HOW RETAIL PRICING CAN DELIVER CUSTOMER VALUE IN A SMART GRID WORLD

1. HOW RETAIL PRICING CAN DELIVER CUSTOMER VALUE IN A SMART GRID WORLD Ahmad Faruqui, Ph. D. Pacific Northwest Demand Response Project July 15, 2010

2. The state of play • The smart grid is being rolled out in many jurisdictions and the federal government has awarded utilities billions of dollars to expedite its deployment • As most of these deployments have not focused on customer benefits, there has been a backlash among customers in some communities who see their monthly bills going up to cover smart grid costs without any commensurate benefits • Customer concerns about costs, privacy and cyber security dominate the agenda of state regulators

3. Retail pricing innovation is a means of engaging with the customer • Customers, especially the new and emerging generation, are concerned about using energy wisely, having a smaller carbon footprint and lowering their utility bills • However, for the vast majority of customers, the price of electricity provides them with very little information about how to achieve these objectives • Most customer-side programs focus on providing rebates or creating standards and assume that electric rates cannot be touched • Price matters in every industry except the electric • Customer-side programs can be turbo-charged if complementary changes in electric rates accompany their rollout

4. A classic example is inclining block rates • About two-thirds of Americans today receive electric service on either flat or declining block rates • The one-third that receive service on inclining block rates do not get much of an incentive to conserve from existing designs • It has been shown that moderately inclining rates can boost energy efficiency levels at very low cost • When coupled with time-varying rates, they can provide the best way to reward customers for using energy wisely and for encouraging them to invest in distributed generation and renewable energy options

5. The full range of retail pricing options

6. Four illustrative inclining block rate designs 30 AverageCustomer 25 20 Cents / kWh 15 10 5 0 0 200 400 600 800 1,000 1,200 1,400 1,600 1,800 2,000 kWh / Month Rate D Rate C Existing Flat Rate Rate B Rate A 6

7. Energy use could decline by up to 5.9 percent and customer bills by up to 9.1 percent 7

8. Price response mitigates the impact on high use customers by shifting the breakeven point 30% 20% 10% 0% -10% Change in Monthly Bill -20% Break-even point -30% -40% -50% No price elasticity With price elasticity -60% Tier 1 -70% 100 200 300 400 500 600 700 800 900 1,000 1,100 1,200 1,300 1,400 1,500 1,600 1,700 1,800 1,900 2,000 Customer Size 8

9. Each rate offers a different value proposition to each type of customer Potential Reward (Discount from Flat Rate) Less Risk, Lower Reward More Risk, Higher Reward RTP VPP PTR Increasing Reward CPP Super Peak TOU TOU Seasonal Rate Inclining Block Rate Flat Rate Increasing Risk

10. Utilities can evaluate these innovative rates against five criteria to configure their menu

11. Scoring the rates – an illustration Degree to which criterion is satisfied: 3 = High 2 = Medium 1 = Low

12. The pure CPP rate provides a strong demand response signal • Customers pay a flat rate for all kWh every day unless a critical day is called • On critical days during the critical peak period customers pay a premium for all kWh used • The critical peak price is equal to the cost of capacity plus the average critical peak LMP • Spreading the off-peak discount over all non-critical hours of the year provides a cost savings to customers

13. The CPP-TOU rate ties more closely to actual system costs than the pure CPP rate • Every day is divided into peak and off-peak periods • Customers pay lower rate for off-peak usage and higher rate for peak period usage • On critical days during the critical peak period customers pay a premium for all kWh used • The critical peak price is equal to the cost of capacity plus the average critical peak LMP • The low off-peak rate provides heating customers with an opportunity to save as compared to a flat rate

14. Like the CPP rate, the CPP-TOU rate has lower rates in most hours of the year

15. The PTR is a mirror image of the CPP and pays customers to reduce peak demand • Customers pay the default rate for all kWh used; if they make no changes in their usage they continue to pay the default rate with no extra costs (“carrot only” approach) • On critical days customers can earn a rebate reductions in usage below an estimate of what they otherwise would have consumed (their “baseline” calculation) • The rebate amount is equivalent to the critical peak price of the CPP and the CPP-TOU • Baseline calculation method and where customer payment originates are important issues to resolve

16. All these rates can yield substantial amounts of demand response – illustrative case PTR impacts are shown for the average low-income residential customer

17. The CPP-TOU rate will produce the greatest amount of permanent load shifting – illustration A slight increase in non-event peak demand could occur under the CPP due to the discounted price during these hours

18. Bill savings are larger for customers with flatter load shapes – illustration

19. Low income customers have demonstrated significant price responsiveness in recent experiments • Low income customer response ranges from 22% to 214% of the average customer

20. Up to 88% of low-income customers could experience bill savings when enrolled in a CPP-TOU rate – illustration

21. References Faruqui, Ahmad, “Inclining toward efficiency,” The Public Utilities Fortnightly, August 2008. Faruqui, Ahmad, Sanem Sergici, and Jenny Palmer, The Impact of Dynamic Pricing on Low Income Customers, The Institute for Electric Efficiency, June 2010. http://www.edisonfoundation.net/iee/reports/IEE_LowIncomeDynamicPricing_0610.pdf Faruqui, Ahmad, Ryan Hledik and Sanem Sergici, “Rethinking pricing: the changing architecture of demand response,” The Public Utilities Fortnightly, January 2010. Faruqui, Ahmad, Ryan Hledik, and Sanem Sergici, “Piloting the smart grid,” The Electricity Journal, August/September, 2009. Faruqui, Ahmad and Sanem Sergici, “Household response to dynamic pricing of electricity–a survey of the experimental evidence,” January 10, 2009. http://www.hks.harvard.edu/hepg/. Journal of Regulatory Economics, Forthcoming. FERC, “A National Assessment of Demand Response Potential,” June 2009, http://www.ferc.gov/legal/staff-reports/06-09-demand-response.pdf .

22. Biography Ahmad Faruqui is an expert on how the smart grid affects electricity customers. He has performed cost-benefit analysis of smart grid programs for utilities in two dozen states and testified before several state and provincial commissions and legislative bodies. He has designed and evaluated some of the best known pilot programs involving dynamic pricing and in-home displays and his early experimental work is cited in Bonbright’s canon. During the past two years, he has assisted FERC in the development of the “National Action Plan on Demand Response” and in writing “A National Assessment of Demand Response Potential.” He co-authored EPRI’s national assessment of the potential for energy efficiency and EEI’s report on quantifying the benefits of dynamic pricing. He has assessed the benefits of dynamic pricing for the New York Independent System Operator, worked on fostering economic demand response for the Midwest ISO and ISO New England, reviewed demand forecasts for the PJM Interconnection and assisted the California Energy Commission in developing load management standards. His most recent report, “The Impact of Dynamic Pricing on Low Income Customers,” has just been published by the Institute for Electric Efficiency. The author, co-author or editor of four books and more than 150 articles, papers and reports, he holds a doctoral degree in economics from the University of California at Davis and a bachelor’s degree from the University of Karachi, Pakistan.