Time-of-use rates or peak-time rebates?

An economist and a sociologist debate electricity pricing issues

Kate Rowland | Feb 22, 2011


Billed as a "Clash of the Dynamic Pricing Titans," a debate last week at the Kellogg School of Management University Club in San Francisco certainly had some sword clashing. But, in my view, the one-trick pony ridden by the consumer advocate was soon left in the dust, with the economist emerging as a clear winner early in the hour. Utilities need a clear path to optimize power delivery and cost, not a battle of wills regarding socialization and the definition of "necessity."

Moderated by To the Point's Judith Schwartz, the debate featured the arguments of The Brattle Group economist Ahmad Faruqui and The Utility Reform Network (TUNE) executive director Mark Toney. Here are some of my favorite tidbits from the "clash."

The challenge of engaging customers 

Faruqui: "The big issue is how to get customers engaged in the conversation, because customers want more reliable power at less cost; they want power that is green at less cost. In other words, they want things that nobody can provide them. That's the big challenge, how to change their expectations. (It's about) educating the people, getting them ready to accept what they have to accept. That is: there is no easy solution."

Toney: "I think there are two policy objectives that [TUNE] would agree we want to see. There's a tremendous value in shifting peak-load electricity use. From a consumer standpoint, we think that that is important because it reduces the cost you have to invest to build new plants just to run 100 hours of the year ... For some people, a price trigger might be useful, but again, there are ways to minimize the harm for certain customers who don't have the ability to shift."

Employing peak-time rebates

Toney: "Peak time rebates are an example which is a non-punitive way to send a price signal. I do think that there's a spectrum of proposals when it comes to time-based pricing, and that there are some that we think are more desirable, less punitive, than others. But we think that price signals are only a very small part of any solution that's really going to engage consumers. What we support is voluntary, opt-in, time-based pricing."

Faruqui: "This is an issue of great importance. There are people who cannot afford to pay for their electricity bills when hot weather arrives. That is regardless of any price signal we give them. They're just impoverished. They don't have enough income ... There are various ways of dealing with people's income not being sufficient. The real issue here is a philosophical issue. I heard you [Toney] say that you think price is a very, very small part of the total solution in terms of the energy picture ... As an economist, and as a policy analyst for years and years, I've always believed we live in a market economy. Demand and supply regulates the production and consumption of just about any product that you are buying today ... Peak-time rebates aer meant as a transition tool, but I don't see them as ultimately the end game. I think the end game has to reflect the cost of producing the power. Just the fact that we have the subsidy doesn't mean that we have to forever perpetuate the subsidies."

Opt-out versus opt-in

Faruqui: "If I am a customer, particularly in a utility service area, do I have the option of not paying for power? I don't. I have to pay for the power. There's a certain tariff that is a standard tariff, and I cannot opt out. I am stuck with it. And that is supposedly based on the cost of producing that power. So the issue is, what should it be based on? If the cost of power varies a lot by the hour, it will cost more to produce during the peak hours ... If we charge a flat rate, not a time-varying rate, then what does that do? It creates a cross-subsidy that's not visible, it's not transparent, and we have that today ... Is it fair today to ignore the problem that half of the customers who cost less are paying more, so that the others who cost more are paying less?"

Toney: "We support inclining block rates all over the country (like in California) for that reason. It provides a conservation incentive, and it addresses some of the question of the fairness of the system.  However, in any large system there are always socialized costs. We don't charge somebody extra because they live in a mountainous territory, which in fact is more expensive to serve. We don't say, 'here is your mountain surcharge, here's your rural surcharge.' ... There will always be a sharing of cost."

Let's continue the debate here. Toney says consumers, and consumer groups, can get behind a program of voluntary time-based pricing, as well as direct load control. Faruqui says consumers have to understand the true cost of producing power, and opt-out programs amount to forever-perpetuated subsidies.What do you think? (The Q&A portion of this debate can be accessed here.)

Kate Rowland
Intelligent Utility magazine

Twitter: @katerowland2

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what markets are we talking about?

Dr. Faruqui says "I've always believed we live in a market economy."  But what aspect of the market economy is he referring to?  Is he referring to "rate designs" (not prices) that will be approved by regulators, and which will be available as pretty much the only option available to consumers?  That's regulation, not market economics.

I thought a market would offer choices.  Perhaps we should watch the restructured electricity markets in North America to see whether and when and how time-differentiated prices arise and evolve in the mass (residential) markets.  That may provide regulated utilities with information about what consumers prefer.

