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HOW RETAIL PRICING CAN DELIVER CUSTOMER VALUE IN A SMART GRID WORLD

Ahmad Faruqui, Ph. D.Pacific Northwest Demand Response Project

July 15, 2010

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The state of play

♦ The smart grid is being rolled out in many jurisdictions and the federal government has awarded utilities billions of dollars to expedite its deployment

♦ As most of these deployments have not focused on customer benefits, there has been a backlash among customers in some communities who see their monthly bills going up to cover smart grid costs without any commensurate benefits

♦ Customer concerns about costs, privacy and cyber security dominate the agenda of state regulators

3PNDRP

Retail pricing innovation is a means of engaging with the customer

♦ Customers, especially the new and emerging generation, are concerned about using energy wisely, having a smaller carbon footprint and lowering their utility bills

♦ However, for the vast majority of customers, the price of electricity provides them with very little information about how to achieve these objectives

♦ Most customer-side programs focus on providing rebates or creating standards and assume that electric rates cannot be touched

♦ Price matters in every industry except the electric

♦ Customer-side programs can be turbo-charged if complementary changes in electric rates accompany their rollout

4PNDRP

A classic example is inclining block rates

♦ About two-thirds of Americans today receive electric service on either flat or declining block rates

♦ The one-third that receive service on inclining block rates do not get much of an incentive to conserve from existing designs

♦ It has been shown that moderately inclining rates can boost energy efficiency levels at very low cost

♦ When coupled with time-varying rates, they can provide the best way to reward customers for using energy wisely and for encouraging them to invest in distributed generation and renewable energy options

5PNDRP

The full range of retail pricing options

Rate Description

Time-of-Use (TOU)Charges a higher price during all weekday peak hours and a discounted price during off-

peak and weekend hours

Super Peak TOUSimilar to the TOU with the exception that the peak window is shorter in duration (often

four hours), leading to a stronger price signal

Inclining Block Rate (IBR)Customer usage is divided into tiers and usage is charged at higher rates in the higher tiers;

meant to encourage conservation

Critical Peak Pricing (CPP)Customers are charged a higher price during the peak period on a limited number of event

days (often 15 or less); the rate is discounted during the remaining hours

Variable Peak Pricing (VPP) Critical Peak Pricing rate with added variability

CPP-TOU CombinationA TOU rate in which a moderate peak price applies during most peak hours of the year, but

a higher peak price applies on limited event days

Peak Time Rebate (PTR)The existing flat rate combined with a rebate for each unit of reduced demand below a pre-

determined baseline estimate during peak times of event days

Real Time Pricing (RTP)A rate with hourly variation that follows LMPs, but with capacity costs allocated equally

across all hours of the year

Critical Peak RTPA rate with hourly variation based on LMPs and with a capacity cost adder focused only

during event hours, creating a strong price signal at these times

6PNDRP 6

0

5

10

15

20

25

30

0 200 400 600 800 1,000 1,200 1,400 1,600 1,800 2,000

kWh / Month

Ce

nts

/ kW

h

Average Customer

Rate A

Rate B

Rate C

Rate D

Existing Flat Rate

Four illustrative inclining block rate designs

7PNDRP 7

Energy use could decline by up to 5.9 percent and customer bills by up to 9.1 percent

Avg Percent Change in UsagePrice Elasticity Rate A Rate B Rate C Rate D

Short Run Mean -5.9% -2.2% -1.0% -0.5%Std Dev 2.0% 0.8% 0.3% 0.2%

Long Run Mean -18.4% -6.7% -3.1% -0.7%Std Dev 6.5% 2.4% 1.1% 0.4%

Avg Percent Change in Class RevenuePrice Elasticity Rate A Rate B Rate C Rate D

Short Run Mean -9.1% -3.1% -1.0% -1.4%Std Dev 3.1% 1.1% 0.4% 0.5%

Long Run Mean -28.4% -9.4% -3.3% -2.6%Std Dev 9.9% 3.4% 1.1% 1.0%

8PNDRP 8

Price response mitigates the impact on high use customers by shifting the breakeven point

-70%

-60%

-50%

-40%

-30%

-20%

-10%

0%

10%

20%

30%

100 200 300 400 500 600 700 800 900 1,000 1,100 1,200 1,300 1,400 1,500 1,600 1,700 1,800 1,900 2,000

Customer Size

Ch

an

ge

in M

on

thly

Bill

No price elasticity

With price elasticity

Break-even point

Tier 1

9PNDRP

Each rate offers a different value proposition to each type of customer

Risk (Variance in

Price)

Reward (Discount from Flat

Rate)

10%

5%

10.5Flat Rate

RTP

CPP

VPP

Inclining Block Rate

Seasonal Rate

TOU

Less Risk, Lower

Reward

More Risk, Higher Reward

Super Peak TOU

PTR

Potential Reward

(Discount from Flat

Rate)

Incr

easi

ng R

ewar

d

Increasing Risk

10PNDRP

Utilities can evaluate these innovative rates against five criteria to configure their menu

Criteria Description

Simplicity & Ease of Understanding

Will customers be able to quickly understand the rate? Is it actionable?

