Changes in regulatory requirements, market structures, and operational technologies have introduced complexities that traditional ratemaking approaches can’t address. Poorly designed rates lead to...
Dynamic Pricing Solutions
How to account for lack of strong price signals. A hard year puts deregulation to the test.
will be the system peak. One can see what National Grid’s hourly retail prices would have been in 2007 if its capacity adder had been designed using the 90 percent probability of peak (POP) approach (see Figure 4) . Under this rate design a capacity adder would be imposed only during the summer week-day hours from 10 a.m. to 10 p.m. The adder would vary by hour based on the probability of peak and the highest adders would occur between 3 p.m. and 5 p.m., the hours most likely to be within 90 percent of system peak. The hourly retail price would have been above 15 cents/kWh during the weekday hours between 12 noon and 5 p.m. in the summer of 2007 and 4 percent lower in the other three seasons, so the average customer’s annual commodity bill would have been about the same.
Although the POP method to collect capacity costs would not create a dynamic price signal like that provided by the DALBMP, it would help to send a strong and persistent signal to customers at the time of system peak so they can better justify investing in operational flexibility to reduce load on the grid at the summer peak. The POP method also would send a stronger signal during the peak summer months to customers who do not have interval meters and who currently are billed for commodity based on an average of hourly retail commodity prices.
Con Edison and Orange and Rockland use a monthly demand charge to collect capacity costs from retail customers. Again, like the approaches used by National Grid and NYSEG/RGE, this approach does not send a dynamic-price signal to customers at the time of the system peak. Instead, it creates an incentive for customers to reduce peak use every month, including the month in which the electric system peaks. The demand charge is based on prices from the NYISO’s six-month strip auction. For New York city the six-month strip price for capacity has been markedly higher during the summer capability period, so customers get a much stronger price signal to curb peak usage during the months from May to October. 7 And for customers with interval meters, Con Edison also narrows the range of hours subject to the demand charge in summer to encourage customers to reduce load during hours that are more likely to be the summer peak. This would seem to have a similar impact as would a capacity adder based on the POP model described above for National Grid.
A Way Out
In order to realize the potential of dynamic pricing programs, customers should be billed for the electric commodity based on their actual hourly electric use and an hourly price that approximates the opportunity cost of consuming electricity in that hour. The easiest and most efficient way to accomplish this would be to abandon the generation reserve requirement, capacity payments and the administrative demand curve for capacity, and pass through market-determined hourly prices that include scarcity rents in those hours when generation is scarce. Policy makers understandably are reluctant to