Taking a utility-centric approach -- telling the people what the system costs are and what the rate design ought to be -- has not worked well.  In a market, entrepreneurs will come up with creative bridges (products and services) between what people really want and what the system costs are.  They will take risks to literally bridge that reality / that disconnection.



Consumers with less choice


I'd like to explore the latest points you've made in further detail. Can you e-mail me at krowland@energycentral.com and we can set up a time to talk by phone?



Here's the reality - the NIMBY's aren't going to allow new generation of any type.  Carbon taxes are going to nail low-cost generators and costs are going to go up.  Unfortunately, no utility (IOU or POU) can afford to give power away.  There is always an element of subsidy.   From  a personal perspective (response to previous comment about similar rates for those in difficult service territories such as mountains), why shouldn't customers in difficult service areas pay either a higher rate or a higher 'connection fee' to cover the costs to the utility to provide the connection?  Living in a higher altitude water district (ok a different commodity), I pay more for water service than those in lower altitudes.  For some 'mountain' customers, the price of housing may be lower, but they should not expect others to subsidize power, water and other services.

Re: TOU or PTR

As I live in a more difficult electricity service area, and do seem to pay more (for whatever reasons) than my urban provincial neighbors, kilowatt-hour by kilowatt-hour, I know whereof you speak. But we chose to live here, and we knew what the costs were.

I agree, too, that no utility can afford to give power away at less than it costs them to generate it. As demand goes up, looking at responsive generation becomes a potentially expensive proposition. Ergo, the increase in DR programs, and the increased focus by FERC on a nationwide initiative better enabling DR.

Frankly, I can't say definitively that any of us has the answer, and that's why debates such as these are so important. If we toss it all out there, and share knowledge and information, the cream will, inevitably, rise to the top.


Time of Use or Peak Time Rebate

Mr. Faruqui has been promoting "default" or mandatory time of use or dynamic pricing for some time and in many jurisdictions, citing the oft repeated refrain from economists that consumers must see the "real" price of electricity to make rational choices.   He misses the point.  Customers will NOT accept mandatory time of use or dynamic pricing.  There is no U.S. jurisdiction in which such a pricing proposal has been implemented and remained in place.  Every attempt to try to impose such pricing programs for basic electricity use has failed or been rejected by legislators or policymakers.  So, let's stop debated theory and get down to the practical problem that Mark Toney has addressed.  We need to reduce peak load demand.  Some folks can participate in such programs and be "winners" on their bill.  Their actions will benefit all customers.  Voluntary direct load control and peak time rebates are sure ways to get customers interested in reducing peak time usage and create real value for all customers in the form of lower generation supply prices.  Why debate theory when we can move on to actual programs that will work?  All the national consumer organizations, including AARP, NASUCA, Consumers Union, and Public Citizen oppose mandatory dynamic pricing.  Why spend time on such a useless debate when we can implement programs that are not punitive and that will provide real value.  Let the economists debate their theory in the classroom.


Barb Alexander

Consumer Affairs Consultant

Mandatory dynamic pricing a classroom failure?


Thank you for your comments. I appreciate your perspective, as well. At some point, I think the issue becomes more than "consumers will not" and turns into "but this is what it costs". Perhaps, with some necessary regulatory changes, the opportunity for competition within the electric utility space will become greater. In the meantime, to play devil's advocate for the sake of debate, consumers still have choice, even with mandatory dynamic pricing. We can choose to use at peak time and pay what it costs, or choose to use at off-peak, when it costs less. We do this, when we can, with gasoline and other consumables. We can learn to be wiser, and more miserly, with our electricity use, as well.

We have become, as consumers, slaves to electricity. Everything we use these days, it seems, is powered by electricity. But we've made those choices.

Ontario has mandated time-of-use pricing throughout the province. So now, in a real-world situation, we will be able to see, over time, the results of that decision.

Is it, then, an either/or option? Or maybe a little bit of column A, and a little bit of column B?


