Improve Demand Response by Instituting Dynamic Pricing

Demand response is a pricing structure that reduces utility and grid operator costs by creating incentives for customers to adjust their demand for electricity in response to system conditions. Properly managed demand response can greatly reduce the long-term cost of managing an electric grid by reducing the need to build expensive “peaking” power plants and replacing them with demand reductions from end-users during peak hours.

Existing state demand response programs are limited in the options they provide to customers. While utilities have varying amounts of demand response, some of it is in the form of interruptible tariffs that have been in place for decades. These tariffs provide customers with a lower rate for power in exchange for agreeing to have service interrupted occasionally when demand is particularly high or supply is particularly low. Some utilities also offer forms of time-of-use rates, in which customers are charged different rates throughout the day. Interruptible tariffs and time-of-use rates help lower overall grid costs, but these are modest first steps. A more advanced form of demand response involves implementing prices that reflect the true cost of delivering electricity throughout the day, known as “dynamic pricing.”

States can capture the benefits of demand response by expanding dynamic pricing in two ways. First, the state public utilities commission could make dynamic pricing the default electricity rate structure for all commercial and industrial customers in the state. Utilities could be required to sell customers insurance to help minimize the volatility of their electric bills, without diminishing the incentives of real-time price signals. Second, residential customers could be allowed to opt into dynamic rates. To help inform customers in this decision, utility bills should be required to show the customer’s monthly costs under both a standard rate and a dynamic rate. Additionally, to help residential customers who do opt into dynamic pricing, utilities can offer “level payment” services, allowing customers to spread the cost of an unusually high month over the following year’s monthly payments. While consumer advocates may be concerned that customers who choose not to opt into dynamic rates will see a price increase, recent research suggests potential increases are modest and are not likely to impact low-income consumers disproportionately.

States can position themselves to capitalize on the smart and efficient building market by putting in place robust market signals, such as dynamic pricing, that compensate consumers for intelligently managing their electricity usage.