How Competitive Metering Has Failed

 

It's time for regulators to face facts and move forward.

Advanced metering-hourly data retrieved daily-and price signals could have prevented California's energy crisis. So says the Congressional Budget Office, which said rolling blackouts would have been averted,¹ and the Electric Power Research Institute, which found that electricity costs in California would have been between as much as 19 percent lower in 2000 with real-time metering in place.² Groups from the Bush Administration to the National Governor's Association to the Consumer Federation of America are calling for real-time meters or demand response programs predicated on them-even in electricity markets without retail competition.³ On the cost side, McKinsey forecasts consumer savings of $10 billion to $15 billion per year resulting from time-based pricing.⁴ And Puget Sound Energy's highly successful 300,000 customer voluntary residential time-of-day program is yet another in a long line of evidence proving that consumers do, in fact, lower electricity demand in response to voluntary time-based prices.⁵ ()

In spite of such compelling support, regulators have failed to develop successful policies to promote advanced metering installations. Quite the contrary; in attempting to protect consumers, regulators have unwittingly created an environment where energy users are led to believe there is no limit to available capacity and utilities are encouraged to construct power (peaking) plants that often operate less than 10 days per year. The former, since prices remain fixed even during the highest summer peaks, and the latter, since utility earnings are increased through adding to the rate base. The UK's Office of Gas and Electricity Markets documented that cost-plus regulation of distribution utilities actually discourages investment in advanced metering.⁶

The advent of wholesale competition with 1992's Energy Policy Act, combined with the availability of silicon-based technology, has made regulatory policies for metering obsolete. Few other resources have such a disconnect between wholesale costs and retail prices. Even such a critical commodity market as gasoline has demand response; high prices lead users to form carpools, reduce non-essential driving, and use more efficient vehicles. The cost/price disconnect for electricity renders consumers impotent: having no knowledge of when costs are high, they have no ability to reduce those costs by withholding demand. At the same time, wholesale providers enjoy a significant information advantage-a phenomenon in recognition of which the Nobel Prize in Economics was just awarded-and exploit that market power to their benefit.⁷ The result: wholesale price spikes in virtually every region.

Policymakers need to empower consumers with information and the ability to control wholesale costs by voluntarily responding to peak prices. Regulators need to ensure that the basic electricity infrastructure is upgraded to meet the current and future realities of the competitive wholesale market (whether or not retail electric markets ever become competitive is irrelevant). The infrastructure must include time-based rate options, real-time meters, and information systems that can deliver that usage information and bill those customers.

The Original Idea

One policy option, competitive metering, has been touted as the best way to bring innovation to metering. So far, it has failed completely to deliver. In such metering markets, licensed competitors may own, install, and/or read electricity meters. In addition, procedures have been worked out to exchange information between the metering providers and distribution utilities, and standards have been adopted to ensure accuracy, safety, and reliability.⁸ The goal of regulators has been to promote innovation, customer choice, and cost reduction.⁹

Several U.S. states, including California, New York, and Pennsylvania-plus the UK-have now had from one to seven years of experience with competitive metering. Others, such as Texas and New Jersey, have plans for or are considering it. Massachusetts looked at and rejected competitive metering in the short term, determining that advanced metering has many benefits but should be provided by utilities.¹⁰

The Dismal Results

The implementation results show that competitive metering has had little success. Very few advanced meters have been installed, reaching far less than one percent of the eligible population. In Pennsylvania, the most robust competitive electric market in the U.S., only 79 meters were installed since competitive metering began two years ago.¹¹ In California (start date: April 1998) and the UK (start date: 1994), real-time meter installations have been limited to customers requiring it to participate in competitive retail markets: customers with peak loads above 50 kilowatts (kW)in California and above 100 kW in the UK-and competitors installed meters on less than one-tenth of one percent of California customers.¹² In New York, no competitive meter installers have been certified, and not a single meter installed.

Also, while opening the markets did attract new competitors to the utilities, those new entrants have been unable to compete. For instance, the California Public Utilities Commission certified 15 Meter Service Providers.¹³ Even before the California competitive retail electricity market collapsed in late 2000, most of these providers had exited the market or had ceased activity. Most advanced meters have been provided and installed by the distribution utilities in every jurisdiction with competitive metering, including California and the UK.

Metering Economics: Avoiding Stranded Assets and Capturing Scale Economies

Metering economics are such that policymakers must provide ways to avoid stranded meter assets and to take advantage of current scale economies. In October 2000, the UK Office of Gas and Electricity Markets (Ofgem), conducted a market survey to assess the status of competitive and advanced metering. Ofgem found that the major barrier to the installation of real-time meters is the fear of stranded assets: customers, electricity suppliers, and meter operators all feared paying for the capital and installation cost of a new meter, then losing the investment upon the customer switching to a new electricity or metering supplier.¹⁴ Meters, including installation costs, are typically depreciated over from 10 to 30 years, clearly much longer than a customer would remain with the same supplier. Thus, regulatory policies for real-time metering have to account for the need for the financing entity to amortize the equipment and installation over several years.