Customer value proposition

Does the rate provide customers with a significant bill savings opportunity?

Retail-wholesale market connection

Does the rate satisfy legislative and regulatory requirements regarding connection to the wholesale market?

Incentive to reduce peak demand

Is the rate expected to produce significant reductions in peak demand?

Incentive for permanent load shifting

Will the rate encourage customers to permanently shift load from higher cost hours to lower cost hours?

11PNDRP

Scoring the rates – an illustration

SimplicityValue

Proposition

Retail-Wholesale Connection

Peak Reduction

Load Shifting Score

Description

Super Peak TOU

3 1 2 2 2 10Provides incentive for permanent load

shifting with strong price signal

CPP 2 3 2 3 1 11Simple, focused rate for targeted reductions

during top load hours

CPP/TOU 2 3 3 3 2 13Provides combined incentive of load shifting

and demand response

PTR 2 2 1 3 1 9

Residential rate produces no immediate “losers”; potentially most applicable for low income residential customers; interruptible

tariff could be used for C&I

RTP 1 1 - 3 3 1 2 8 - 10 Conveys variability in hourly LMPs

CP RTP 1 1 - 3 3 3 2 10 - 12CP RTP provides additional curtailment

incentive beyond LMP during top load hours

Degree to which criterion is satisfied: 3 = High 2 = Medium 1 = Low

12PNDRP

The pure CPP rate provides a strong demand response signal

Illustrative CPP Rate for Residential Class - SummerAll-In Rates

$0.00

$0.20

$0.40

$0.60

$0.80

$1.00

$1.20

$1.40

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24

All

-In

Rat

e ($

/kW

h)

Existing Rate = 12.6 cents

Off Peak Rate = 11.4 cents

Critical Peak Rate = 123.4 cents

Illustrative CPP Rate for Residential Class - WinterAll-In Rates

$0.00

$0.20

$0.40

$0.60

$0.80

$1.00

$1.20

$1.40

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24A

ll-In

Rat

e ($

/kW

h)

Existing Rate = 12.6 cents

Off Peak Rate = 11.4 cents

• Customers pay a flat rate for all kWh every day unless a critical day is called• On critical days during the critical peak period customers pay a premium for all kWh used• The critical peak price is equal to the cost of capacity plus the average critical peak LMP• Spreading the off-peak discount over all non-critical hours of the year provides a cost savings

to customers

13PNDRP

The CPP-TOU rate ties more closely to actual system costs than the pure CPP rate

Illustrative CPP/TOU Rate for Residential Class - SummerAll-In Rates

$0.00

$0.20

$0.40

$0.60

$0.80

$1.00

$1.20

$1.40

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24

All

-In

Rat

e ($

/kW

h)

Existing Rate = 12.6 cents

Critical Peak Rate = 123.4 cents

Peak Rate = 20.5 centsOff Peak Rate = 10.2 cents

Illustrative CPP/TOU Rate for Residential Class - WinterAll-In Rates

$0.00

$0.20

$0.40

$0.60

$0.80

$1.00

$1.20

$1.40

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24A

ll-I

n R

ate

($/k

Wh

)

Existing Rate = 12.6 cents

Peak Rate = 20.5 centsOff Peak Rate = 10.2 cents

• Every day is divided into peak and off-peak periods• Customers pay lower rate for off-peak usage and higher rate for peak period usage• On critical days during the critical peak period customers pay a premium for all kWh used• The critical peak price is equal to the cost of capacity plus the average critical peak LMP• The low off-peak rate provides heating customers with an opportunity to save as compared to a flat rate

14PNDRP

Like the CPP rate, the CPP-TOU rate has lower rates in most hours of the year

Hours of the YearCPP-TOU Rate

Peak Hours

98411%

Critical Peak

Hours601%

Off-Peak Hours771688%

15PNDRP

The PTR is a mirror image of the CPP and pays customers to reduce peak demand

Illustrative PTR Rate for Residential Class - SummerAll-In Rates

-$1.40

-$1.00

-$0.60

-$0.20

$0.20

$0.60

$1.00

$1.40

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24

All

-In

Rat

e ($

/kW

h)

Existing Rate = 12.6 cents

Peak Rebate = -110.8 cents

Illustrative PTR Rate for Residential Class - WinterAll-In Rates

-$1.40

-$1.00

-$0.60

-$0.20

$0.20

$0.60

$1.00

$1.40

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24

All

-In

Rat

e ($

/kW

h)

Existing Rate = 12.6 cents

• Customers pay the default rate for all kWh used; if they make no changes in their usage they continue to pay the default rate with no extra costs (“carrot only” approach)

• On critical days customers can earn a rebate reductions in usage below an estimate of what they otherwise would have consumed (their “baseline” calculation)

• The rebate amount is equivalent to the critical peak price of the CPP and the CPP-TOU• Baseline calculation method and where customer payment originates are important issues to resolve

16PNDRP

All these rates can yield substantial amounts of demand response – illustrative case

