1. 1 Wealth Transfers Under Real-time Electricity Pricing Severin Borenstein Haas School of Business, UC Berkeley University of California Energy Institute 11 th Annual POWER Research Conference March 24, 2006

2. 2 A Brief History of Retail Electricity Pricing In the beginning, there was flat-rate pricing In the beginning, there was flat-rate pricing eg, 12 cents/kWh regardless of when the power is consumed eg, 12 cents/kWh regardless of when the power is consumed But the long-run cost is higher for delivering power during peak demand times But the long-run cost is higher for delivering power during peak demand times Which begat time-of-use (TOU) tariffs, with 2 or 3 different rates depending on time/day Which begat time-of-use (TOU) tariffs, with 2 or 3 different rates depending on time/day History Ended….at least in most places History Ended….at least in most places But WAIT! TOU just captures average changes over the many months the rates are in effect. But WAIT! TOU just captures average changes over the many months the rates are in effect.

3. 3 Real-Time Retail Electricity Pricing Wholesale price of electricity varies hourly or more frequently Wholesale price of electricity varies hourly or more frequently Price varies greatly day to day Price varies greatly day to day June 3pm weekday price varies by factor of 10 June 3pm weekday price varies by factor of 10 Real-time pricing (RTP) allows retail electricity prices to reflect that stochastic variation in supply/demand balance Real-time pricing (RTP) allows retail electricity prices to reflect that stochastic variation in supply/demand balance TOU captures around 10% of the time variation in wholesale price that would be 100% captured by RTP TOU captures around 10% of the time variation in wholesale price that would be 100% captured by RTP Potential efficiency gains are less than 10% of energy cost, but that’s up to $1B/yr in CA Potential efficiency gains are less than 10% of energy cost, but that’s up to $1B/yr in CA

4. 4 Obstacles to RTP Technology of metering and information Technology of metering and information Already cheap enough for large customers Already cheap enough for large customers Getting cheaper for small/residential Getting cheaper for small/residential Wealth Transfers Wealth Transfers Some (lots of) customers would be losers Some (lots of) customers would be losers Similar to pricing a new --and partially controllable-- risk factor into insurance Similar to pricing a new --and partially controllable-- risk factor into insurance Risk Risk Spiky prices mean that one bad hour could create a horrendous bill Spiky prices mean that one bad hour could create a horrendous bill

5. 5 Direct Estimation of the Size of Transfers from RTP Adoption Starting with a simple analysis assuming no demand elasticity - pure transfer effect Starting with a simple analysis assuming no demand elasticity - pure transfer effect this is a worst-case on losses due to this is a worst-case on losses due to Ability to respond to price Ability to respond to price Market-wide price compression due to RTP Market-wide price compression due to RTP Data on realtime consumption of 1142 large customers in PG&E territory, 2000-03 Data on realtime consumption of 1142 large customers in PG&E territory, 2000-03 Largest customers who had interval meters for this entire period Largest customers who had interval meters for this entire period Using a set of real-time prices (actual and simulated), calculate customer costs under breakeven flat rate, TOU, and RTP Using a set of real-time prices (actual and simulated), calculate customer costs under breakeven flat rate, TOU, and RTP

6. 6 Real-Time Prices Two Approaches: Two Approaches: Actual wholesale prices Actual wholesale prices Simulated LR competitive wholesale prices Simulated LR competitive wholesale prices Actual are the NP15 real-time prices Actual are the NP15 real-time prices But idiosyncratic due to electricity crisis and subsequent excess capacity and low prices But idiosyncratic due to electricity crisis and subsequent excess capacity and low prices Simulated prices are from a model of wholesale prices with equilibrium capacity investment and actual demand patterns Simulated prices are from a model of wholesale prices with equilibrium capacity investment and actual demand patterns