What electricity "costs"

Kate:  Consumers now pay what electricity costs--it is an average price that reflects the contracts that a utility obtains on the wholesale market or it is the average of the generation supply portfolio owned by the utility.  No one questions whether the current prices are "real."  What you are suggesting is that consumers must or should see time of day pricing.  Why?  What is the purpose?  If the purpose is to stimulate peak load demand, let's do that in the most efficient and effective manner.  Peak time rebates and direct load control will have the desireable result.  If the purpose is to make "ma and pa" who use 500-700 kWh of electricity per month pay a higher bill because they (1) don't understand the new pricing program; (2) don't have any immediate or obvious usage to reduce since they are home all day and need heat and cooling during all hours; or (3) they live in a rental unit and the entire heating and cooling apparatus is controlled by the landlord or (4) they are poor and cannot invest in any new technologies to shift peak load or reduce usage through new appliances or investments in weatherization, etc., then I strongly disagree.  Let's focus on what the purpose is--lowering the overall price of electricity--and then devise the most efficient means to get there.  Dynamic pricing is NOT cost effective compared to a targted load control program for folks with central air.



Dynamic Pricing

I've just finished listening to the first part of the debate and I would agree that Dr. Faruqui gave the better accounting.  However I'd also have to say both men made good points and both men have some things wrong.  Of course, it goes without saying that many of the issues raised in this debate are unique to the parallel economic universe of electric utility regulation.

I agree with Dr., Faruqui that dynamic pricing (aka, heat wave pricing) is the desired end state, but forcing consumers to opt out will lead to the backlash he wants to avoid.  Therefore, consumers should be allowed to migrate away from flat pricing when and as it suits them, but with the understanding that they will pay more under flat rate pricing.  Shadow bills for all consumers would help illustrate (and prove or disprove) this point. 

I disagree vehemently with Dr. Toney that peak-time rebates are an appropriate pricing mechanisms for a couple of reasons.  First, as he stated in another context late in the first part of the debate, it's impossible to prove the counterfactual - in this case how much a consumer would have used absent the rebate - which is the sole basis for calculating the rebate.  Second, peak-time rebates reduce prices in a few hours but keep them higher than they otherwise should be in other hours, which as Dr. Faruqui points out tends to harm lower income customers more than others.  Third, peak-time rebates operate in only a few hours, whereas dynamic pricing operates all the time and provides a nearly perfect mechanism for coordinating supply with flexible demand over a variety of time scales.  if it makes sense to put in centrally controlled switches on air conditioners, it makes even more sense to put in price-sensitive controllers that can switch or modulate the output of an air conditioner in accordance with customer preferences and operate all the time instead of on hot days only.

Mr. Tomey also seems to ignore the fact that "Smart Meters" are essential for any kind of time-based pricing, whether it be real-time pricing, time-of-use pricing, critical peak pricing or peak-time rebates.  Traditional meters that record cumulative consumption won't work.

Perhaps the most stunning insight from this debate was Ms. Schwatrz's finding that low-income consumers liked dynamic pricing and that she was unable to find any instances where consumers did not like it in the 80 studies she examined.  I doubt consumer advocates will be convinced, but she confirms what many of us have suspected.  there will always be people who do not like a particular rate design, so they should have an alternative (preferably a single alternative).

Jack Ellis, Tahoe City, California

Re: dynamic pricing


Keep listening to the last half of the debate, and the discussion that ensued. There's some real meat there. If I'd had more room here, I would have included some of that, as well. In particular, I felt that EPRI's Erfan Ibrahim framed the smart meter argument clearly and succinctly. In part, here is what he said:

"The main purpose of the smart meter is not necessarily for it to be a gateway for a demand response signal. That's a facility it can provide. But it's really meant for the utility to have an intelligent sensor at the extremity of the grid. And the information from that, sent back into a distribution grid management, SCADA-type application can help with what's called Volt/VAR optimization." (And then he explained Volt/VAR optimization quite clearly, too.)

He went on to say, "If you have smart meters, and this information about load on the perimeter can be fed back into the predictive models for optimization, you can get the most efficient allocation of electricity on the various segments. That could be a tremendous demand response program from the utility itself, where if you are at 122 volts and it's a peak time, you can bring it down to 114 volts....Without any customer involvement, you will save a lot of electricity."

I think these debates provide a valuable opportunity for all of us to agree, disagree, and ultimately get to the heart of what's next and why. (And, oh, I love a good debate!)


great discussion!

This forum is so valuable because we need to create a cash positive path for renewables and the "powers that be" are heavily invested in the old power production methods. Oil and gas for transportation and nuclear and coal for non-transport power.

Thanks, IU, for keeping these topics vibrant! Wish I could be at your upcoming conference.