Friday, July 29, 2011

Time of Use Rates and "Cherry Picking"

One of the concerns that I have heard expressed by Utilities about implementing Time of Use rates is that customers will "cherry pick" (i.e. those customers who already have advantageous load profiles will adopt TOU rates.)

Of course they will, and you want them to


In an earlier post I referred to an analogy that Paul Centolella used in a blog entry at the Harvard Business Review.  I'm going to use it again, so I'll quote it again:

Today most consumers are charged a flat rate for every kilowatt hour they consume. They are billed monthly. And, despite wholesale power costs that can be as much as ten times higher during peak hours than at other times, consumers have little idea which energy uses cost the most. This would be equivalent to receiving your grocery bill weeks after you visited the market and being charged the same price for each item, whether you bought chewing gum or caviar. {emphasis added}
I'm going to riff a bit on the economic consequences of that last underlined bit.  Of course, "analysis by analogy" is always risky, but bear with my little thought-experiment for a little while.

If everyone pays the same rate for caviar as for chewing gum, and the same price for fillet mignon and hot dogs, and the same price for Dom Perignon and PBR, what's going to happen, just based on Economics 101?

Well, I learned in Econ 101 (which was a looooong time ago) that if a scarce item is priced lower than its scarcity based price, people will buy more of it than they would if it were priced at it's scarcity based price.  Let's look at the consequences for our hypothetical grocery store.  Of course, since we're talking about utility services here, we'll assume that the grocery store has a monopoly on providing a place to shop.

  • People will buy more Dom Perignon, fillet and caviar than they would if those items were priced at a (higher) rate that reflected scarcity.
  • Since the grocery store has to cover all of its costs, that unified cost-per-unit will have to cover all of the costs, resulting in that unit rate being higher than an average of all scarcity-based prices would be (because more of the scarce items are being bought than would be under scarcity pricing.)
  • The people who do buy hot dogs, PBR and chewing gum get the honour of subsidizing the purchases of the greater quantities of fillet, champagne and caviar.
Now, let's look at our "cherry pickers."  The "cherry pickers" are the ones who, in our analogy, are the ones who (a) are buying hot dogs, PBR and gum and (b) are paying attention.  They wise up and cease providing the subsidy.  Are they "cherry pickers" or "thought leaders?"  From the Utility standpoint, they're taking advantage of the fact that they already have a load profile that works well under TOU rates, and not "paying their share," which makes them "cherry pickers."  This is another example of the Utility thinking in terms of "ratepayers" rather than "customers".

From the customer standpoint, they're just responding rationally to economic forces.

What happens when they tell their neighbours (who probably have similar load profiles, but aren't paying attention) "Hey, you can save a bunch of money on TOU rates!"  More people get on TOU rates, reducing the subsidy further.

Okay, so what happens to our composite non-TOU rate?  It goes up, right?  This is bad, right?

Nope.  Uncomfortable, probably unpopular with some, but not bad.

That higher rate creates economic incentive for those who can use less on peak power (can eat less filet and caviar,) but haven't thus far, to make the needed changes, and go on TOU rates.  It isn't until you get to this point that you see changes to peak usage.

Now go the next few iterations: Those who can reduce / move their peak usage do so, as the economic pressures provide incentive.  Who's left on the composite rate?

Those who either can't or won't reduce or move their peak usage.  However, it represents the costs of serving only those who can't or won't change usage.

The next question is: What about those who can't afford the equipment to change their usage, can't change behaviour, and can't afford higher rates?  There are two answers to that:

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