Transitioning to Dynamic Pricing

With the advent of the smart grid, dynamic pricing is receiving increasing interest by state commissions throughout North America as a means of enhancing economic efficiency by reducing the need for expensive peaking capacity. But several barriers stand in the way of its rapid deployment.As noted by MIT's Paul Joskow in a recent discussion of the economics of climate change, quot;On the demand side there are relatively low cost ways to reduce electricity consumption by increasing energy efficiency in building, lighting, heating, ventilating, air conditioning and other equipment. That's why getting the retail price signals right is important and why muting them with regulation based on traditional cost of service models is inconsistent with promoting adoption of economical energy efficiency opportunities.quot; While the rate design process (in conjunction with the revenue requirements process) in principle results in utility recovery of all prudent costs, it provide sufficient incentives to utilities to pursue energy efficiency and demand response programs at a level commensurate with state and federal goals. A review of default rate designs across the continent reveals that prices paid by customers do not reflect the scarcity of capacity to produce energy at various times of day.There is a lack of recognition that the default rates embody a hedging or risk premium which insulates customers from price volatility and eliminates any incentive that they would otherwise have for moving to dynamic pricing tariffs. In addition, customers lack the information to become smart shoppers. Policy makers have bought into a viewpoint espoused by defenders of the status quo that customers are averse to being placed on dynamic pricing tariffs, since not only will they face price volatility but they may also pay higher bills. This is contradicted by evidence from fifteen recent pilots with dynamic pricing, which clearly showed that once customers experienced a dynamic tariff, not only did they understand and respond to the price signals, they also overwhelming preferred dynamic tariffs to their conventional hedged rate form. The experiments also showed that a well-thought out customer education program is needed to sustain customer response. In order to make a transition to dynamic pricing, a new framework is needed to develop innovative rate designs