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Rate Design Is the No. 1 Energy Efficiency Tool Rate Design Is the No. 1 Energy Efficiency Tool It is one thing to understand the theory of efficient pricing and another thing to actually implement it. However, the job is getting easier, as wholesale markets simplify the task of estimating marginal generation and transmission costs, advanced metering infrastructure makes time-varying pricing feasible, and the industry recognizes the value of straightforward, easy-to-understand prices. Hethie Parmesano Hethie Parmesano is Senior Vice I. Energy Efficiency efficiency measures in the President at NERA Economic Makes Headlines, but electricity sector. Typical Consulting, where she focuses on Too Little Attention to recommendations include costing, pricing, and regulation of the Rate Design reinstitution of integrated electric, gas, and water utility resource planning (IRP),1 new industries. She also directs NERA’s Headlines in the national appliance and building Marginal Cost Working Group, a media, not to mention the trade standards, subsidized investment group of utility companies interested in sharing research and ideas on press, have been documenting the in efficiency-enhancing marginal costing and its use in new focus on energy efficiency. equipment, standby or buy-back applications such as pricing, Global climate change concerns, rate or interconnection subsidies planning, and retail access efforts to remove barriers to for distributed generation (DG),2 implementation. In addition, she has development of renewable energy and revenue ‘‘decoupling’’ conducted studies related to electric 3 sources, concerns about meeting mechanisms. utility strategic planning, including pricing strategy. growing demand for electricity, ften lost, or and efforts to make new O underemphasized, is the electricity markets more fundamental role of economically competitive all point to an efficient electricity pricing in enhanced role for energy eliciting energy efficiency 18 1040-6190/$–see front matter # 2007 Elsevier Inc. All rights reserved., doi:/10.1016/j.tej.2007.06.002 The Electricity Journal activities by energy users. For cost incurred by the utility to efficient are rates that change as example, in a March 2007 report supply the extra kilowatt-hours, system and market conditions to Congress, the U.S. Department thenshewillbemakinga change. Examples include critical of Energy listed rate design as the decision that is not only right for peak pricing (CPP) and real-time final of 10 recommended her, but also efficient in terms of pricing (RTP). mechanisms for enhancing society’s resources. This requires CPP charges a pre-set high energy efficiency (and tempered an electric rate design that price for energy consumed dur- that recommendation with the charges for the extra ing hours declared (usually a day note that ‘‘this goal must be consumption at the utility’s ahead) to be critical, in terms of balanced with other ratemaking marginal cost, and recovers costs high cost, reliability, or both. objectives.’’)4 In fact, rate design that do not vary with usage in RTP charges prices that vary should be at the top of the list. fixed charges or some bill hourly, depending on system or Efficient rate design is an component (such as an early market conditions, and are set essential starting point if the goal typically either a day ahead or an is to maximize the cost- hour ahead. effectiveness of other efficiency Unfortunately, the nfortunately, the prices efforts. U most U.S. consumers pay There is nothing new in the prices most U.S. are not well-correlated with the theory of efficient pricing; consumers pay are not marginal cost of providing consumers make economically well-correlated with the electric service. As a result, the efficient energy-related decisions marginal cost of reductions in electricity bills from when they face prices equal to reducing electricity use, or shifting marginal cost. What are new are providing electric use from peak to off-peak periods, affordable metering and service. do not match the costs the utility communication technologies, (and more generally society) better information about avoids when less energy (or less marginal costs, an peak-period energy) is used. understanding of the importance energy block) that is not likely to of clear price signals, and a significantly affect consumption. sense of urgency. ate designs that relegate III. Efficient Electric Rate R local distribution and Design Supports Other customer-related costs that do not Energy Efficiency II. Economically vary with consumption to fixed Initiatives Efficient Electricity charges (e.g., a monthly customer Pricing charge or charge per unit of Recent legislation, state energy contract capacity or design plans, and stakeholder reports When a consumer is demand) and recover generation, have identified a number of considering cranking up the air transmission and upstream initiatives that are designed to conditioning on a hot summer distribution costs that do vary improve energy efficiency. In afternoon, she should be with usage in charges that vary by many cases, improving the weighing the extra charges on season and time of day result in efficiency of electricity rates the next electricity bill against more efficient consumption would complement these other the value of the extra comfort decisions than traditional rate activities. Consumers may still that afternoon. If the effect on structures with low or no fixed need help identifying her bill of that extra charges and no time- opportunities for improving consumption matches the extra differentiation.5 Even more energy efficiency in their homes July 2007, Vol. 20, Issue 6 1040-6190/$–see front matter # 2007 Elsevier Inc. All rights reserved., doi:/10.1016/j.tej.2007.06.002 19 or businesses, or coming up with CPP programs) increases the Appliance standards and building the initial investment, but they do benefits of energy efficiency codes help buyers make efficient not need a subsidy if the savings activities, promotes load choices by screening out on their electricity bills match or shifting (from high-cost to inefficient options. However, the exceed the cost of making the low-cost periods), and improves standards and codes must be changes. system reliability without carefully set, based on estimates ne initiative is to encourage requiring investment in new of marginal costs and expected O DG investment, particularly capacity. use over the life of the appliance/ projects using renewable Many utilities have (or used to building. technologies. Simply reforming have) direct load control programs equirements to consider regular rates to reflect the under which the utility R both supply and demand- structure of marginal costs can controls off particular electrical management investments when improve the cost effectiveness of equipment (such as air developing plans to meet future DG. Rate structures with high electricity requirements is known demand charges tied to as integrated resource planning maximum level of use (sometimes Even (IRP). When customers face over an entire year or more) efficient prices, they will reduce the cost-effectiveness of with efficient undertake cost-effective demand- investing in self-generation that price signals, side investments on their own, may not be available in all hours. consumers provided they have sufficient Time-differentiated marginal may not make information. Thus, a component cost-based rates encourage design of demand-response becomes and operation of DG facilities that cost-effective embedded in the load forecast maximize electricity production equipment choices. that the utility is planning for, and in the critical on-peak hours. less investment (demand- or Rates with energy charges that supply-side) is required than reflect marginal energy costs would otherwise be the case. provide a signal to consumers to conditioners and water heaters) Even with efficient price install and operate their own during critical hours, and signals, consumers may not make generating facilities when the cost rewards participating consumers cost-effective equipment choices. For of doing so is less than the utility’s with bill reductions. Setting the example, individuals may have marginal cost of supplying that bill credits to reflect the utility’s difficulty assessing costs and energy. avoided costs helps maximize the benefits over multi-year time Another efficiency-promoting efficiency of the programs. periods, and firms often require policy is to encourage short-notice OfferingRTPandCPPprograms investments with a two- or three- demand response to enhance may reduce the need for direct year payback. However, with the system reliability and counteract load controls, as consumers will financial incentives in place in the market power by generators have the incentive to control their form of efficient rates, energy bidding in the wholesale energy own electricity use during the efficiency programs can market. Customers respond to high-costperiods.However,itis concentrate on providing electricity prices by changing unlikely that all customers will information and even up-front their behavior, appliance stocks, have the metering and funding. There is no reason for and building characteristics when communication equipment other consumers to provide the prices warrant such changes. required for RTP and CPP, and subsidies; instead the programs Introducing marginal-cost-based direct load control programs help can be designed so that the time-of-day rates (and RTP and fillthatgap. recipients repay the up-front 20 1040-6190/$–see front matter # 2007 Elsevier Inc. All rights reserved.,
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