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The Transformative Power of Time-Varying Rates

The California Public Utilities Commission’s decision to move ahead with default deployment of time-of-use (TOU) rates in 2020 in the service territory of the state’s three investor-owned utilities has unleashed a flurry of negative headlines in the media. Many parties are fearful that instead of yielding any benefits, TOU rates will cause customer bills to go up.

But as best as can tell, that has not happened anywhere else where TOU rates have been deployed. Here are a few examples of success:

  • In Arizona, some 57 percent of Arizona Public Service’s (APS’s) customers in Arizona have chosen to receive service on TOU rates. People have chosen these rates because they are saving money on their utility bills.
  • In Oklahoma, some 20 percent of Oklahoma Gas and Electric’s (OGE’s) customers have chosen to receive service on variable-peak pricing rates.
  • In California’s capital city, the Sacramento Municipal Utility District (SMUD) has begun moving all its residential customers to default TOU rates.
  • Fort Collins, Colorado has moved all its residential customers to TOU rates on a mandatory basis.
  • The largest deployment of TOU rates is in Ontario, Canada. That province deployed TOU rates to all residential and small business customers about ten years ago on a default basis, soon after it had deployed smart meters. Some 90 percent of customers have elected to remain on the default TOU rate. Despite the narrow price differential between the pricing periods, empirical analysis over a three-year period showed that the residential class reduced its demand during peak periods by almost three percent. That is a significant reduction when expressed in MWs for the entire province.

What is the message that comes across all these deployments? First of all, there was no hue or cry in any of these deployments. Second, over and over again, we see that when customers are given an opportunity to save money by changing their behavior, they invariably do so.

Globally, there are more than 300 deployments of time-varying rates, including TOU rates, critical-peak pricing, variable peak pricing, real-time pricing and peak time rebates. Most of these deployments have taken place across the past two decades.

We have summarized the results of these deployments in a database called Arcturus (see the Appendix for details). Figure 1, drawn from the database, below summarizes the results of each rate treatment by type of rate as a percent peak reduction. The figure shows that time-varying rates yield significant reductions in peak demand.

Figure 1: Average Peak Reduction from Time-Varying Rate Pilots

Source: Results from 334 pricing treatments collected in the Arcturus 2.0 database. Graph does not include 15 Variable Peak Pricing (VPP) treatments (3 without enabling technology and 12 with enabling technology). See Faruqui, Ahmad, Sanem Sergici, and Cody Warner, “Arcturus 2.0: A meta-analysis of time-varying rates for electricity.” The Electricity Journal 30(10) (December 2017): 64-72.

While there is much variation in the results across the pricing treatments, one would expect the reduction in peak demand to be correlated with the effects of the peak to off-peak price ratio on peak reductions. This is indeed the case.

As shown in Figure 2 below, a curve can be fit to the results of the time-varying pilots to capture the key relationship between time-varying rates and customer behavior. In both figures, the horizontal axis shows the ratio of peak to off-peak prices. The vertical axis shows the percent reduction in peak demand induced by various peak to off-peak prices.

The “Price Only” curve shows the impact simply of sending the price signal to customers, unaided by any smart technologies. Customers respond to higher peak to off-peak ratios by lowering their peak demand, but at a diminishing rate. When the price ratio is 2:1, the reduction in peak demand is a little over 5 percent. When the price ratio is 4:1, the reduction is 10 percent. At 6:1, it’s a little over 12.5 percent.

Their price responsive behavior of customers on time-varying rates yields of an arc of price response. The “Enabling Tech” curve shows what happens if time-varying rates are accompanied by enabling technology such as a smart thermostat. The impacts are considerably higher than under the “Price Only” curve. With a price ratio of 4:1, the reduction in peak demand is 25 percent, compared to 10 percent without enabling technology.

Based on this wide body of empirical evidence, regulators and utilities should give serious consideration to deploying cost-reflective time-varying rates to their customers. The benefits in terms of peak demand reduction and lower customer bills could be substantial.

Figure 2: Price Responsiveness with and without Emerging Technology

Appendix

Arcturus is a database containing the results of 349 experimental and non-experimental pricing treatments from over 60 pilots. The pricing experiments typically take the form of a treatment group that is enrolled on a time-varying rate and a control group that remains on a standard residential rate. The purpose of the experiment is to measure how much customers reduce their electricity usage during peak-hours in comparison to a control group.

The studies begin as early as 1997, and the most recent study was published in 2017. They include 57 utilities spanning nine countries and four continents. Only pilots that adhere to the rigorous standards of experimental research design are added to the database. Similarly, results from pricing treatments that are not statistically significant at acceptable levels are deemed to have no effect.

Arcturus contains four different types of time-varying rate designs: TOU, CPP, PTR, and VPP, with the majority being TOU rate designs.

  • CPP and PTR rates differ from TOU designs in that the higher price periods are not known well in advance. Under a CPP or PTR structure, the utility notifies customers a day in advance and sometimes on the day of the event. In much of the U.S., peak events typically coincide with the hottest days of the summer when load from residential air-conditioning drives up forecasted peak demand.
  • A PTR rate design resembles CPP, except customers receive a rebate for shifting on-peak usage to the off-peak hours rather than paying a higher rate. No discount is offered during the off-peak periods and the standard tariff applies during all hours.
  • Under a VPP rate, during the peak period, customers are charged a rate that varies by the utility and usually mimics the wholesale price of electricity. In this way, VPP is a hybrid of a TOU rate design and real-time pricing. Because peak-prices mimic the market prices for electricity, VPP rate designs more accurately match the utility’s cost of producing electricity.

CoAuthored by Ahmad Faruqui and Cecile Bourbonnais[1]


[1] The authors are economist with The Brattle Group located in San Francisco. Comments can be directed to Ahmad.Faruqui@Brattle.Com.

Ahmad Faruqui's picture

Thank Ahmad for the Post!

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Discussions

Matt Chester's picture
Matt Chester on March 10, 2019

This is great, Ahmad. Thanks so much for sharing. From a political/logistic perspective, what are the biggest hurdles to actually getting TOU rates implemented more widely?

Ahmad Faruqui's picture
Ahmad Faruqui on March 12, 2019

The biggest hurdle is fear of the unknown. There is a perception that most customers will see higher bills. That is not the case. At least half of them would see lower bills with a well-designed rate and more than half would see lower bills if they respond to the price signal by using more power during the lower priced periods. Another barrier is the lack of smart metering and IT/billing systems but that is changing rapidly. 

Matt Chester's picture
Matt Chester on March 13, 2019

Yeah that's what I was thinking too, thanks for the response! It seems on a psychological level, when you talk about TOU there's immediately a perception that the utility is trying to nickel and dime you, when studies tend to show they would benefit customers. It's a similar issue towards educating people on carbon taxes-- people freeze up when they even think it could unfairly hit them in the wallets

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