Time-Varying Retail Electricity Prices: Theory and Practice by Severin Borenstein

Outline of Talk  The Value of Time-Varying Retail Prices  Time-Varying Prices in Practice  Issues in Implementing RTP Risk Mitigation for Customers Meeting Retailer Revenue Requirements Mandatory vs. Voluntary RTP Role of Demand Response in Reserves

The Value of Time-Varying Retail Prices  Efficient pricing in the short-run gives efficient incentives to consume and efficient load shifting among periods  Efficient pricing gives optimal long-run incentives to invest in capacity  More immediate demand response reduces generator incentive to exercise market power in wholesale market  Bottom Line: Lower Long-Run Costs, Higher Consumer Benefits (Borenstein & Holland, 2002)

Methods for Implementing Time-Varying Retail Pricing  Key differences among plans Granularity of retail prices Timeliness of retail price setting - “dynamic” Adaptability to varying revenue target Bill Volatility – protection against price spikes  Granularity and Timeliness are different, but interact in important ways  Adaptability need not conflict with protection against volatile bills

Flat-Rate Service Revisited  poor granularity, no time variation  prices are not timely, change annually (?)  very adaptable -- change rate to hit revenue target, but prices are very inefficient  protection against volatile bills Wholesale price spikes smoothed over long periods

Real-Time Retail Pricing (RTP)  Excellent Granularity Prices usually change hourly  Very Good to Excellent Timeliness Using “day-ahead” or “real-time” price  Arguments against RTP bills will be volatile not adaptable to meet revenue requirements  BUT straightforward alterations to RTP overcome these objections

Alternatives to RTP  Time-of-Use Pricing  TOU with Demand Charges  Critical Peak Pricing  Interruptible Demand  Paying for Demand Reduction

Issues in Implementing RTP  Customer Price/Bill Risk on RTP  Meeting Retailer/Utility Revenue Requirements  Mandatory versus Voluntary RTP  RTP and Reserve Requirements

Mitigating Customer Risk Under RTP  Customer risk comes from the possibility of unexpected high, and persistent, wholesale prices -- leading to high bills  Hedge through long-term contracts Hedging by Retailer on Behalf of Customer  How to pass along gain/loss from hedge while minimizing distortion of retail price? Active Hedging by Customers

Mitigating Customer Risk Under RTP  Retailer Hedges for Customers Still charges RTP on the margin Passes through gains/losses from hedge with minimum distortion of retail price  Customer Baseline Load (CBL) approach  Constant adder/subtractor to retail RTP  Active Hedging by Customers “BYO Baseline” offered by retailer Hedging instruments from energy sector

Meeting Retailer/Utility Revenue Requirements Under RTP  RTP revenues won’t match retailer’s costs if some power bought under long-term contract if some power generated by retailer if retailer has fixed costs unrelated to energy  e.g., distribution costs if retailer has sunk/stranded costs

Meeting Retailer/Utility Revenue Requirements Under RTP  Collect differential as lump-sum, so marginal price is still RTP CBL approach does this Politics of setting lump-sum levels/baselines  Collect differential as constant per kilowatt- hour adder or subtractor still have variability in RTP  small inefficiency of consumption

Example: Passthrough of Fixed Hedging Gains with Constant “Subtractor”

Mandatory versus Voluntary RTP  If RTP is so great, why do we have to make it mandatory? We don’t. But don’t cross-subsidize flat rate customers  The vicious cycle of equalizing average price between RTP and non-RTP customers some RTP customers will always be paying more than they would on flat rate so will switch to flat eventually RTP collapses

Voluntary RTP Without Cross-Subsidy  The virtuous cycle of allowing each group to stand on its own -- no cross-subsidy lowest-cost customers on flat-rate better off switching to RTP mimics a competitive market outcome lower prices for those who are cheaper to serve  if that’s “cherry picking,” I’m for it all customers still pay for fixed/sunk costs,  not a method for dodging sunk cost liability

The Role of Demand Response in System Reserves  RTP will not eliminate the need for reserves so long as price-responsive demand is slower than callable supply  But RTP offers more than peak demand reduction demand “tilts” as well as shifts  RTP will gradually reduce use of reserves as system operators recognize its reliability  Eventually, RTP will reduce the standard for percentage reserves

How Price-Responsive is Demand?  Evidence from California 2001 and other conservation programs  Evidence from RTP programs and pilots  Evidence from dynamic pricing programs and pilots  These estimates almost certainly understate price responsiveness as technology improves The next programmable thermostat

Conclusions  Static pricing of electricity is based on old metering technology, has large inefficiency  RTP is the gold standard of electricity pricing  Resistance to RTP is understandable, but not difficult to address  Real barrier to RTP is metering cost, but only for small customers (and maybe not even them) start with large customers to get biggest bang for buck but offer small customers RTP (and CPP)