The evolution of Utility rates

Electricity prices have increased significantly in the last few years especially in Cyprus making electricity prices in the country one of the highest in Europe. This is due to the dependency of our electricity system on imported fuels and Co2 costs that are associated with generating electricity from these fuels. Another factor that is responsible for the highest prices in the EU is the frequency of heatwaves which correlate significantly to increased peak demand which results in significant increases in electricity prices.


The ways utilities charge for electricity even though we are living in a smart world are very primitive. Pricing products, in general, is a straightforward process with a bottom-up approach, considering the costs plus your margins and you get the price for a product. For electricity, because there are a lot of variables that affect the cost of electricity (such us time of generation, seasonality, etc.) and utilities believe its too complicated to calculate for all the variables the cost of electricity, they average out the cost of electricity, add their margins and divide it by the number of customers they have. This was a satisfactory method to calculate the utility rate of customers until the 90s, but people have realized that this is an unfair method for some customers and just completely wrong. Giving an example to make things clearer, the cost of electricity for a utility during a heatwave, where demand is at its highest and during periods that utilities need to start using expensive power plants from the 60s here in Cyprus, is very high in comparison to the middle of the night, where demand is very low and more efficient power plants are used. This means that someone using 1 kWh during that hot day and someone using that 1kWh during the night get charged the same. That is why improved, and smarter utility rates have been created (presented below), that disincentives people from using electricity during peak times and even rewards them. These are massive demand-side management tools that utilities should use to reduce costs, create incentives for distributed generation and even batteries.


Time of use rates (TOUs)

Time of use rates (TOUs) is the next step of utility rates slightly more advanced, where a utility charges different prices for electricity consumption depending on the time the electricity is being used, have been used in many other countries with great success. The successful deployment of TOUs has been around since the 80s. The main reasons that they are more effective than traditional rates are because they reflect a more accurate picture of the real cost of electricity and therefore they can be expected to improve the efficiency of resource allocation in the economy and because they provide an incentive to customers to modify usage patterns by reducing peak load and shifting their usage from peak to off-peak periods. These rates have shown time after time the effectiveness they have in reducing electricity prices.

12 pricing experiments [1] that have been done testing and checking the effectiveness of such utility rates have come with the following conclusions:

  1. TOU rates have significant correlation in the reduction of peak period electricity consumption and a slight correlation in small increases in the off-peak consumption.

  2. Consumers with higher electricity consumption respond more in comparison to lower electricity consumption customers.

  3. Price elasticities of peak and off-peak electricity consumption exists however the range of that elasticity is big.

Many utilities have identified the effectiveness and power of Utility rates and the power of demand site management, however Time of Use rates should be only the beginning. More innovative utilities have started experimenting with dynamic pricing rate.


Dynamic pricing

For example dynamic pricing rate coupled with a smart thermostat used in Oklahoma, USA only for residential customers that was done a few years ago have concluded with great success averaging peak load drops of 40% and average bill saving of 20% to their customers. Improvements in utility rate design to make them more cost reflective will instantly benefit some customers and will benefit utilities in the long term.


Demand charges

Apart from dynamic pricing a number of utilities are currently experimenting also with demand charges, which greatly incentivize battery storage. France, Italy and Spain have mandatory demand charges on residential customers. Experiments with demand charges have shown that are greatly effective and do not raise bills on small customers.


Conclusion

Transitioning into the new green era with a more decentralized electricity grid, utilities need to adapt to the new reality. Failing to adapt to the new reality might lead to a regretful ending to those utilities and follow the steps of Nokia, Blockbuster, and Blackberry.


Source: A.Faruqui, J.R.Malko, The residential demand for electricity by time-of-use: a survey of twelve experiments with peak load pricing (1983)

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