Catalyst with Shayle Kann - With Great Power: Why dynamic rates are gaining momentum

Episode Date: May 28, 2024

This week, we’re featuring a crossover episode of With Great Power, a show produced by Latitude Studios in partnership with GridX. Subscribe on Apple, Spotify, or wherever you get podcasts. Ahmad Faruqui has been researching electricity pricing since the mid 1970’s, when the cost of a kilowatt-hour was flat. But in the 80’s and 90’s, he started working on dynamic pricing – pioneering the concept of time-of-use rates. The big breakthrough for time-of-use rates came during the fallout from the California energy crisis. Later, thanks to the rollout of smart meters, more power providers started experimenting with dynamic rates. Now, new technology is making time-of-use rate design more transparent. This week, Ahmad talks with Brad about why dynamic pricing is gaining momentum among electric utilities – and what makes for good rate design.  On June 13th, Latitude Media and GridX will host a Frontier Forum to examine the imperative of good rate design – and the consequences of getting it wrong. Register at the link in the show notes, or go to latitudemdia.com/events. See you there!

Hey, Catalyst listeners. It is Stephen Lacey, executive editor at Latitude Media. I'm dropping into the feed with a bonus episode for you this week. And this is one of the only places I can say this and know that many eyes will light up. It's an episode about rate design. Actually, it's about a person central to the history of modern electricity rates. An economist named Ahmad Faruqi. Our team at Latitude Studios co-produces a podcast with GridX called With Great Power. We've dropped an episode in to this feed before. It's all about the people. who are pushing change in the power sector. And in this current season, we're working on right now, we've talked with the utility CEO who faced tough decisions about reforming net metering, a power systems expert exploring AI applications, a PG&E strategist looking at new ways to deploy batteries, and more. Now, dynamic pricing impacts everything around us. Ride hailing, airline travel, your Amazon purchases,

and it's absolutely critical for valuing and dispatching distributed resources and promoting efficiency. efficiency, but it hasn't always gone well in practice. So this week, we featured a story of how Ahmad Faruqi became focused on time-of-use electricity pricing after the California energy crisis, and his experience with the good, bad, and ugly of electricity rates in the decades after. And if you like this episode, you're in luck. Amad's going to be joining me live on June 13th at 1 p.m. Eastern alongside Scott Engstrom, who is the co-founder and chief customer officer of GridX. We're going to examine the imperative of good rate design

and the consequences of getting it wrong. You can sign up for that event by clicking the link right in the show notes or go to Latitudemedia.com slash events. And don't forget to subscribe to With Great Power, which you can find anywhere you get your podcasts. Okay, on to the episode. Enjoy.

Back in early 2000, four years after California deregulated its energy supply, electricity prices started soaring. The California Public Utilities Commission says it wants to know what many of us have been asking for weeks. Why have utility bills skyrocketed?

It wasn't known at the time, but new energy traders in the deregulated market were manipulating prices by creating artificial imbalances and supply and demand. By the end of the year, the situation was totally out of control. There were rolling blackouts across the state

and skyrocketing wholesale prices rippled in the neighboring states. It was a complete disaster. From April to December of 2000, we saw an 800% increase and wholesale energy prices. And that was the start of months of rolling blackouts across the state

that put lives at risk and hurt the economy. In the aftermath of the crisis, California restructured its market again. And that new market called for better ways to charge customers for electricity. The California energy crisis of 2000, 2001, shook up the world quite a bit,

the world of electricity. And that's when smart meters began to finally be considered and rolled out. After 20 years studying, dynamic rates, Ahmed Faruqi finally saw an opportunity to test out innovative billion schemes. Unlike analog meters, smart meters could track electricity consumption every hour, which meant utilities could charge different prices each hour based on overall demand. This is a concept known as time-of-use pricing. And California became one of the first states in the country

to do a pricing pilot, a brand-new kind of pricing pilot with 2,500 customers and three utilities working jointly in that pilot along with the two commissions. But the pilot wasn't a hit with customers. They didn't understand why electricity seemed to be getting more expensive, not less. You would keep telling them the price is lower during many hours of the day, but they would say, well, but you're charging me a higher price during the most important time of the day, which is my evening hours, my dinner time, my TV time, my family time. And Ahmed, a trained economist, didn't understand why customers are not responding to the price signals.

So he set out to understand why. I would talk to taxi drivers and waiters and restaurants, the person sitting next to me on a plane, friends, neighbors, and relatives, all of those, and it took another 10 years for us to learn those lessons. This is With Great Power, a show about the people building the future grid today. I'm Brad Langley.

