faruqui argued. "Go from a flat rate, the default rate for 99 percent of the country, to a situation in which critical peak pricing becomes the default rate. It wouldn't be mandatory. A customer could opt-out and select other options. They could pick a flat rate or a real-time rate if they want to be aggressive. But the anchor to these choices rests on critical peak pricing."

The logic: opt-in programs get one-fifth the involvement of opt-out programs.

Whoa! Opt-out over opt-in? Isn't that another major sticking point with regulators? 

Opt-out doesn't imply a mandatory program, Faruqui argued. Opt-out simply establishes CPP as the new default rate, but other options, including a flat rate or real-time prices might be offered as alternatives. You're simply forcing customers to make an active choice and providing them with tools to calculate which choice is best for them. And this can be accomplished in steps, using customer segmentation to find a receptive, initial audience and working outward to other customer segments. 

Tomorrow: incremental steps for regulators and utilities on the path to dynamic pricing. 

Phil Carson
Intelligent Utility Daily  




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