7. 7 Simulating A Long- Run Competitive Model of Electricity Markets Demand is actual load for 2000-03 Demand is actual load for 2000-03 Free entry/exit of generation capacity in very small (1MW) increments Free entry/exit of generation capacity in very small (1MW) increments L-shaped production costs of each unit L-shaped production costs of each unit 3 technologies – differ in FC and MC 3 technologies – differ in FC and MC Some system demand elasticity Some system demand elasticity due to actual demand elas or import elas due to actual demand elas or import elas All generation breaks even over sample period with payments only for energy All generation breaks even over sample period with payments only for energy

8. 8 KbKb KmKm KpKp P1P1 P2P2 P3P3 P4P4 P5P5 P6P6 D1D1 D2D2 D3D3 D4D4 D5D5 D6D6

9. 9 Deriving Retail Prices RTP prices are wholesale prices plus $40/MWh for Transmission & Distribution (T&D added to all retail prices) RTP prices are wholesale prices plus $40/MWh for Transmission & Distribution (T&D added to all retail prices) Two kinds of TOU prices: Two kinds of TOU prices: TOU-C – Breakeven by TOU period (cost-based) TOU-C – Breakeven by TOU period (cost-based) TOU-F – Using actual ratio of prices among periods (fixed-ratio) TOU-F – Using actual ratio of prices among periods (fixed-ratio) Flat-Rate tariff – Constant rate over sample Flat-Rate tariff – Constant rate over sample All rates set to cover wholesale cost for the sampled customers as a stand-alone group All rates set to cover wholesale cost for the sampled customers as a stand-alone group

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11. 11 Wealth Transfers from Switching to RTP Distribution of change in bills shows Distribution of change in bills shows More losers than winners, median bill increases More losers than winners, median bill increases Compared to flat rate 90% of customers Compared to flat rate 90% of customers See -3% to +6% in bill under TOU-F See -3% to +6% in bill under TOU-F See -6% to +15% in bill under RTP See -6% to +15% in bill under RTP Wealth transfers are larger with more volatile wholesale prices Wealth transfers are larger with more volatile wholesale prices Change from TOU-F to RTP would cause 90% of bills to change by between -4% and +8% Change from TOU-F to RTP would cause 90% of bills to change by between -4% and +8%

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13. 13 How much does price response mitigate losses? Not as much an economist would like Not as much an economist would like Even with elasticity of -0.1 a large share of customers are losers in a switch from TOU-F to RTP Even with elasticity of -0.1 a large share of customers are losers in a switch from TOU-F to RTP Larger elasticity has a big effect, but probably not realistic in the short run Larger elasticity has a big effect, but probably not realistic in the short run

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15. 15 Mitigating Transfers with a two-part RTP Program Two-part RTP program requires baseline quantity purchase at the “old” TOU prices Two-part RTP program requires baseline quantity purchase at the “old” TOU prices Preserves some of the cross-subsidies of the TOU pricing if: Preserves some of the cross-subsidies of the TOU pricing if: There were cross-subsidies across TOU periods There were cross-subsidies across TOU periods Baseline is a customized hourly load shape that differs for each customers Baseline is a customized hourly load shape that differs for each customers Some transfers continue due to correlation of stochastic shocks to price and customer demand Some transfers continue due to correlation of stochastic shocks to price and customer demand

16. 16 A typical two-part RTP design for these customers preserves about half of the cross-subsidy Customers buy their average month/weekday- weekend/hour quantity at TOU-F price Customers buy their average month/weekday- weekend/hour quantity at TOU-F price Pay/receive real-time price for deviations Pay/receive real-time price for deviations

17. 17Conclusions Transfers (end of cross-subsidies) pose a serious challenge for RTP programs Transfers (end of cross-subsidies) pose a serious challenge for RTP programs More than half of all large customers could have higher bills More than half of all large customers could have higher bills Changes are small proportionally, but still thousands of dollars Changes are small proportionally, but still thousands of dollars Mitigated somewhat by price response, but still many losers Mitigated somewhat by price response, but still many losers Two-part RTP programs reduce the transfers by preserving historical cross-subsidies Two-part RTP programs reduce the transfers by preserving historical cross-subsidies