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Dynamic Pricing Solutions

How to account for lack of strong price signals. A hard year puts deregulation to the test.

Fortnightly Magazine - January 2009

abandon these mechanisms until they are confident that demand-side resources are as reliable as generation resources, and will fully participate in the day-ahead price discovery process. However, hourly-pricing customers are not likely to invest in the equipment and processes necessary to enable demand response unless they are subject to significant hourly price signals.

One possible way out of this dilemma is to consider changing the way that LSEs are billed for capacity. If load-serving utilities were billed for capacity mainly during the summer months, they would be more apt to collect capacity costs from commodity customers in a way that sends a strong price signal to customers at the time of the system peak. These signals do not necessarily need to be dynamic in order to achieve the most important goals of dynamic-pricing programs—clipping peak load. Indeed, it seems that a strong and persistent signal at the time most likely to be the system peak would create an even stronger financial incentive for customers to modify their operations or to invest in the on-site generation equipment required to curb load on the system at the time of the peak. If customers responded to these signals, the need for system-wide capacity would be tempered, the capacity requirement would be lower and customers over time would pay less for capacity.

As a next step in this direction, utilities might consider running dynamic pricing pilot programs to evaluate customer response to alternative commodity rate designs to restore the missing price signals at the time of the system peak. The results from these pilots would help policy makers to better evaluate the potential advantages of AMI, dynamic pricing programs, and changes required to implement effective commodity rate designs at the retail level. Indeed, pilot programs that delivered significant price signals to customers at the time of the system peak were an important first step in developing and implementing more broad-based AMI/dynamic pricing programs in California.

In the mean time, utilities can continue to invest in, and promote, energy-efficiency programs. Installing more energy-efficient equipment (better air conditioning systems or raising thermostats on existing equipment, for instance) saves more kilowatt hours during the peak hours of the day when customers use these devices most, and therefore has the potential to significantly reduce summer peak loads. Other measures that promote energy efficiency would have similar built-in demand response potential. It seems like centrally administered subsidized demand-response programs also would continue playing a useful role.



1. Faruqui, Ahmad and Stephen George, “The Value of Dynamic Pricing in Mass Market,” Electricity Journal , July 2002.

2. Some believe that dynamic-pricing programs also help to lower wholesale market prices, but this depends on how the demand side of the market participates in the wholesale price discovery process. More important, lower wholesale prices simply transfer income from producers to consumers and results in no net savings to society as a whole.

3. See McDonough, Catherine, and Robert Kraus, “Does Dynamic Pricing Make Sense for Mass Market Customers?” Electricity Journal , August-September 2007.

4. Barbose, Galen, et al.,