Will Demand-Based Electricity Pricing Solve California's Energy Crisis?

Or will the cost of metering kill an effort at reform?


25 August 2004--Proving that even people who have seen the extremes of energy shortages have short memories, Californians broke their own electricity usage records this summer, topping out at 44 872 megawatts on 12 August. (And that figure doesn't even include the cities of Los Angeles and Sacramento, which operate their own grids).

As recently as 2001, Californians faced the threat of 30 to 50 days of blackouts, and with some price incentives, they responded by cutting their consumption. But as soon as the immediate threat disappears, consumers' incentive to conserve energy diminishes, and demand returns to treacherously high levels. With more than 33 million residents, California is the most populous state in the U.S., and is expected to add another 16 million people by the year 2020, necessitating a long-term solution.

In March 2003, spurred by the possibility of another energy crisis, the California Public Utilities Commission (CPUC) ordered California utilities to test new pricing options that would require consumers to pay more for their electricity during periods of high demand, hoping to provide an incentive to conserve. The resulting statewide pricing pilot, which continues through December of 2004, incorporates Internet-enabled digital "smart meters" such as the Carrier EMi thermostat that inform participants of real-time rate changes so they can tailor their usage to correspond with current prices. California's pilot project mirrors a similar transition taking place in Canada, where utilities plan to deploy the meters in 800 000 homes in the province of Ontario by 2007.

When the California utilities announced their intention to offer supply-and-demand pricing to the pilot's experimental group of more than 2000 residential and small-business customers around the state, many energy-conscious lawmakers rejoiced at a long-overdue innovation. Electricity billing has remained virtually the same since 1889, when Elihu Thomson designed the first commercial watthour meter. Utilities in most states, including California, record the number of kilowatthours each customer uses per month and charge a fixed hourly rate for this usage. Hourly pricing increases on a tiered basis as total monthly usage increases--for instance, a customer whose electricity usage exceeds a set number of kilowatthours will pay several more cents for each additional kilowatthour used. This fixed-rate system does not reflect dynamic changes in the value of electricity, however. Consumers are charged the same hourly price for electricity on low-consumption days and on peak days when power plants strain to meet demand. As a result, they have little motivation to conserve energy when it is at a premium.

To find a way to create this motivation, the pilot's planners tested three demand-based pricing methods. The first, time-of-use (TOU) pricing, offers customers an on-peak and off-peak rate schedule that is consistent from day to day; say, from noon to 6 p.m. the rate is higher than the rest of the day. The second plan, fixed critical peak pricing (CPP-F), includes a TOU rate on most days and a considerably higher "critical" rate on 15 of the hottest days of the summer, with customers informed a day ahead of time when these high rates will be in effect. The final method being tested, variable critical peak pricing (CPP-V), is the most dynamic option. It differs from CPP-F in that the high-price period on "critical" summer days varies--the critical rate can change from minute to minute. Customers are told about this variance on the day it happens through data transmitted to their smart meters by the utility or through phone or e-mail notification.

The preliminary results are promising, with price incentives appearing to ease the drain on energy resources and save consumers money. An analysis of first-year pilot data showed an average reduction in residential electricity usage of nearly 20 percent during critical demand periods. "The bottom line with respect to the initial findings is that customers respond by lowering usage when prices are higher," says CPUC spokeswoman Terrie Prosper.

Lower usage may also translate into lower utility bills. About 80 percent of pilot participants saved money on their summer 2003 bills by switching to a time-varying rate, with the smart-meter-enabled CPP-V group saving the most. Reports indicate that consumer satisfaction is also high. "People think [demand-based pricing] should be implemented--it's more straightforward than tier-based pricing and it saves them money," says CPUC commissioner Arthur H. Rosenfeld.

Representatives of The Utility Reform Network (TURN), a San Francisco-based consumer advocacy organization, however, urge caution, arguing that the substantial costs associated with installation of smart meters may be prohibitive. San Francisco-based Pacific Gas and Electric Co., north and central California's energy provider, has estimated a minimum cost of US $1.8 billion for smart meter deployment across California, which would be passed on in the form of higher hourly rates.

Essentially, consumers would be paying an extra monthly fee to rent the meters from the utility that owns them and takes charge of their upkeep, notes TURN staff attorney Marcel Hawiger. "It's unclear whether the cost of the meters and associated technologies would be outweighed by shifting usage away from peak times," he says. "Our analysis indicates 60 percent of residential customers will not be able to shift their loads sufficiently to outweigh the meter installation costs." Hawiger thinks customers with central air conditioning stand to save the most by limiting usage during peak hours, but that others will not see a dramatic price drop, since many high-load appliances such as refrigerators cannot be turned off easily during the day. In order for dynamic pricing to be worthwhile, customers would have to save enough energy to outweigh the ongoing cost of the meters, which will run from $90 to $175 for installation alone.

Should demand-based electricity pricing be offered statewide as a permanent solution to the looming energy crisis, or would the costs of implementing such a program send rates sky-high? Energy commissioners are biding their time on an answer until early next year, when the pilot program will be complete and a full analysis of the effects of pricing options can be formulated. "The initial analysis is based on summer 2003 data, so we're still in sort of a debugging phase," Rosenfeld says. "We want to have as much evidence as we can before going forward."