Customer Response to Dynamic Pricing- A Long Term Vision Sanem Sergici, Ph.D.

1. Customer Response to Dynamic Pricing- A Long Term Vision Sanem Sergici, Ph.D. Ahmad Faruqui, Ph.D. 2009 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 13-20 percent • CPP tariffs in conjunction with enabling technologies lower peak demand by 27-44 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” • Educating customers • Offering them tools • Creating two-part rates • Providing temporary bill protection • Crediting the hedging premium • 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 2009. • Faruqui, Ahmad and Ryan Hledik, “The Power of Dynamic Pricing,” The Electricity Journal, April 2009. • Faruqui, Ahmad and Ryan Hledik, “Transitioning to Dynamic Pricing,” Public Utilities Fortnightly, March 2009. • Faruqui, Ahmad and Sanem Sergici, “Household Response to Dynamic Pricing of Electricity–A Survey of the Experimental Evidence,” Discussion Paper, The Brattle Group, January 2009. Can be downloaded from http://www.hks.harvard.edu/hepg/ • Faruqui, Ahmad and Lisa Wood, “Quantifying the Benefits of Dynamic Pricing in the Mass Market,” Edison Electric Institute, January 2008. • Faruqui, Ahmad, R. Hledik, S. Newell, and H. Pfeifenberger, “The Value of Five Percent,” The Electricity Journal, October 2007.