Puget Sound Energy's Experience with Real-Time Metering

In preparing this article, I spoke with Gary Swofford, vice president and chief operating officer, of Puget Sound Energy. He made the following points: "You make the point that we can accomplish a shift in usage with programs for which customers actively volunteer. I think that was true with old systems when customers didn't get any feedback on their usage, and it was just a fixed time-of-use rate that was in place that didn't have anything to do with what was going on in the market place. But today, we have the capability to give near real-time feedback with the metering technology currently available. If we are going to get the real value out of the deployment of metering and the other technologies needed to achieve a demand response to the wholesale price of electricity, then we are going to need to make sure that everyone participates." "The experience with our program up here, where we have 300,000 customers on time-of-day pricing, is that they like being on it even though they were put on the program with an opt-out provision. Our experience to date is that less than one percent has opted out and, more importantly, according to the survey we have done, 90 percent understand, accept, like, and use the program "Our experience with active-volunteer systems is that very few people volunteer unless you put an awful lot of effort into marketing, and even then the numbers are small. Also, the only ones who volunteer are the ones who can save and everyone else will stay away, which means the energy wasters or the ones who don't care when they use it don't participate and they have no incentive to do so. "Deployment of a demand response system really has nothing to do with deregulation. It has to do with the ability of the customers using energy to see the price of the energy they are using at the time they are using it, and, if they believe it's too expensive, they can choose not to use it. Even in regulated retail markets, the wholesale cost of electricity has to get passed along to the end-use customer eventually, so even in those circumstances customers can help influence the wholesale price they will pay by reacting to the price. "There is a misconception that has existed for some time that demand response systems only make sense in areas where states have deregulated and retail access is available to customers. Washington State is a good example of where we have not deregulated but we have the largest deployment of real-time metering in the country. Our customers understand that they can help control the wholesale price of electricity that we as the utility have to pay and pass along to them. They are very supportive of what we are doing and the information they have available to them." -C.K.

Another item which UK meter suppliers complained about was a "lack of customer density."¹⁵ This is because metering enjoys significant scale economies inherent in density: it is cheaper to install, maintain, and read meters that are physically close together than meters that are dispersed. In a study for New York, Arthur Andersen reported that one-by-one installation costs six times more than contiguous installation for residential meters, and eight times more for commercial meters.¹⁶ And customer acquisition costs vastly exacerbate deployment costs. Cost-effective deployment of real-time meters requires capturing of these scale and scope economies.

How to Fix It

The current lack of advanced metering and time-base pricing has resulted in price spikes, brownouts, rolling blackouts, and higher power costs. Policymakers need to act and empower energy users with the information and other benefits of such metering.

While the evidence is not favorable, some believe that, in the long run, competitive metering may support an advanced metering infrastructure.¹⁷ In the short-run-up to 10 years-regulatory leadership is clearly needed. This occurs for two reasons: 1) the greatest benefits of real-time metering accrue to customers as a group, because demand response reduces wholesale prices for all customers (this is economics' classic "tragedy of the commons"); and 2) utilities have no incentive to invest in advanced metering. Utilities would make no greater profits and would take the risk inherent in any change.

Regulators and legislators need to do two things. First, they need to examine the extensive research already done and satisfy themselves that real-time metering will save consumers substantially. A five to ten percent reduction in generation costs means the investment in advanced metering would have a payback of just over a year. Many other benefits would come along, as cited by Massachusetts:¹⁸

1. price reductions, both at the wholesale and retail levels;
2. improvements in the reliability of supply;
3. the development by suppliers of new products and services (e.g., multiple pricing options);
4. improvements in the wholesale financial settlement process administered by the Independent System Operator - New England; and
5. incentives for investment in energy efficiency measures. In addition ... price- responsive demand would improve distribution service reliability and would lower the costs incurred by distribution companies in providing this service.

Second, policymakers must provide appropriate incentives to utilities-good public policy would suggest mandates. The proper incentive depends on the state, the status of incentive regulation, and other factors. Some examples of good incentives are low-cost state financing, assured long-term cost recovery, tax credits, accelerated depreciation, and allowing utilities to earn profits-at their risk-on the sale of value-added information services.

1. Causes and Lessons of the California Electricity Crisis, Congressional Budget Office, September 2001.
2. , Steven Braithwait and Ahmad Faruqui, February 1, 2001.
3. Remarks by the President to the Capital City Partnership, President George W. Bush, May 17, 2001; Electricity Deregulation and Consumers-Lessons from a Hot Spring and a Cool Summer, Mark Cooper, Consumer Federation of America, August 2001; Comprehensive National Energy Policy, National Governor's Association, Policy Position NR-18, August 7, 2001. Note that the Consumer Federation specifically supports demand response programs for commercial customers and is silent regarding residential customers.
4. , McKinsey, May 1, 2001.
5. , Brattle Group, August 30, 2001.
6. , OFGEM, March 2001.
7. , Working Paper, Frank Wolak, Department of Economics, Stanford University and Robert Patrick, Graduate School of Management, Rutgers University. February 1997.
8. , California Public Utilities Commission, D.98-12-080, December 17, 1998; Final Order Adopting Advanced Meter Standards, Pennsylvania Public Utilities Commission, .
9. Decision Unbundling Meters, Meter Reading, and Related Services, California Public Utilities Commission, .
10. Report to the General Court, Department of Telecommunications and Energy, December 29, 2000.
11. Pennsylvania Public Utilities Commission, October 1, 2001.
12. On Your Mark, Get Set, Slow: The Developing Market for Competitive Metering, , May 2000.
13. Meter Service Providers Certified by the CPUC, California Public Utilities Commission Web site http://www.cpuc.ca.gov/static/industry/electric/electric+restructuring/metering/ msps.htm, October 10, 2001.
14. Op. cit.
15. Op. cit.
16. , Arthur Andersen for New York Department of Public Service, November 1998.
17. Op. cit., Massachusetts Department of Telecommunications and Energy.
18. Op. cit.

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