Time to get serious about time-of-use rates

Stephen S. George, Ph.D.,
& Ahmad Faruqui, Ph.D.,
Charles River Associates

Product and service prices that vary by time of use (TOU) are neither new to the electricity industry nor uncommon in everyday life. Examples include telephone service, air travel, theater tickets and parking.

TOU electricity pricing was first proposed in a British technical report more than 50 years ago. Since that time, many utilities have implemented TOU rates-sometimes on a mandatory basis-for very large consumers. Many also offer TOU pricing to smaller consumers on a voluntary basis. However, very few consumers have chosen this option, leading many utility executives and regulators to conclude that small consumers have no interest in such complex rates.

However, there is growing evidence to the contrary. Utilities and regulatory commissions should consider offering TOU pricing to all small consumers for the following reasons:

  • Wholesale price volatility has increased significantly. Since consumers rarely face this price volatility, there is very little demand response in the market place, which contributes to supply-side market power and high market clearing prices.
  • Flat and discounted standard offer prices in competitive retail markets make it very difficult for new entrants to attract consumers. If consumers faced TOU prices, retailers could offer risk-management services that might provide sufficient value to attract customers.
  • The cost of metering has dropped dramatically, especially when deployed on a large scale.
  • The improved cost and availability of complementary technologies promise a future of relatively painless, cost-effective load management.

Policymakers remain skeptical, however, and raise the following questions:

  • Will small consumers really shift load?
  • Will small consumers accept TOU rates, especially if imposed on a mandatory basis?
  • Do the economic benefits of TOU rates outweigh the implementation costs?

The answer to all three questions is yes.

A series of TOU rate experiments funded by the U.S. Department of Energy in the late 1970s provided conclusive evidence that small consumers would shift usage. Since then, there have been more than a dozen studies indicating that small consumers respond to TOU price signals. These studies suggest that consumers on average will reduce peak usage by 20 percent in response to a doubling of prices in the peak period. Super-high, critical peak prices may elicit reductions of as much as 50 percent.

A large-scale pilot program currently underway at Puget Sound Energy (PSE) suggests that small consumers may willingly accept TOU rates. PSE placed roughly 240,000 residential consumers on TOU rates last fall and gave them the opportunity to switch back to a traditional average price tariff. Less than one percent have switched back. A customer survey showed that 85 percent of consumers are satisfied with the program and nearly all would recommend the rate to others.

Another example of customer acceptance comes from Gulf Power’s new Good Cents Select program that combines traditional TOU rates with a critical pricing option, two-way communication and a sophisticated load management capability. In the first year of operation, more than 3,000 residential consumers signed up for the program, and paid Gulf Power almost $5.00 per month for the privilege.

Is TOU cost effective?

So it would appear that consumers will shift load in response to TOU rates and many are comfortable with such rates. But are these rate options cost effective in light of the incremental metering, billing and other related costs required to implement them? A recent study done by Charles River Associates for Xcel Energy suggests the answer may be yes.

Xcel Energy filed this study in December 2001 in response to a request by the Minnesota Public Utilities Commission to examine the cost effectiveness of TOU rates. Several rate options were examined, including a traditional three-part TOU rate with fixed prices for each rate period. A second option layered a critical peak price on top of the three-part rate. The critical peak price, equal to 20 cents/kWh, applied to the peak and shoulder periods for 10 extreme summer days, the timing of which wasn’t known until the day before. The third price option, extreme-day pricing, has a high price in effect for all 24 hours of ten critical days during the summer, and a low price for all other days.

Each rate option was evaluated on several different criteria, two of which were the participant test and the total resource cost (TRC) test. The participant test compares the benefits and costs to consumers. The TRC test compares the benefits and costs to society, where benefits consist primarily of avoided energy and capacity costs.

The analysis showed that the net present value (NPV) over 20 years to participants for the traditional TOU rate totaled $84 million, and for the critical and extreme-day rates it equaled roughly $140 and $192 million respectively. Results from the TRC test were even more impressive, with the traditional TOU rate showing an NPV of $112 million, and the critical and extreme-day pricing options showing NPVs of $623 and $548 million respectively.

TOU rates for mass-market consumers have the potential to provide substantial benefits to consumers and utilities. It is time to get serious, and start evaluating them through cost-benefit analysis, followed by carefully designed pilot programs.

George is a vice president with Charles River Associates. He has more than 25 years experience in the electric industry, focusing on restructuring and corporate and market strategy. He can be contacted at sgeorge@crai.com.

Also a vice president at Charles River Associates, Faruqui has experience in pricing and rate design. Prior to working for Charles River Associates, he was area manager for retail and power markets at the Electric Power Research Institute. He can be reached at afaruqui@crai.com.

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