Electricity Pricing Should Clue Consumers to
Judicious Use

By SEVERIN BORENSTEIN
 

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
6 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.

- - -

Severin Borenstein Is the Director of the UC Energy
Institute and a Professor of Business Administration and
Public Policy at UC Berkeley's Haas School of Business

Copyright 2001 Los Angeles Times