Dynamic Pricing is Smart Grid’s Secret Sauce

Dynamic pricing can reduce load by up to 20%

A Smart Grid facilitates dynamic pricing and distributed consumer demand response by putting in place digital communication technologies that make information more transparent and more readily available to consumers in a timely fashion. When some retail consumers choose dynamic pricing (typically either real-time pricing or time-of-use pricing), they respond to price signals by shifting their demand away from peak hours. Ubiquitous information to consumers reduces overall energy use, but more importantly, it reduces peak energy use by 5-20%, depending on pricing and market design and the availability of end-use enabling technology.

Dynamic pricing is one of the most valuable direct consumer benefits enabled by a Smart Grid.  Dynamic pricing makes the value and cost of their energy use transparent to consumers, and it enables consumers to see when cost exceeds value. Dynamic pricing particularly benefits consumers whose consumption is flexible; however, it does not harm the inflexible customer because it reduces the quantity of peak power demanded, thereby reducing average prices paid by inflexible customers.  When dynamic pricing reduces peak demand, it also reduces transmission and distribution losses, and associated operating costs.

Delivering long-awaited promises

The combination of a Smart Grid with dynamic pricing, plus product offerings such as renewable (“green”) power, creates the conditions that can finally deliver on the long-awaited promise of energy efficiency, as well as reduced operating costs:

·         Information transparency and dynamic pricing optimize fuel use and can reduce emissions. The connection between a Smart Grid and dynamic pricing can also create environmental benefits. Dynamic pricing can also contribute to improving environmental quality by enabling customers to shift demand away from peak periods with high prices or by reducing their overall use. This economizing incentive is the source of the conservation benefits of market-based pricing. Conservation brought on by dynamic pricing reduces energy costs and increases energy efficiency. This conservation typically takes two forms -- curtailing consumption (reducing overall use) and shifting use to non-peak hours. Environmental benefits result from using more efficient generators that operate closer to the conditions for which they were designed, and reduced transmission and distribution losses.

·         Reduction in long-term investment and higher load factors mean less resource use. The shift away from peak consumption reduces the required investment in generation capacity to satisfy peak period demand. Customers shifting and reducing demand would lead to less required investment and new plant and wires construction, which would also reduce long-run average cost by reducing capital costs. Furthermore, many of those assets are used during only a few peak hours each year, which means that building to meet peak demand requires using many physical and financial resources that sit idle much of the year. In addition to the cost savings from reducing the amount of idle peak capacity, reducing peak capacity creates environmental value by reducing required resource use to meet our electricity needs. Thus, dynamic pricing would lead to both environmental benefits and reduced production costs.

·         Ability to offer differentiated “green power” products. A Smart Grid reduces the information costs to retailers and to consumers of offering and choosing green power products. Thus, consumers can have access to retail products that better match their values.

·         Renewable resource interconnection. A Smart Grid facilitates the interconnection of renewable resources and distributed storage that can mitigate some of the intermittency problems associated with generation from renewable resources.

Empowering consumers to make “smarter” energy choices

Such diverse value-added services empower consumers and enable them to control their electricity choices with more granularity and precision than the environment in which they think solely of the total amount of electricity they consume. Digital metering and end-user devices also decrease transaction costs between buyers and sellers, lowering barriers to exchange and to the formation of particular markets and products. Whether it is a building control system that enables the consumer to see the amount of power used by each function performed in the building, or an appliance that can be automated to change its behavior based on changes in the retail price of electricity, these products and services provide customers an opportunity to make better choices with more precision than ever before. In aggregate, these choices lead to better capacity utilization, better fuel resource utilization, and provide incentives for innovation to meet their needs and capture their imaginations. In this sense, technological innovation and dynamic retail electricity pricing are at the heart of decentralized coordination in the electric power network.

Improving the system’s load factor via Smart Grid-facilitated dynamic pricing and other Smart Grid strategies reduces required investment in distribution infrastructure. Moreover, communication technologies have become less expensive over time, while the costs of planning, siting, and constructing physical infrastructure have increased dramatically. Thus, investments in Smart Grid technologies can achieve many of the same reliability and resource adequacy objectives that traditional physical investments are intended to achieve, and they increasingly do so at lower relative cost.

A symbiotic relationship

Digital technologies are increasingly available that reduce the cost of sending prices to people and their devices. Dynamic pricing and the digital technology that enables communication of price information are symbiotic. Dynamic pricing without enabling technology is meaningless; technology without economic signals to which to respond is extremely limited in its ability to coordinate buyers and sellers in a way that optimizes network quality and resource use. (The exception to this claim is a time-of-use contract where the rate structure is known in advance. However, even on such a simple dynamic pricing contract, devices that allow customers to see their consumption and expenditure in real time instead of waiting for their bill can change behavior.)

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