Electricity Pricing Should Clue Consumers to Judicious Use

It now appears that the companies selling power to California will cut a deal to sell it at a fixed price for the next decade or so. The price will be well below the level in today’s wholesale market and well above the price that everyone expects the generators would be able to get in a few years. So, they are offering to reduce their eye-popping profits in the short term in return for a guarantee of very healthy profits for many years after that.

The deal that federal and state officials are brokering would solve the financial crisis in electricity, a crisis that caused neighboring states to refuse to sell us power for fear they wouldn’t get paid. The deal, however, would not address the supply shortage that we will face this summer and for the next two years. And that is what could cause the wheels to come off the booming California economy.

The companies that now are threatening to move out of the state are focused on reliable supplies, not the price of power. Intel and others in the Silicon Valley are pointing out the enormous costs they face from an unreliable power grid that could suddenly cut them off.

But there is a simple solution. If we can’t increase supply--and there is little chance of that in the next year--we can decrease demand, particularly at the peak times when the power shortage will be greatest. Conservation is an old tune, but with today’s technology, we can give it new and happier lyrics.

Real-time pricing, where the price to the customer changes every hour, can be in use for large commercial and industrial users before this summer. Technology has brought down the cost of metering power use on an hourly basis and the Internet allows customers to see what the price of power will be every hour. Real-time pricing can tell companies--and eventually households as well--when power supplies are tight and prices are high, as well as when supplies are plentiful and cheap. (In France, they’ve used a simplified version in homes and businesses for years with a red/green light indicator for high or low prices.)

Of course, we could increase conservation with rolling blackouts. The difference is that real-time pricing gets conservation from the places where it is least costly and disruptive. Intel is telling us that cutting its power use could be disastrous. Safeway and others have shown that they can cut power use without disasters. Real-time pricing allows Safeway to save lots of money by cutting its use and Intel to keep its production line running. Rolling blackouts rely on a flip of a coin to make the choice of who “conserves.”

There is understandable resistance to real-time electricity pricing because in the current debate it has been incorrectly associated with increases in overall monthly bills. But the average level of electricity prices and their variability are completely separable.

Let’s say the deal out of Washington is for power at 6 cents per kilowatt-hour. If we stick with the approach of the past, the price will be 6 cents all the time, during winter and summer, on hot afternoons and cool nights, during the peak and the off-peak consumption times. And during those peak times, we will run short on power. When we run short enough, the system operator will switch off someone’s circuit.

Here’s the alternative, a (simplified) real-time pricing approach. Charge 4 cents per kilowatt-hour most of the time. When power gets really short, charge 50 cents per kilowatt-hour. It is worth that much (actually, much more) to Intel, but Safeway would lower its lighting, raise the air conditioner from 72 degrees to 76 degrees and thus reduce its bills. Safeway’s bills over the year would be lower than under the old approach. Intel’s bills would be slightly higher, but it would be assured that it can get the power it needs to have.

We can set the peak price charge and the hours it is implemented so that the average electricity price is still 10 cents per kilowatt-hour. In fact, for any flat-pricing scheme, there is a real-time variable pricing scheme that produces the same average price, but also gives the right incentives to scale back consumption when the system is strained. Those who consume disproportionately at peak times would pay a bit more and those who consume off-peak would pay a bit less on average. No one would get blacked out and those who need the power at peak times would be assured of getting it.

Critics of real-time electricity pricing argue that electricity is a necessity for many uses and users. But that’s the point. The current system of threatening rolling blackouts or using interruptible contracts that shut down the user completely for hours at a time reduces power consumption in the most disruptive way. Real-time pricing would do it in the least disruptive way.

Real-time pricing also yields important environmental benefits. We build power plants to cover the peak-time demand. Some of those plants run only a few hours a year. Yet, they are necessary under the current system because there is virtually no way to get demand to scale back during those few peak hours. With real-time pricing, we would need fewer land-using, view-spoiling, property-value-reducing power plants to meet the peaks.

The state and federal governments have stepped forward just in time to solve the financial crisis that California’s electricity deregulation has wrought. Let’s hope that the companies and regulators can solve the supply shortage before it drags down the state’s economy.