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Time-Varying Electricity Pricing

March 25, 2015 By Josh Kessler

The Environmental Defense Fund’s senior manager for Grid Modernization posted a blog entry this week about the importance of time-varying electricity pricing to reduce usage at peak hours of the day – such as hot summer days when consumers come home from work and turn on their air conditioners. Across the US, consumers used between 47 and 84 percent more power during peak hours than average hours, according to data from DOE’s Energy Information Administration. This has major implications for energy costs. Why?

Price and Environmental Impacts of Peak Power

During off-peak hours, electricity demand is met primarily through generation from more efficient plants, which are cheaper to operate since they use less fuel. As demand increases, a greater portion of demand must be met through less efficient, often older, power plants. This means that for every unit of energy produced, these plants have higher emissions and are more expensive to operate, and therefore they charge higher prices to cover their fuel costs. But in competitive electricity markets, all sources of generation receive the same “marginal clearing price” for their electricity. That means operating these inefficient plants drives up the price of all generation, including the more efficient plants. For more information, see Retail Energy Buyer’s explanation of how wholesale energy markets function.

Time-Varying Pricing Encourages Conservation during Peak Hours

Time-varying pricing is the practice of charging higher prices during periods of high demand to incentivize customers to reduce their electricity use at those times. A January blog post from EDF Economist Beia Spiller describes four types of time-variant pricing:

  1. Real-time (spot market) – Prices vary over short periods of time based on fluctuations in supply and demand. This is primarily used by large commercial customers.
  2. Time-of-use – Separate prices are set for off-peak and on-peak hours—and in a few cases “super-peak.” Energy Choice Matters reported an example of a new pricing mechanism from a Texas retail energy provider that charges residential customers 7.3 cents per kWh for energy supply during the week and does not charge at all for energy supplied on the weekend. (The utility transmission and distribution charge of 3.3 cents per kWh still applies.) Similarly, some retail providers offer plans charging lower prices at night.
  3. Critical peak pricing – A form of demand response (DR), customers who sign up for critical peak pricing agree to cut electricity use to a specified level prior to a critical peak event. San Diego Gas & Electric explains that, when an event takes place, customers have the option of (1) cutting demand to the specified level and insulating themselves from critical peak prices or (2) paying an above-market price for electricity if they exceed their specified capacity limit.
  4. Critical peak rebate – Another form of DR, customers receive payments for reducing demand during critical peaks.

Commercial customers seeking to reduce demand can turn down their air conditioning or refrigeration equipment, limit the use of certain energy-intensive equipment, or turn down some of the lights. Residential customers can turn down the air conditioning or wait until later to use appliances like dryers and dishwashers.

Smart Energy Technologies

An article on Dynamic Pricing of Electric by Dr. Paul Joskow and Dr. Catherine Wolfram states that as of 2010 only 1 percent of residential customers, and a similar percentage of small business customers, were on time-of-use plans – though it was more common for large-scale customers. The paper cites three reasons for expanding the use of time-variant rates:

  1. Time-of-use prices fail to give consumers sufficient incentive to meet demand during critical peaks.
  2. Smart meters, combined with advanced data processing and communications, allow utilities or DR providers to send information to customers about short-term price fluctuations and encourage customers to reduce demand during periods of high demand (as opposed to simply setting prices in advance for specific hours of use).
  3. The Federal government has provided incentives to develop smart grid infrastructure.

EDF notes that 50 million smart meters had been deployed in the US as of July 2014. Products like Nest (owned by Google) send price signals to small-scale customers about energy “rush hours.” Similarly, manufacturers like GE are coming out with smart appliances that can be controlled remotely through smart phones and shut off when signals are sent to signify periods of high demand. The range of products and services relying on the smart grid that can benefit from time-variant pricing or DR payments will continue to expand rapidly in the coming years for residential, commercial and industrial customers. Savvy, well-informed energy managers and individuals will be able to take advantage of these developments to cut their energy costs while benefiting other local consumers by contributing to the stability of the grid.

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