By Elizabeth B. Stein

Today, most residential electricity customers are charged the same price regardless of when the electricity is actually being used. Charging customers a uniform price for electric service looks a bit like buying groceries by the cart instead of by the items purchased (e.g., apples versus filet mignon) – simple, to be sure, but so riddled with inefficiencies that no one would actually propose operating a supermarket that way. A cartful of filet mignon may weigh the same as a cartful of apples, but the value of these items and the cost of bringing them to market is drastically different. Similarly, electricity costs differ depending on the time of day power is produced and delivered.

Time-variant electric pricing addresses this issue by charging customers different prices depending on when electricity is used, reflecting the true costs of producing and delivering electricity. This gives customers greater control over their electricity bills by allowing them to reduce their energy use at higher-cost times. A recent blog post by my colleague, economist Beia Spiller, explained how time-variant electricity pricing can benefit customers, utilities, and the environment, and described several different types of time-variant pricing.

Given its compelling economics, one would think time-variant pricing would be widespread. Part of the reason it’s not is sheer inertia, but there’s more to it than that.

What would it take to fix this?

Changing the paradigm, first and foremost, requires technology that supports a more specific pricing signal. The most straightforward approach entails widespread introduction of advanced, or smart, meters, which collect detailed electricity use data.

Traditional electricity meters measure the gross amount of electricity that passes through them from the time they are plugged in until they are taken out of service. Typically, about once a month, a reading is taken and the difference between each reading and the prior reading is deemed to be the amount of electricity used for the billing period. The bill is calculated by multiplying this amount by rates that stay consistent throughout the billing period. In order to apply different prices during different times within the same billing period, you need a meter that can distinguish among these sub-periods, or ‘intervals.’ The more targeted you want the pricing to be, the smaller the intervals need to be. Simply put, time-variant utility rates cannot exist without this technological prerequisite.

The good news is we’re making progress. According to a recent federal report, slightly more than 30 percent of residential customers have advanced meters. The bad news is that having the right meters is not enough. As discussed in a blog post on Energy Exchange and a recent article in the Washington Post, the presence of smart meters doesn’t automatically mean time-variant pricing is available. Introducing time-variant pricing requires the utility company to have complementary technology, such as modern billing systems capable of calculating and delivering complex bills to residential customers.

But, we’re still not there yet. Even if we have all those components in place ­– advanced meters and related technologies, complex billing systems, and time-variant prices – adoption of time-variant pricing might still remain low. Customers are often given the opportunity to opt in to time-variant pricing programs, rather than being charged time-variant prices with the opportunity to opt out. This type of choice structure invariably leads to low adoption rates of the non-default option – not just with time-variant pricing, but with a host of other types of decisions, such as organ donation. This structure makes design and deployment of time-variant pricing much more challenging.

What stands in the way of getting all the pieces in place?

As discussed above, smart meter saturation is insufficient to transform the marketplace, but there are other barriers as well. For starters, utility regulators may not be convinced advanced metering and related technologies would be cost-effective. The widespread rollout of smart meters might make the most economic sense in the long run, by making the entire energy system more efficient and avoiding use of the most expensive power, but not all regulators are certain about this outcome before the transformation has begun to occur.

In addition, developing a menu of time-variant pricing challenges the longstanding utility business model. Traditionally, electricity rates are set by regulators in a way that gives the utility the opportunity to profit on infrastructure investments it makes, while also ensuring safe and reliable electric service. With time-variant pricing, utilities and regulators find it difficult to fairly allocate the costs of earlier infrastructure investments among customers with different usage habits, while still providing prices that reward customers who use energy at less costly times. Moreover, since time-variant pricing may reduce a utility’s future infrastructure costs, and thus squeeze its opportunity to earn profits, utilities may be reluctant to move in this direction without other opportunities to profit.

Do customers want to fix this?

Customers who have never had access to time-variant pricing may not know how to begin to think about this prospect. However, one of the most encouraging harbingers for change is that in the areas where customers have actually experienced robust time-variant pricing regimes, they have responded quite favorably. A time-variant pricing pilot conducted by the Sacramento Municipal Utility District showed not only do study participants report high levels of satisfaction with the programs, but in some cases, they are more likely to perceive the prices they are charged as fair compared to those customers who have flat pricing. Moreover, low-income participants, who are often thought to be at greater risk from a change in rates than other communities, showed higher-than-average acceptance of time-variant pricing.

In a world where flat electricity prices are the default, achieving even moderate levels of time-variant pricing adoption requires prices be designed, deployed, and communicated in a manner that makes them so attractive people will overcome inertia and choose them over more familiar offerings. Better pricing is key to a better functioning electricity market, paving the way to a low-carbon future.