Some people say utilities are slow to change, they don't innovate fast enough. And while that might not always seem like the most cutting-edge industry, there are lots of really smart people working really hard to make the grid cleaner, more reliable, and customer-centric. This week, I'm speaking with Ahmed Faruqi, a former principal at the Brattle group and an expert in rate design. Amid started researching electricity rates in the late 70s, right around the time President Jimmy Carter passed a Public Utility Regulatory Policies Act,

also known as Purpa. The legislation led to time-of-use pricing pilots across the country. We had 16 pricing pilots throughout the U.S., including Puerto Rico, but nobody had smart meters. And so the biggest barrier in the 80s and 90s was the absence of smart meters. But those wouldn't come for another two decades. And during that time, Ahmed continued to research smart rates. And then the California energy crisis happened. Suddenly put pricing in the spotlight. And so smart meters were just a prerequisite to having smart rates.

After he wrapped up the California pricing pilot in 2006, Ahmed joined the Brattle Group, where he worked with utilities across the country and the world on smart rates, until officially retiring in 2021. So I started our interview by asking Ahmed how pricing pilots evolved in the years following the energy crisis. You worked on projects of Maryland, Connecticut, Illinois, Florida, Ontario, lots of places

with different demographics. How did these projects change over the 20 years you worked on? Did you see a steady evolution? I have to say there was definitely some change in those experiments, the pilots, across the different regions, that you mentioned. I also worked on some of these issues internationally.

There was a common thread, though, which is, will customers really want to be on these rates? What do we need to do to customers on the race? Because unless the customers take the rates, it's not going to do anything to peak demand or electricity, costs, etc. The change that came was through a technology, not digital meters, but through electric cars. Electric cars or EVs, as they're called, or the defining moment,

customers finally realize that they can lower their charging cost if they just charge during the off-peak hours, which typically were in the nighttime. So I think now, so this is about five to ten years ago, EVs arrive on the scene, and suddenly there is a customer longing for a lower rate, and the time of use pricing finally came of age, I would say, just about 21 years after the experiment in California.

Do you see another kind of killer application emerging? I know we hear a lot about heat pumps. Do you think heat pumps might have the same impact to kind of get people more towards dynamic pricing? So heat pumps actually came up for discussion about five years ago. I was talking to a person in Illinois who was asking me, can Tom of Hughes prices help promote heat pump penetration?

And I thought hard about it, and I concluded it by itself cannot, because a heat pump, which is both an air conditioner in the summer and a heat source in the winter, will be running precisely when there is a peak situation in the summer or a peak situation in the winter. Actually, it will create a peak demand in the winter that currently doesn't exist. So a heat pump and time of use rates will not necessarily, it won't be a good marriage, so to speak, But what will make a difference, and this is not time of use rates, but it is a marginal cost pricing rate that I have in mind. So what you would do is for a customer who buys a heat pump, you would say we're going to give you a lower price for just using the heat pump. Your bill for everything else will stay unchanged,

but you're adding a new beneficial electrification load. So we're going to price that at marginal cost. And with today's digital technologies and AI, they can easily track how much electricity the heat pump is using. So if the average rate, like for example here in California and the PG&E service area, is 40 cents on average for the typical house, where the heat pump uses it will be 10 cents. And you could add a time of use layer on it too,

but it will be a substantially lower price just for the heat pump. If you pull out your crystal ball, how do you see this influx of DERs continuing to impact rate design? So DERs, by which, I guess for me, energy efficiency is a DER, demand response, or load flexibility is a DER, and so is solar and batteries and electric cars. So all of these new technologies lumped together are DERs. Some of them will raise load growth, EVs and heat pumps, certainly being those two. But then there are other DERs which will lower load growth, like energy efficiency, demand response, and certainly solar.

So what will be the net effect of those is anybody's guess at this point in time. So there are some people who are saying it will lead to incredible low growth. And some are excited about it. They're salivating on the prospects of more revenue coming in. But the customer is equally smart and digital, and they will undertake steps to manage their bill. So I have a hunch. It may cancel out. but it may not cancel out, and right now we are, the crystal ball is very fuzzy.

The other major issue, especially in California, is a duck curve and peak demand in general. Talk a little bit about the nexus of peak demand and dynamic rates. Yes, the duck curve has become more pointed with the passage of time. And if you look at places like Australia or Hawaii, it is even more pronounced. So what we will see happen, let's say with time of use pricing, and maybe, be dynamic pricing as well. Dynamic pricing is just a more sophisticated version of time of use pricing.

