Daniel Englander
Using Realtime Pricing to Cut Power Demand July 7, 2008 at 6:40 AM
The transition to a restructured electricity supply industry in the U.S. has, to an extent, allowed for greater efficiencies stemming from the introduction of new technology. Specifically, the ability of new entrants to compete against incumbent utilities - at least in the 1980s and 1990s - was premised on the introduction of the combined cycle gas turbine. Compared with the coal monoliths the incumbent utilities favored, CCGT plants were quicker to start up, cheaper to run, and had fewer maintenance problems. As such, they were able to bid into power pools relatively cheaply, oftentimes setting the market-clearing price, forcing incumbent utilities from the role of price setter to that of price taker.
Though both wholesale and retail electricity prices fell at the outset, decentralized supply, an increasing number of small plants, and rising demand - along with some freakishly hot weather - led to increasing volatility in the spot electricity markets. During the last week in June 2000, for example, wholesale power prices jumped from around $50/MWh to over $550/MWh. These price spikes continued for over a year, until the collapse of the California Power Exchange in the summer of 2001.
Retail consumers, however, would not feel the effects of the hourly increases until a few months later. This is because retail electricity prices are adjusted a few times yearly, while wholesale prices vary on the hour. As such, retail demand is relatively inelastic, with sticky prices sheltering retail consumers from volatility in the spot electricity markets. Here’s an example. People use more electricity on hot days in August, increasing demand for electricity, and forcing system operators to accept bids from power plants higher up on the power pool’s merit order - the more expensive plants. On extremely hot days, power demand may even hit its upper capacity range, forcing system operators to accept bids from peaker plants - expensive, inefficient plants that are quick to turn on and ramp up - effectively sending the power pool price through the roof.
The easiest way to remedy this is to cut demand, and the easiest way to cut demand is to reveal electricity prices to retail consumers. If I knew the electricity I am currently paying $0.09/kWh for would increase to $0.60/kWh by lunch, I might think twice about leaving on the lights or the AC. Multiply this effect by the two million or so electricity customers in the Boston metro area, and the supply constraints and demand shocks that lead to price spikes could be dampened. In addition to grid-straining problems, flat rate retail pricing also creates pricing inefficiencies. Briefly, if real time pricing led to cuts in peak demand, more investment could be allocated to satisfying baseload and intermediate power requirements, increasing off-peak prices. In this case, firms with the ability to move in between markets will reap increased profits, while firms with too many sunk costs may exit as they are unable to switch to baseload or intermediate power. In theory, at least, this would have the effect of making the electricity supply industry more efficient. Realtime pricing would also open a significant market for smart grid and advanced meter companies.
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