NewEnergyNews: Designing A More Flexible 21ST Century Power System

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    Monday, June 22, 2020

    Designing A More Flexible 21ST Century Power System

    FixedBill+ Making Rate Design Innovation Work for Consumers, Electricity Providers, and the Environment

    June 2020 (The Brattle Group and Energy Impact Partners)

    A fixed billing solution that benefits consumers, electricity service providers, and the environment

    A new trend has emerged in residential electricity rate design. Colloquially referred to as subscription pricing or “Netflix pricing,” the approach involves pricing electricity in the same way as a growing number of subscription-based consumer goods. Rather than charging customers based directly on the amount of electricity they consume each month, customers are offered a fixed monthly bill that is guaranteed to remain constant for a specified term (typically a year). Interest in this fixed-bill idea among electricity service providers (including utilities, competitive retail suppliers, and other third parties) was initially driven by the observation that many customers prefer simplicity and freedom from managing their energy use.

    This paper – which reflects the perspectives of researchers from industry, investing, academia, and consulting – presents a compelling opportunity to improve on the conventional fixed bill approach. Our proposal is referred to as FixedBill+. It combines the simplicity of a conventional fixed bill with the flexibility benefits, environmental benefits, and cost savings from energy efficiency (EE) and demand response (DR) programs. Enrollment in FixedBill+ would be contingent on customer acceptance of certain EE and DR measures. FixedBill+ could be offered on an opt-in basis and the fixed bill amount would be individually tailored to each customer’s usage history.

    As a result, our proposed FixedBill+ approach could reduce customer bills relative to today’s typical residential rates, while improving electricity service providers’ profit margins, due to system cost savings resulting from the EE and DR measures. Under the illustrative but plausible assumptions in this paper, customers could expect a 3% (around $40 per year) discount in a FixedBill+ offer, relative to their standard rate. These savings are coupled with complete bill stability – a feature that does not exist in standard volumetric rate offerings. At the same time, FixedBill+ is an opportunity for electricity service providers in regulated and non-regulated markets to improve profit margins. FixedBill+ affords electricity service providers the opportunity to charge a reasonable hedging premium in order to accept the risks that are inherent in a year’s worth of energy supply and demand. The provider could also share in some of the cost savings achieved through EE and DR measures. The result is a win-win for consumers and service providers.

    The environment wins as well. In our illustrative example, 100,000 participants in a FixedBill+ offering could be expected to reduce their energy use by over 1 million MWh.

    For a largely natural gas-based electricity system, that is the carbon equivalent of more than 100,000 gasoline-powered cars being taken off the road for a year. Figure 1 highlights the attributes of FixedBill+ versus those of conventional fixed bills and the standard volumetric rate in which most residential customers are currently enrolled.

    While these illustrative benefits are significant, the devil is in the details for this innovative rate concept. There are still areas of uncertainty. Market research, regulatory innovation, and pilot programs will pave the way for electricity service providers to roll out FixedBill+ at scale. In particular, in order to safeguard the societal benefits of FixedBill+ model, regulators will need to develop appropriate mechanisms to ensure that the right incentives are in place to maximize cost-effective EE and DR. We recommend further work in these areas as a next step toward introducing the FixedBill+ as a new addition to the menu of rate offerings available to consumers.

    Identifying the problems with current rate offerings

    Although the way we generate electricity is changing, and the way we use electricity is changing, the way we pay for electricity has largely remained the same for decades. Recently, though, electricity service providers1 have begun to explore an alternative way to price electricity that may better align with both consumer preferences and the needs of the power system. This new pricing mechanism is commonly referred to as a “fixed bill.”

    At its core, a fixed bill is what it sounds like: a single, flat bill that does not change from month to month based on how much energy you use. For example, you might pay $100 per month regardless of your energy consumption (in kilowatt-hours (kWh)) or your peak demand (in kilowatts (kW)).

    In the past, competitive energy retailers have marketed these types of pricing schemes as “all-you-can-eat” energy plans – targeting customers who wanted to consume lots of power, and were willing to pay a premium to avoid thinking about it. Many consumers are drawn to the predictability and simplicity of these plans, but the concept has drawn sharp criticism from advocates of EE and demand-side flexibility. These advocates point out that fixed bills remove the marginal price signal that efficiently harmonizes supply and demand. Basically, standard fixed bills give consumers no reason to try to conserve.