In Australia, they have introduced what they call the sponge tariff. And it is basically the off peak period is now in the afternoon, as opposed to at night. And that's what we will begin to see happen, is time of use

pricing will still be there, but the periods will shift from, like, for example, for for PG&E, the peak period, about 30 years ago was from noon to 6 p.m. Then it shifted to 2 to 7 p.m. And now it shifted to 4 to 9 p.m. The peak will keep on going into the later evening, early nighttime hours,

and the off-peak will be in the middle of the day when the sun is shining, and you have a lot of solar generation, both supply side and customer side. Maybe for the benefit of our audience, taking a quick step back, because we're using different terms here, in your expert opinion, What's the difference between time of use pricing and dynamic pricing? The time of use pricing simply means that prices vary across the time periods of a day. So there's a peak period, a mid-peak period, and an half-peak period. They are the same hours every day and they are the same prices every day.

Dynamic pricing says, well, but on 100 to 200 hours of the year, the system, the power system has a critical condition. There might be outages because there's a shortage of supply. And therefore, in those few hours, 100 to 200 hours, we have to have even higher prices. And that's what creates a dynamic price. It's kind of like search pricing that Uber has. So we've seen success of time of use rates across the country. You know, here in California, Southern California Edison, PG&E, SCE even, you know, showed that, you know, you know, time of use rates could shift peak demand.

You know, utilities like PSCG Long Island have rolled out a really successful pilot that leads to bill savings and load shift. And there's so many more examples of utilities that are doing this successfully. Why do you think it's taking so long for the utility industry to adopt dynamic rate structures or TOU rates in mass? It just feels like a no-brainer. What's stopping utilities from doing this? Part of it is cultural inertia.

It's something new and different. They haven't done it. There's also a very strong engineering and financial mindset that is concerned that they will lead to revenue loss. And that concern, by the way, has been there since 1979. Revenue loss. Only the free riders will take these rates, the ones who see immediately a lower bill without taking any action. Even though there is so much empirical evidence that that is not the case. You mentioned PSEG Long Island.

and that is absolutely a sterling example, a successful example. I believe LIPA is doing something very similar also in New York. And in New Jersey, PSENG is introducing optional time of use rates, which I helped design. I testified in that case, one of the exceptions I had in my retirement. So I believe we are beginning to see change happen

that we have not seen in years. Actually, the person who reached out to me from PSE and G, New Jersey, he said to me, we have waited for 10 years to reach out to you. Now you're retired. Now you're ready to do it. Can you please make an exception? So I said, yes, I'll make an exception. And in places like the state of Washington, even in Nova Scotia in Canada, they are,

so people in these new areas still continue to think that their customers are different. So everyone feels the need to do their own pilot, which is fine. but let's not get stuck in doing pilots forever. Let's try to actually move to actual implementation. And my advice is you don't really need to do a pilot because you already have 400 pilots across the globe. People do respond. Not everyone responds, but you don't need everyone responding.

How do we make this simple for customers? How do we give them to understand very complex topics, so they're more inclined to take advantage of these types of programs? I think every customer understands the benefits of a sale. Macy's, Nordstroms, they all have sales. Everyone knows that. Everybody also knows terms like rewards and rebates. People don't like to think about higher prices,

so let's stop emphasizing the higher price. Let's start emphasizing the lower price. And I know there's a bit of a bail-and-switch trap that we could fall into, so we have to do it carefully and honestly. But why should we not lead with the lower price as the attraction? That's what worked with EVs. It worked like a charm. The fact that your charging cost will fall by more than half

if you have off-peak charging. That's what we need to use for all of these innovative new pricing options. Using terms like real-time pricing, terms like locational, marginal cost real-time pricing, I mean, that's guaranteed to fail. While we're talking about different kind of compare and contrast topics, I'd love to get your opinion. A lot of conversation around time of use specifically is opt-in versus opt-out. Maybe spend a few minutes talking about the difference between opt-in and opt-out, and if you fall on one side of the fence for which one you think is better for the industry and for customers.

So for years, I was a big supporter of opt-out pricing. My view was that is the cost of service. Our job is to convince. accurately the cost of service to customers. But what that ignored was the fact that for decades we have had flat rate pricing. And so if you go suddenly to Tom of Use pricing for every customer, in other words, opt-out, that's like a big change. Customers are not going to be ready for it. So if you are interested in doing ultimately cost-based opt-out pricing, do it gradually. begin with opt-in,

begin with word of mouth kicking in, customers saying, hey, this is really good, I'm saving money to their neighbors and friends. Let the opt-in open the road towards opt-out. Don't suddenly go to opt-out. So I support both of them, and you could have both of them at the same time.

You could have an opt-out default rate, which has, let's say, a differential of two to one between peak and off-peak. So off-peak is 50% lower. Or you could say peak is two times higher. That's the default. Don't make it any sharper than that. If you want to have sharper differentials, make them opt-in,

and those opt-in differentials will appeal to people with electric cars and solar. But don't come in with a peak price that is five times higher in your default rate. One utility tried it. Actually, one state tried it in Missouri, and then they rejected it because of the political crisis that they were about to precipitate. We continue to have somewhat of a mindset that, again, is more economic and engineering tinted than customer-focused.

