Demand Response in California’s Electricity Futureby

Severin Borenstein,

Professor, Haas School of Business

Director, UC Energy Institute (www.ucei.org)

A Brief History of Electricity Pricing In the beginning, there was no metering Then <someone> begat aggregate consumption

meters Businesspeople and economists said it was better

But utilities still had to plan for highest plausible demand

Unlike nearly most other industries, price didn’t adjust to reflect demand changes Technology to do so didn’t exist or was too expensive “buyers wouldn’t respond to prices anyway”

“System Operator’s 1st, 2nd, and 3rd, priority is reliability” Avoiding blackouts was/is job #1 But, maybe in a pinch demand could help out Thus begat “interruptible service”

Lower rate, but first to black out if system is short Promise not to black out very often Actually, mainly an industrial customer discount “Interruptions” were actually just high prices

Interruptible service minimizes phone calls, but is the most costly way to ration demand Not all power usage has the same value Not all power usage is “critical to our lives”

Time-Varying Prices for Electricity Time-of-Use Pricing

Peak/Off-peak, but highest costs are in few hours TOU with Demand Charges

Old technology attempt to capture highest peaks Critical Peak Pricing

New technology attempt to capture highest peaks Paying for Demand Reduction

The “nice guy” approach, but with many headaches Realtime Pricing

The gold standard

The Value of Time-Varying Retail Prices

Efficient pricing in the short-run gives efficient incentives to consume and efficient load shifting among periods

Efficient pricing gives optimal long-run incentives to invest in capacity

More immediate demand response reduces generator incentive to exercise market power in wholesale market

Reduces need for reserve capacity Bottom Line: Lower Long-Run Costs, Higher

Consumer Benefits, CSEM WP#116

Methods for Implementing Time-Varying Retail Pricing

Key differences among plans Granularity of retail prices Timeliness of retail price setting - “dynamic” Adaptability to varying revenue target Bill Volatility – protection against price spikes

Granularity and Timeliness are different, but interact in important ways

Adaptability need not conflict with protection against volatile bills

Flat-Rate Service Revisited

poor granularity, no time variation prices are not timely, change annually (?) very adaptable -- change rate to hit revenue

target, but prices are very inefficient protection against volatile bills

Wholesale price spikes smoothed over long periods

Real-Time Retail Pricing (RTP)

Excellent Granularity Prices usually change hourly

Very Good to Excellent Timeliness Using “day-ahead” or “real-time” price

Arguments against RTP bills will be volatile not adaptable to meet revenue requirements

BUT straightforward alterations to RTP overcome these objections

Issues in Implementing RTP Customer Price/Bill Risk on RTP Meeting Retailer/Utility Revenue

Requirements Mandatory versus Voluntary RTP RTP and Reserve Requirements

Mitigating Customer Risk Under RTP Customer risk comes from the possibility of

unexpected high wholesale prices Hedge through long-term contracts

Active Hedging by Customers or Hedging by Retailer on Behalf of Customer

How to pass along gain/loss from hedge while minimizing distortion of retail price?

Mitigating Customer Risk Under RTP Retailer Hedges for Customers

Still charges RTP on the margin Passes through gains/losses from hedge with

minimum distortion of retail price Customer Baseline Load (CBL) approach Constant adder/subtractor to retail RTP

Active Hedging by Customers “BYO Baseline” offered by retailer Hedging instruments from energy sector

Meeting Retailer/Utility RevenueRequirements Under RTP

RTP revenues won’t match retailer’s costs if some power bought under long-term

contract if some power generated by retailer if retailer has fixed costs unrelated to energy

e.g., distribution costs

if retailer has sunk/stranded costs

Meeting Retailer/Utility RevenueRequirements Under RTP Collect differential as lump-sum, so marginal

price is still RTP CBL approach does this Politics of setting lump-sum levels/baselines

Collect differential as constant per kilowatt-hour adder or subtractor still have variability in RTP

small inefficiency of consumption

Example: Passthrough of Fixed Hedging Gains with Constant “Subtractor”

Real-time Pricing with Monthly Bill Stability(Assumes contract at 6 cents/kWh. Prices include 4 cents/kWh T&D)

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1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30

Day of June 2000

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PX (hourly price)

PX Month Avg (18.08cents)

100% Contract (10 cents)

20% PX Month Avg + 80%Contract (11.62 cents)

PX Adjusted for Contract (PX-6.46 cents)

Mandatory versus Voluntary RTP If RTP is so great, why do we have to make it

mandatory? We don’t. But don’t cross-subsidize flat rate customers

The vicious cycle of equalizing average price between RTP and non-RTP customers some RTP customers will always be paying more

than they would on flat rate so will switch to flat eventually RTP collapses

Voluntary RTP Without Cross-Subsidy The virtuous cycle of allowing each group to

stand on its own -- no cross-subsidy lowest-cost customers on flat-rate better off

switching to RTP mimics a competitive market outcome lower prices for those who are cheaper to serve

if that’s “cherry picking,” I’m for it all customers still pay for fixed/sunk costs,

not a method for dodging sunk cost liability

The Role of Demand Response in Resource Adequacy and Reserves RTP will not eliminate the need for reserves

so long as price-responsive demand is slower than callable supply

But RTP offers more than peak demand reduction demand “tilts” as well as shifts

RTP will gradually reduce use of reserves as system operators recognize its reliability

Eventually, RTP will reduce the standard for percentage reserves

Demand Response and Renewables Demand response flattens load, reducing

peaks and raising off-peaks Reduces use of peaker gas power Helps wind and solar power Can make baseload coal more attractive

Demand response is not Energy Efficiency Both will play a critical role in CA energy future

How Price-Responsive is Demand? Evidence from California 2001 and other

conservation programs Evidence from RTP programs and pilots Evidence from dynamic pricing programs and

pilots These estimates almost certainly understate

price responsiveness as technology improves The next programmable thermostat

Where is Demand Response in now? Nowhere in California (worse than pre-2000),

but working groups and pilot projects to restart it – CPUC/CEC joint initiative

Still great resistance to RTP. Most initiatives are Critical Peak or paying for demand reduction

Open question of resource adequacy for a “non-core” group and role of demand response

Conclusions Static pricing of electricity is based on old metering

technology, has large inefficiency RTP is the gold standard of electricity pricing Resistance to RTP is understandable, but not

difficult to address Real barrier to RTP is metering cost, but only for

small customers (and maybe not even them) starting with large customers probably gets biggest bang

for buck Demand response will play significant role in

resource adequacy and future CA electricity industry