Projected Change in Critical Peak Demand

-20%-20%

-12%

-13%

-21%

-12%

-14%

-20%

-14%-15%

-25%

-20%

-15%

-10%

-5%

0%

Residential Small C&I Medium C&I

Ch

ang

e in

Dem

and

Du

rin

g E

ven

t H

ou

rs

PTRCPPCPP-TOUCP RTP

PTR impacts are shown for the average low-income residential

customer

17PNDRP

The CPP-TOU rate will produce the greatest amount of permanent load shifting – illustration

A slight increase in non-event peak demand could occur under the CPP due to the discounted price during these hours

Projected Change in Non-Event Peak Demand

0% 0.4% 0.3% 0.3%

-5%

-2% -3%-1% -1% -2%

-25%

-20%

-15%

-10%

-5%

0%

5%

Residential Small C&I Medium C&I

Ch

an

ge

in D

eman

d D

uri

ng

No

n-E

ven

t P

eak

Ho

urs

PTRCPPCPPTOUCP RTP

18PNDRP

Bill savings are larger for customers with flatter load shapes – illustration

Distribution of Dynamic Pricing Bill ImpactsResidential Customers on CPP-TOU Rate

-15%

-10%

-5%

0%

5%

10%

15%

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%

Ch

an

ge

in

Av

era

ge

Mo

nth

ly B

ill

Before customer price response

After customer price response

"Losers""Winners"

19PNDRP

Low income customers have demonstrated significant price responsiveness in recent experiments

 Low income customer response ranges from 22% to 214% of the average customer

22%

50%66% 66%

84% 100% 100%

200%214%

0%

50%

100%

150%

200%

250%

California SPP: CARE vs. Average

PG&E SmartRate

2009: CARE vs. Average

PG&E SmartRate

2008: CARE vs. Average

CL&P's PWEP

Program (PTP high): Hardship vs.

Average

California SPP: Low Income vs. Average

BGE 2008: Known Low Income vs.

Known Average

Customer

CL&P's PWEP

Program: Known Low Income vs.

Known Average

Customer

Pepco DC (price only): Low Income vs. Average Residential

Pepco DC (price +

thermostat): Low Income vs. Average Residential

Pea

k R

edu

ctio

nLow Income Customer Responsiveness Relative to Average Customer Response

Average customer response

20PNDRP

Up to 88% of low-income customers could experience bill

savings when enrolled in a CPP-TOU rate – illustration

Distribution of Dynamic Pricing Bill ImpactsLow Income Residential Customers on CPP-TOU Rate

-15%

-10%

-5%

0%

5%

10%

15%

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%

Ch

ang

e in

Ave

rag

e M

on

thly

Bill

Before customer price response

After customer price response

"Winners" "Losers"

21PNDRP

References

Faruqui, Ahmad, “Inclining toward efficiency,” The Public Utilities Fortnightly, August 2008.

Faruqui, Ahmad, Sanem Sergici, and Jenny Palmer, The Impact of Dynamic Pricing on Low Income Customers, The Institute for Electric Efficiency, June 2010. http://www.edisonfoundation.net/iee/reports/IEE_LowIncomeDynamicPricing_0610.pdf

Faruqui, Ahmad, Ryan Hledik and Sanem Sergici, “Rethinking pricing: the changing architecture of demand response,” The Public Utilities Fortnightly, January 2010.

Faruqui, Ahmad, Ryan Hledik, and Sanem Sergici, “Piloting the smart grid,” The Electricity Journal, August/September, 2009.

Faruqui, Ahmad and Sanem Sergici, “Household response to dynamic pricing of electricity–a survey of the experimental evidence,” January 10, 2009. http://www.hks.harvard.edu/hepg/. Journal of Regulatory Economics, Forthcoming.

FERC, “A National Assessment of Demand Response Potential,” June 2009, http://www.ferc.gov/legal/staff-reports/06-09-demand-response.pdf .

22PNDRP

Biography

Ahmad Faruqui is an expert on how the smart grid affects electricity customers. He has performed cost-benefit analysis of smart grid programs for utilities in two dozen states and testified before several state and provincial commissions and legislative bodies. He has designed and evaluated some of the best known pilot programs involving dynamic pricing and in-home displays and his early experimental work is cited in Bonbright’s canon. During the past two years, he has assisted FERC in the development of the “National Action Plan on Demand Response” and in writing “A National Assessment of Demand Response Potential.” He co-authored EPRI’s national assessment of the potential for energy efficiency and EEI’s report on quantifying the benefits of dynamic pricing. He has assessed the benefits of dynamic pricing for the New York Independent System Operator, worked on fostering economic demand response for the Midwest ISO and ISO New England, reviewed demand forecasts for the PJM Interconnection and assisted the California Energy Commission in developing load management standards. His most recent report, “The Impact of Dynamic Pricing on Low Income Customers,” has just been published by the Institute for Electric Efficiency. The author, co-author or editor of four books and more than 150 articles, papers and reports, he holds a doctoral degree in economics from the University of California at Davis and a bachelor’s degree from the University of Karachi, Pakistan.