So you can have both, but you have to have different price ratios. So what's the optimal recipe for good dynamic rate design? What are those key components that will lead to success? Keep the peak period short. Make sure the off-peak savings are considerable. Make sure you educate an informed, customers and what actions they need to take to benefit from the rate. And if you want,

offer both opt out, mildly differentiated rate like a two to one ratio and opt in with a five to one ratio. Give them choices. Don't be stuck on just one rate. I think giving choices is the biggest lesson we have from working on this for years and years. As you know, no two customers are alike. I mean, even within the same house, you'll find the spouses have different preferences, and neighborhoods have different preferences. So give them choices. You've mentioned a couple utilities during our conversations of examples of how this is successful. What utilities or states do you think are getting this right, these innovative new rate structures? And if you're so inclined to put on your controversial hat, who has struggled? Are there certain states or utilities that have

struggled more so than others. So the ones that have succeeded, I mentioned SMUD, you mentioned PSCG, Long Island. There are a few others as well. Oklahoma Gas and Electric, actually, about 10 years ago, I discovered that Oklahoma was ahead of California when it came to dynamic pricing, and thankfully they hired me to help them out on a couple of issues, so I went there. And what I discovered was the reason they were successful is because they talked the customer's language. had videos, they even had murals on their headquarters building showing four different families and how they're living their life with dynamic pricing rates. So that made a huge difference. Paying attention to the customer makes a difference. Doing it gradually makes a difference.

And having the right kind of rate design also makes a difference. Those are good examples. The ones that didn't work out were either the ones. that did it too quickly whose rates were unfriendly, the peak period was very long, or the peak price and the off-peak price didn't differ much at all. And so even though the customer shifted load, expecting to save money, they ended up not saving much.

This was Puget Sound Energy in the state of Washington. Again, 20 years ago, they rolled it out to 300,000 customers as an opt-out time-of-use rate. but the differential was just 30% between peak and off-peak. A year later, when customers got their shadow bills, showing how much they had saved, most of them had saved just about nothing. And one person was quoted in the Seattle Times. She said, I shifted half my load from the peak to the off-peak period

because that's what the utility asked me to do. And here's what I end up paying is just more, not less, despite the shifting. Who knows what the story was. But those kinds of setbacks, I think we have learned from them. Puget Sound itself has learned from them. They have a new pilot. I was part of their pilot, and they showed good results. I don't know what the next steps are.

But I believe people are learning by doing. How do you expect to see rates change in the next few years? Will the democratization of power generation or the distributed grid kind of push more utilities to adopt these modern race structures, whether dynamic pricing or TOU or, or others? Absolutely. I think the culture has changed. Part of it is a demographic. New generation of people are coming into the utilities and the commissions. And also the customers are now, the millennials and so on, very different preferences. They want choices, they want more green power, and they want more control over their energy lifestyle. Plus, they're acquiring these new

technologies, all the DERs that we have been discussing. Small is beautiful. Emphasis is shifting from the power plants to the consumers all around, and therefore, rates will have to change. And if they don't change those utilities, they don't change them, they'll go bankrupt. So we call this show With Great Power, which is a nod to the power industry. It's also a famous Spider-Man quote, with Great Power comes great responsibility. So tell us, what superpower do you bring to the energy industry?

I don't think I bring much personally to the energy industry other than lessons learned. I have made every mistake possible. And yes, I have changed my views on certain topics. But I think we learned by doing. And I think I'm a living example of that. Some people don't like the new positions that I have in many issues, but that's the new life that we all have to live. We can't just be, as I put it, rigid like an ox.

Well, Ahmed, you are a rate design expert and rock star. and I appreciate you coming on the show with us. Thank you very much. Brad, it was a pleasure. Ahmed Faruqi is a freelance economist and former principal at the Brattle Group. With Great Power is produced by GridX in partnership with Latitude Studios. Delivering on the clean energy future is complex. GridX exists to simplify that journey. GridX is the enterprise rate platform that modern utilities rely on to usher in our clean energy future.

We design and implement emerging race structures, and we increase consumer investment in clean energy, all while managing the complex billing. needs of a distributed grid. Our production team includes Aaron Hardick and Mary Catherine O'Connor, and Bailey is our senior editor. Stephen Lacey is our executive editor. The original theme song is from Sean Marquant, Roy Campanella mixed the show.

And the grid X production team includes Jenny Barber, Samantha McCabe, and myself, Brad Langley. If this show is providing value for you, and we really hope it is, we'd love if you could help us spread the word. You can rate a review app on Spotify, or you can share a link with a friend, colleague, or the energy nerd in your life. As always, thanks for listening. I'm Brad Langley.