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Demand Response: Breaking Out of the Bubble

Using demand response to mitigate rate shocks.

Fortnightly Magazine - March 2007

hours to achieve this goal. 4

• The average residential customer dropped usage in the critical peak period by 13 percent in response to a price signal that was about five times higher than the standard tariff price.

• Customers with enabling technologies dropped their load by twice as much. In most cases, customers simply raised their thermostat setting by a couple of degrees. In other words, customers responded to higher prices without making any drastic changes in their lifestyle.

• More important, empirical evidence suggests that the majority of the load drop came from a minority of customers. Several customers choose to make no load reductions and were content with buying through at the higher prices.

A drop of 13 percent in critical peak loads can have a substantial impact on wholesale energy costs in the near term, benefiting all customers (see sidebar, p. 49 which discusses the benefits of a 3 percent reduction). But by lowering the need for investing in peaking generation (and transmission and possibly distribution) capacity, demand response can have a greater impact on the long-run price of electricity. 5

During the 2000-2001 power crisis, California’s retail customers unknowingly exacerbated the demand-supply imbalance by not lowering their electricity usage. Then Gov. Gray Davis famously said that had he been able to raise electric rates, he would have solved the problem in a few minutes. Customers finally cut their usage in response to blackouts and a barrage of appeals by the state of California to conserve power. In the process, one utility was bankrupted and two others were brought to the verge of financial ruin. Ultimately, these costs were recovered from retail customers who were hit by price hikes in the 20 percent range. 6 In addition, the state’s multi-billion dollar budget surplus became a multi-billion dollar deficit as government officials signed expensive long-term contracts for the supply of electricity to Californians.

While these facts are only too well known to utilities and regulators, dynamic pricing has yet to find its way into the mainstream of utility ratemaking. One reason is that customers are not really aware that the price they pay for electricity today includes a significant risk premium for insuring them against wholesale price volatility. Effectively, policy-makers have made this choice for them. What the policy-makers have failed to communicate to customers is that the average price of electricity will go down if dynamic pricing is introduced.

The State of Play

EPACT requires utilities to provide individual customers with advanced interval meters upon request and “time-based” rate schedules that reflect the variance in wholesale prices. It is unclear whether time-based prices are synonymous with dynamic pricing or whether static, time-of-use (TOU) rates also qualify. And, while EPACT encourages DR devices, it does not encourage utilities to attract customers to time-based rates. According to the FERC staff report cited earlier, while 7 percent of retail customers are on advanced metering systems that would allow dynamic pricing signals to be conveyed, a very small percentage of customers are actually on dynamic pricing rates. 7

In April of last