Copyright © 2009 The Brattle Group, Inc. Antitrust/Competition Commercial Damages Environmental Litigation and Regulation Forensic Economics Intellectual Property International Arbitration International Trade Product Liability Regulatory Finance and Accounting Risk Management Securities Tax Utility Regulatory Policy and Ratemaking Valuation Electric Power Financial Institutions Natural Gas Petroleum Pharmaceuticals, Medical Devices, and Biotechnology Telecommunications and Media Transportation Customer Response to Dynamic Pricing- A Long Term Vision Sanem Sergici, Ph.D. Ahmad Faruqui, Ph.D NASUCA Mid-Year Meeting Boston, Massachusetts June 30, 2009

2 Recent pricing pilots provide compelling evidence on price responsive demand ♦ Sixteen experiments with more than 15,000 residential customers have shown that customers respond to dynamic prices by lowering their peak usage ♦ The magnitude of price response depends on several factors, such as the magnitude of the price increase, the presence of central air conditioning and the availability of enabling technologies ♦ Time-of-use (TOU) rates lower peak demand by 3-6 percent ♦ Critical peak pricing (CPP) tariffs lower peak demand by percent ♦ CPP tariffs in conjunction with enabling technologies lower peak demand by percent

3 The effectiveness of price responsive demand

4 If dynamic prices lower peak demand by just 5 percent, that will create $66 billion in benefits over the next two decades ♦ This value reflects the benefits associated with the avoided capacity, generation and T&D investment costs due to demand response ♦ These benefits will eventually accrue to the customers in the form of lower monthly bills (short-run) and lower rates (LR) ♦ What is keeping us from harnessing these benefits? The cost of advanced metering infrastructure (AMI) Disagreement on what constitutes a smart rate Fear of a customer backlash

5 There are six ways of “bridging the chasm” 1. Educating customers 2. Offering them tools 3. Creating two-part rates 4. Providing temporary bill protection 5. Crediting the hedging premium 6. Offering a menu of dynamic pricing rates

6 1- Educating Customers ♦ Get them to buy-into dynamic pricing by showing them it can: lower energy costs for society as a whole lower their monthly utility bill prevent energy crises improve system reliability, and lead to a cleaner environment

7 2- Offering tools to customers ♦ At the simplest level, provided them information on where their utility dollar goes and what actions will help them lower their bill ♦ At the next level, provide them real-time in-home displays which disaggregate their power consumption and tells them how much they are paying by the hour Twelve pilots with more than 11,000 customers have shown that feedback mechanisms can lower usage by seven percent on average, with a range from three to 13 percent

8 3 - Designing two-part rates ♦ Customers would buy a predetermined amount of power at a known rate (analogous to how they buy all their consumption today) and buy the remainder (the second part) at dynamic pricing rates ♦ Customers would pick their own predetermined amount or it could be based on consumption during a baseline period

9 4- Temporary bill protection ♦ Give them full bill protection in the first year. Phase this out over time For example, in year two, their bill would be no higher than five percent; in year three, no higher than ten percent; in year four, no higher than fifteen percent and in year five, no higher than twenty percent In the sixth year and beyond, bill protection would be provided for a fee

10 5- Crediting customers for the hedging premium ♦ The supplier has to hedge against the price and volume risk embodied in the open-ended fixed price contract which is today’s rate design ♦ Research suggests that this risk premium ranges between 5-30 percent of the cost of a fixed rate ♦ So customers who move to dynamic pricing rates should be credited for the insurance premium

11 6- Give customers a choice of rate designs ♦ Dynamic pricing rates may be too risky for some customers ♦ They should have the option of migrating to other time-varying rates (with varying peak periods and varying number of periods) ♦ If the critical-peak pricing rate (combined with a time-of-use rate) becomes the default rate, risk-averse customers should have the opportunity to migrate to a fixed time-of-use rate and risk-taking customers should have the opportunity to migrate to a one-part or two-part real-time pricing rate

12 Concluding Remarks ♦ The benefits of dynamic pricing are well established and increasingly within reach as AMI and other smart grid technologies are deployed ♦ What stands in the way are concerns by regulators and utilities about price volatility and a fear of customer backlash ♦ There are at least six ways to make the transition to dynamic pricing ♦ These should be considered by commissions and utilities

13 References ♦ Faruqui, Ahmad, Sanem Sergici and Ahmed Sharif, “The Impact of Informational Feedback on Energy Consumption- A Survey of the Experimental Evidence,” Energy: The International Journal, 2009, forthcoming. ♦ Faruqui, Ahmad, Sanem Sergici and Lisa Wood, “Moving Toward Utility-Scale Deployment of Dynamic Pricing in Mass Markets,” Institute for Electric Efficiency Whitepaper, June ♦ Faruqui, Ahmad and Ryan Hledik, “The Power of Dynamic Pricing,” The Electricity Journal, April ♦ Faruqui, Ahmad and Ryan Hledik, “Transitioning to Dynamic Pricing,” Public Utilities Fortnightly, March ♦ Faruqui, Ahmad and Sanem Sergici, “Household Response to Dynamic Pricing of Electricity–A Survey of the Experimental Evidence,” Discussion Paper, The Brattle Group, January Can be downloaded from ♦ Faruqui, Ahmad and Lisa Wood, “Quantifying the Benefits of Dynamic Pricing in the Mass Market,” Edison Electric Institute, January ♦ Faruqui, Ahmad, R. Hledik, S. Newell, and H. Pfeifenberger, “The Value of Five Percent,” The Electricity Journal, October 2007.