BRINGING DYNAMIC PRICING TO THE MASS MARKET

Ahmad Faruqui, Ph. D.NARUC Winter Meetings

Washington, D.C.

February 19, 2007

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The demand response imperative

• Electricity capacity margins are projected to fall below minimum levels in several areas in the next 2-3 years

• Electricity rates are likely to go up • Rising capacity costs • Rising fossil fuel prices • Climate Change

• We don’t have time to build our way out of this problem• Customers should be given the ability to control their usage,

ensuring that the lights stay on and their bills come down • AMI and dynamic pricing can help

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However, not every customer is on AMI, nor is every AMI customer on dynamic pricing

• Regulators and utilities are concerned about AMI costs, the perceived “rate volatility” associated with dynamic pricing, and the related potential for customer and political backlash

• In attempts to ensure rate stability, regulators and utilities forgo the benefits that dynamic pricing can bring in the form of reducing customers’ energy bills

• In the eastern PJM region, a load drop of 3% in the top 100 hours of only 5 utilities would yield customer benefits of $275 million per year

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Under traditional ratemaking, bills will rise for 50% of the customers who choose dynamic pricing

Distribution of Bill Impacts

-15%

-10%

-5%

0%

5%

10%

15%

20%

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%

Percentile of Customer Base

Ele

ctri

city

Bil

l In

crea

se (

Dec

reas

e)

Customers with Peakier ConsumptionCustomers with Flatter Consumption

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That fear may keep customers from even trying out the new rates

• And fear of that fear may keep us from even offering dynamic pricing to customers, since we are anxious to “protect the customers from themselves”

• How do we break out of this bubble?

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Flat rates embody an implicit but very real risk premium that insures customers against price volatility

Probability Distribution of Risk Premium

0%

1%

2%

3%

4%

5%

6%

7%

8%

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

20%

22%

24%

26%

28%

30%

32%

34%

36%

38%

40%

42%

44%

46%

48%

50%

52%

54%

56%

58%

60%

62%

64%

66%

68%

70%

Risk Premium

Pro

bab

ilit

y o

f O

ccu

rin

g

3% risk premium

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By crediting customers for the risk premium, dynamic pricing rates become attractive for 70% of customers

Distribution of Bill Impacts

-20%

-15%

-10%

-5%

0%

5%

10%

15%

20%

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%

Percentile of Customer Base

Ele

ctri

city

Bil

l In

crea

se (

Dec

reas

e)

Revenue Neutral

Risk Adjusted

Customers with Peakier ConsumptionCustomers with Flatter Consumption

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With demand response, dynamic pricing becomes attractive to over 95% of customers

Distribution of Bill Impacts

-25%

-20%

-15%

-10%

-5%

0%

5%

10%

15%

20%

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%

Percentile of Customer Base

Ele

ctri

city

Bil

l In

crea

se (

Dec

reas

e)

Revenue Neutral

Risk Adjusted

Load Shifting

Customers with Peakier ConsumptionCustomers with Flatter Consumption

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With creative ratemaking, we can bring the benefits of DR to millions of customers

Impact on Four Representative U.S. Utilities

MW

MW

MW

MW

$

$

$

$

0

500

1,000

1,500

2,000

2,500

Large Southeastern

Large Western

Midsize Mid-Atlantic

Small Midwestern

MW

or

Mil

lio

ns

of

2007

Do

llar

s

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Additional reading

• Brattle Group, The. “Quantifying the benefit of demand response for PJM,” prepared for PJM Interconnection LLC. and MADRI, January 2007

• Faruqui, Ahmad. “Breaking out of the bubble: how dynamic pricing can mitigate rate shock,” Public Utilities Fortnightly, March 2007, forthcoming

• Federal Energy Regulatory Commission (FERC), The US. Demand Response and Advanced Metering, Staff Report, August 2006

• North American Electric Reliability Corporation (NERC). “2006 Long-Term Reliability Assessment,” October 16, 2006.

• Plexus Research, Inc., Deciding on Smart Meters, Edison Electric Institute, September 2006.

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Contact information

Ahmad Faruqui, Ph. D.Principal

The Brattle Group353 Sacramento Street, Suite 1140San Francisco, CA 94111Voice: 415.217.1026Fax: 415.217.1099Cell: 925.408.0149

Email: Ahmad.Faruqui@Brattle.Com