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Rethinking 'Dumb' Rates

Achieving the smart grid’s potential requires a revolution in electricity pricing.

Fortnightly Magazine - March 2009

Change is in the air throughout all segments of our society, and our electric system is no exception.

The smart grid that’s beginning to emerge in North America will rely on hardware like “smart” meters, “smart” appliances and thermostats, remote sensors, and sophisticated communications systems. These devices, when linked together, will enable utilities and their customers to respond in real time to conditions on the power grid, thereby creating new opportunities to reduce costs and increase customer value. 1

Indeed, for the vast majority of customers, electricity still is measured the same way it was in the 19th century: A “dumb” electromechanical meter tallies kilowatt-hours of consumption and is read manually about once a month. With today’s 21st century technology, we can do much better!

Achieving the full potential of the smart grid, however, will require a revolution in the way we price electricity at the retail level. This involves replacing flat or “blended” retail prices that ignore variations in wholesale market prices (or generation costs, outside of organized markets). Instead of charging the customer a single price reflecting the average of costs between monthly meter reads, utilities will offer “dynamic” prices that reflect hourly variations in power costs.

Dynamic pricing offers customers new options to manage their utility bills, as well as the potential to reduce wholesale power costs as customers respond to high peak prices. Illinois regulator Bob Lieberman calls it “value pricing,” which is perhaps a better nomenclature. 2 Without dynamic pricing, we will forego some of the greatest benefits of the smart grid. As I’m fond of saying, “There’s no point in having smart meters if you’re still going to have dumb rates.” 3

Dynamic pricing is made possible by relatively recent developments in metering, particularly the availability of cost-effective advanced metering infrastructure. AMI typically includes: 1) interval meters, capable of recording customer consumption at least hourly; 2) an integrated two-way communications network that can transmit variable price signals to the consumer and detailed customer usage data to the distribution utility; and 3) a sophisticated data management and billing system that keeps track of multiple rates and time periods. Importantly, AMI offers a number of collateral benefits as well, which can help bolster a business case for AMI deployment. 4

Dynamic pricing can be structured in a variety of ways, but typically is classified into three different approaches:

Critical-peak pricing (CPP) , whereby prices increase by a factor of five or so during peak hours when electrical capacity is stressed, with such peak periods typically limited to 100 hours per year. In exchange for paying high peak prices, the customer receives slightly lower rates the rest of year than

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