    In this paper, we present a variation on the conventional fixed bill offering that would still provide the same predictability and simplicity to consumers, while tending to reduce energy costs (both financial and environmental) and giving electricity providers a stake in all of these benefits. We refer to this concept as FixedBill+, with the ‘+’ being vital to making sure that this delicate balance holds.2 Here are the three key elements embedded within that symbol.

    1. Comprehensive energy management FixedBill+ involves a quid pro quo between an electricity consumer, their electricity service provider, and society. In exchange for the convenience and stability of a fixed bill, the consumer must permit the provider to reach beyond the electricity meter, into their home, and take limited control of a set of agreed-upon energy-related functions. For example, FixedBill+ customers might be required to allow their energy provider infrequent control of their home or business HVAC (heating, ventilation, and air conditioning) system, which can be achieved through occasional adjustment of a connected thermostat. This would allow the energy provider to time power use more efficiently to take advantage of natural ebbs and flows in electricity demand. Collectively we will refer to these actions as demand-side management (DSM), which includes both EE and flexible DR.

    2. Periodic adjustments At first blush, there seems to be a dichotomy between fixed billing and variable billing, but there is not. Instead, they should be considered points on a spectrum – a range of timeframes along which an electricity service provider might offer to take on the risk and responsibility for managing energy costs on behalf of a customer. As such, the initial fixed bill offer must be individually tailored to each customer’s historical electricity usage. Of course, no provider can offer to fix a customer’s bill forever, because of the myriad uncontrollable factors that affect the cost of supplying energy and the evolution of customer demand. Imagine, for example, if a fixed-bill customer buys a new electric vehicle (EV), or perhaps even a small fleet of electric space heaters. And even the best DSM portfolio is unlikely to hold back a customer who is truly committed to an all-you-can-eat mentality. So, pricing in a FixedBill+ system will need to rise or fall based on average consumption over some period. For example, the FixedBill+ offer might peg a consumer’s fixed bill for the coming year to the price that it cost to serve that consumer over the preceding year (weather adjusted).

    In addition to restraining customers’ all-you-caneat instincts, these periodic adjustments create an incentive for consumers to invest in long-term efficiency upgrades, such as new, more efficient appliances – for which buying decisions are more difficult for a third-party energy manager to influence. In fact, annual adjustments create an ideal opportunity for the provider and customer to motivate (and finance) major efficiency investments, the same way wireless companies now use contract expiration as an opportunity to re-evaluate each customers’ service package and equipment.

    3. Incentives for energy providers to reduce costs The easiest way for energy providers to profit from a fixed bill is to charge a risk premium above their expected cost to serve each customer. Yet, FixedBill+ will only be a boon for society if energy providers are also incentivized to reduce the actual total cost of service for each customer. That means all of the “upstream” links in the energy value chain – such as wholesale energy markets and distribution utilities – need to pass on truly costreflective signals to the retail level. It also means giving retail energy providers – whether they are utilities, competitive suppliers, or other third parties – a stake in the cost savings.

    The alignment of incentives to reduce costs and carbon emissions, while maximizing electricity provider earnings, is a particularly important dimension of the FixedBill+ proposal. Of course, the regulatory changes required for this alignment differ between areas where customers are serviced by vertically integrated electric providers and areas with retail choice. We will spend some time discussing these differences later in this paper.

    First, it is worth asking: Why care about the fixed bill model at all? And why focus on it now?

    Why fixed billing?

    Two distinct forces in the electricity market are propelling arguments in support of fixed bills. One set of forces is on the supply side of the market; the other, demand.

    STARTING WITH THE SUPPLY SIDE

    At an aggregate level, the generation mix is gradually transitioning from fossil-fuel-based power plants to renewable energy wind and solar plants. This is a key factor because fossil-fuel-based power is affected by variable costs (i.e., price per megawatt-hour, or $/ MWh) dependent on fuel prices, whereas renewable energy plants require substantial up-front investment but have very few costs that can truly be considered variable (because their “fuel” is free). In other words, the cost of the electricity supply is becoming increasingly fixed in the short-to-medium term. Hence, fixed billing will increasingly align with the underlying nature of the cost of energy in this regard.

