Demand Response in California’s Electricity Future: Demand Response in California’s Electricity Future by Severin Borenstein, Professor, Haas School of Business Director, UC Energy Institute (www.ucei.org)


A Brief History of Electricity Pricing: A Brief History of Electricity Pricing In the beginning, there was no metering Then 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”: “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-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: 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: 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: 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): 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: 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: 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: 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: Meeting Retailer/Utility Revenue Requirements 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: Meeting Retailer/Utility Revenue Requirements 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”: Example: Passthrough of Fixed Hedging Gains with Constant “Subtractor”


Mandatory versus Voluntary RTP: 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: 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 : 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 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?: 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?: 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: 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