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Predicting California Deman Response

How do customers react to hourly prices?
Fortnightly Magazine - July 1 2003

during hours when wholesale prices are high, the price that final customers pay for some or all of their electricity consumption should be high, and when wholesale electricity prices are low, the price that final customers pay for some or all of their electricity consumption should be low. Both of these conditions should apply regardless of the time of day or season of the year when the consumption takes place.

For this reason, it is important to distinguish between time-of-use pricing, where prices change depending on the time of day regardless of system conditions, and dynamic prices that respond to current system conditions. Time-of-use retail prices do not allow active demand-side participation in the wholesale market because the retailer does not have the ability to reduce demand during hours with high wholesale prices by sending a price signal to final customers indicating this increased cost of wholesale electricity.

In contrast, dynamic pricing allows electricity retailers to send prices to final customers that signal current conditions in the wholesale market. All final customers equipped with meters that can record their consumption during each hour of the month can benefit from shifting their electricity consumption away from these high-priced hours to other hours of the day. Customers without hourly meters cannot realize this benefit, because the retailer can measure only their total monthly consumption, rather than their consumption during each hour of the year.

Though some express concern that exposure to hourly price changes creates more price risk for customers, such pricing would not preclude individual customers from reducing their price risk by purchasing forward contracts at fixed prices to cover some or all of their expected consumption. Indeed, dynamic pricing would give customers the appropriate incentives to weigh the costs and the benefits of risk-management products on the basis of their individual preferences.

Because of the sizes of their monthly electricity bills and their sophistication as purchasers of electricity, large industrial and commercial electricity customers are likely to realize the largest dollar savings from dynamic pricing. Consequently, these customers should be able to justify the cost of purchasing the hourly metering technology necessary for dynamic pricing. As the price of interval-metering technology falls, we expect that it will become economic for residential and small business customers to purchase according to dynamic pricing plans.

We strongly urge state public utility commissions to support the widespread adoption of hourly metering technology and dynamic-pricing plans. For large industrial and commercial customers, we see no reason to delay implementing these programs. We also encourage extending these pricing programs to residential and small business customers as soon as it is economic. Even though the dollar benefits per customer may be lower for these customers, a number of studies suggest that residential and small business customers are able to shift their electricity demand in response to time-varying prices. Consequently, the aggregate price response from residential and small business customers may be greater than what could be achieved from large industrial and commercial customers.

Sincerely,

Severin Borenstein
James Bushnell
Peter Cramton
Alvin K. Klevorick
Benjamin F. Hobbs
Carl Shapiro
Paul