    Somewhat more urgently, simple per-kWh pricing for the transmission and distribution (T&D) portion of the bill is also becoming a poor mechanism for cost recovery – mostly owing to the growth of distributed generation and the potentially massive changes in electricity demand caused by rooftop solar, distributed energy storage, EVs, and other possible avenues of electrification. The costs of T&D are mostly sunk. In the short-to-medium term they are essentially fixed, much like the costs of renewable energy, while in the longer term they are driven by local peak demand conditions. But these costs have historically been recovered through almost entirely variable rates.

    Our goal with this paper is not to wade into our industry’s ongoing debate about how to compensate distributed generation, or exactly how to balance short-term versus long-term price signals for T&D. However, it is important to note one benefit of FixedBill+ in the context of this debate: It inherently makes price signals to consumers more reflective of the largely sunk nature of T&D costs, while still providing a framework that encourages the cost-effective deployment of distributed energy resources (DER).

    MOVING ON TO THE DEMAND SIDE

    On the demand side, the primary driver of interest in fixed bills is consumer preference. In other aspects of their lives, consumers have come to think of fixed bills as a form of subscription pricing, and they have come to like it. From music, to TV, to razors, many consumers are demonstrating a strong preference for fixed bill pricing schemes for certain types of products. What do these products have in common? Consumers have a fairly consistent, predictable demand for these products, and do not want to spend time thinking about every microtransaction. Electricity fits into that category pretty snugly.

    In some ways, electricity could be an even better fit for ‘subscription’ pricing than music or TV, because consumers tend to enjoy spending time selecting pop songs and prestige dramas much more than they enjoy spending time managing energy costs. In fact, consumers’ general distaste for thinking about their energy consumption is one of the few consistent axioms of the energy industry. Our energy costs today are higher than they ought to be because so many of us value our time more than we do the potential savings or environmental impacts we could achieve.

    Therein lies an important “carrot” for policymakers and regulators in the FixedBill+ model. Properly implemented, it takes the responsibility for DSM off the shoulders of consumers, and places it on sophisticated electricity service providers and regulators. Electricity service providers are paid to find electricity markets fascinating, and they can be motivated to extract small amounts of value from large numbers of consumers.

    Technology makes the “+” possible

    What makes this moment so ripe for experimentation with FixedBill+? One answer is that consumers are increasingly accustomed and attracted to the idea of subscription pricing. But this demand “pull” would not be sufficient on its own. Electricity service providers also need the right technology to make the model work. Today, that technology is available through smart meters, smart energy devices, and DER management systems.

    1. Smart meters

    Meters yielding hourly or sub-hourly interval data have been rolled out to more than half of US households. These meters enable energy providers to calculate the actual cost of service for each individual customer. In non-regulated markets, this hypothetically enables load-serving entities to be billed according to the specific load profile of their individual customers, rather than an average load profile for each customer class. While this practice has not yet been implemented in every market, there is no longer a technical limitation to doing so. For FixedBill+, the importance of this technical capability cannot be overestimated. 3 Disclosure: AutoGrid is an EIP portfolio company.

    2. Smart energy devices

    The cost to make a device “smart” (connected to a network, and running at least basic software applications) has fallen dramatically, so there are now smart options for most major sources of energy demand. Thermostats are the first to achieve lift-off in the market, but other devices are following suit – such as EV chargers, household battery systems, pool pumps, and even hot tub controls. Energy providers can be granted some measure of control over these devices in order to achieve the first and most important tenet of FixedBill+: comprehensive energy management.

    3. DER management systems

    Software tools from companies like AutoGrid3 enable energy providers to manage resources for hundreds of thousands of consumers at once, all coordinated towards the needs of the grid as a whole. And increasingly, the makers of smart energy devices like those described above are building energy management functionality into the devices themselves.

    A recent study by The Brattle Group found that there will be 200 GW of cost-effective load flexibility potential in the US by 2030, worth more than $15 billion annually and driven largely by the technological advancements described above. The FixedBill+ could be one compelling way to unlock that potential. Figure 2 summarizes the factors driving the FixedBill+ opportunity…

    Illustrating the FixedBill+ concept…FixedBill+ business models…

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