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Rethinking 'Dumb' Rates

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

Fortnightly Magazine - March 2009

storm restoration; and savings achieved through remote connection and disconnection of customers.

Another oft-cited benefit of AMI is its ability to reduce market prices through customer demand response. In this respect, the greatest potential is likely to occur where reserve margins are tight, leading to price spikes when the system is stressed. In 2007, the Brattle Group analyzed this issue in the Mid-Atlantic region for state regulators and the PJM Interconnection. Brattle examined a hypothetical 3-percent peak reduction in five key PJM zones during the 20 most costly five-hour periods. The study concluded that load curtailment could save as much as $182 million per year by lowering locational market prices. 9 It’s because of this ability to control peak prices that FERC Commissioner Jon Wellinghoff calls demand response the “killer application” for the smart grid. 10

Does it matter if some customers are unable to respond to dynamic prices? Not really! A small percentage response can have a big impact on wholesale market prices ( i.e., the cost of generation and transmission). Furthermore, demand-response benefits tend to spill over to other customers. Such recurring customer savings could help to offset any rate impacts associated with AMI deployment.

Furthermore, low-income customers are among likely winners under dynamic pricing, since they tend to have favorable usage patterns. Under traditional blended rates, larger customers with big air conditioning loads often are subsidized by other customers, especially those with little or no air conditioning. For many customers, dynamic pricing provides a long-overdue credit for their economical use of the electrical system! In any case, dynamic pricing assigns costs more fairly than traditional blended rates, whether or not an individual customer responds to price signals. 11

One of the most important benefits of dynamic pricing and AMI may be the most difficult to quantify: empowering customers via more options. There clearly is value in providing customers with more choices through enabling technologies. For example, a dynamic-pricing customer with a smart thermostat has the opportunity to choose between comfort and economy, simply by adjusting the controls on her smart T-stat. What a difference from conventional load-control programs where the utility controls the switch! Intangible benefits like this help to explain dynamic pricing’s typically high retention rates.

Perhaps the real sleeper among the consumer benefits of dynamic pricing is its potential to free consumers from hidden charges for the privilege of rate stability. Even though blended rates are the norm for most retail consumers, utilities and other service providers typically include a premium in customer bills reflecting the cost of retail rate stability when wholesale prices fluctuate.

Under blended rates, retail customers are spared the burden of price volatility, while utilities and competitive service providers are compensated for absorbing the cost of hedging the uncertainty associated with volatile wholesale prices. This so-called “hedge premium” implicitly is passed along to consumers in traditional blended electricity rates and rarely is quantified by utilities or their regulators. Furthermore, retail consumers aren’t normally given the opportunity to avoid paying this hedge premium—except perhaps when they are offered a dynamic-pricing option that involves