Real-time pricing for all customers as soon as possible Requires real-time metering technology

1. Solutions to California’s Energy Crisis: Real-Time PricingbyFrank WolakChairman, Market Surveillance CommitteeMarch 17, 2001

2. Solutions to current problem at State Level Real-time pricing for all customers as soon as possible Requires real-time metering technology Commercial and industrial consumers--large saving per customer Residential and small business--large savings in aggregate All customers have opportunity to reduce energy bill if they respond to prices No need to consume less energy, could consume more Example: Two periods, two prices: $10/MWh and $100/MWh Consumer purchase 1/2 MWh in each period, Total bill is $55 Consumer shifts 1/4 MWh from high price to low price period Total bill becomes, $32.50 Suppose consumer is currently paying $20/MWh Pay this consumer $15/month for taking on real-time price risk If price-responsive, then bill is $17.50 = $32.50 - $15.00 If not price-responsive, then bill is $40.00 = $55 - $15.00

3. Solutions to current problem at State Level • Real-time pricing is feasible for all large commercial and industrial customers by this summer • For all customers with peak demand above 200 KW • State must act fast through an emergency order • Can set different monthly payments for taking of real-time price risk • Set payment for each type of customer to create potential for lower bill if customer is price responsive • Research results from other markets can be very useful (UK experience described later in slides) • Real-time pricing creates win-win situation • California taxpayers pay less for electricity • California consumers pay less for electricity • Consider example from previous slide • Without real-time pricing, consumer pays $20 and California taxpayers pay $35 = $55 - $20 = Wholesale energy purchases - revenues collected from consumer • With real-time pricing, consumer pays $17.50 and California taxpayers pays $15 to consumer to take on real-time price risk

4. Solutions to current problem at State Level • Why real-time pricing makes sense? • Safe to assume that retail revenues plus payments by State government must exceed wholesale purchase costs • Two groups pay for wholesale purchases • California taxpayers • California ratepayers • Virtually every California resident is member of both groups • Without real-time pricing, even with single State buyer there still no price elasticity in aggregate demand and high spot price remains • Increased tax revenues must be collected from California consumers • No way for taxpayer to avoid paying higher wholesale price for power • California taxpayers pay large blue box on next slide • With real-time pricing, all customers have opportunity to reduce their total payments and wholesale energy prices through there actions • California taxpayers pay smaller green box on next slide • California consumers purchase less electricity

5. Real-Time Pricing versus Tax Revenue Financing Price Supply Price Responsive Demand PID Tax Revenue Payments PPR Pretail Inelastic Demand Quantity QID QPR

6. Solutions to current problem at State Level • Why real-time pricing makes sense? • Significant commitment to real-time pricing for this summer and next summer will allow to state to obtain lower prices in forward contract negotiations • Generators will recognize that effects shown on previous slide will operate to reduce spot prices and demand, particularly during high load periods • This implies that spot market prices will be lower this summer and next summer than they would be in the absence of significant real-time pricing • The lower spot prices that will result from a significant commitment by the state to real-time pricing will create a lower opportunity cost to a generator signing a forward contract for the next two years • Consequently, generators will be more likely to sign forward contracts for the next two years at lower prices than they would in the absence of a large commitment by the state to real-time pricing • This is major benefit to immediate and significant commitment by the state to • real-time pricing

7. Real-Time Pricing not Time-of-Use Pricing Time-of-use pricing does not create win-win situation for California taxpayers and consumers Time-of-use pricing provides limited signals to consumers to respond to real-time wholesale prices Time-of-use pricing creates the same basic incentives as current rate-freeze billing scheme Time-of-use pricing may not yield lower average spot electricity prices or increase incentives for generators to sign low-priced forward contracts Time-of-use pricing creates similar incentives to those from load-profile billing

8. Residential electricity pricing Load-profile billing • Can only measure total monthly consumption of electricity • Representative load shape used to compute weighted-average energy price for month • Monthly bill = (monthly consumption) x (monthly weighted-average energy price) • Demand reduction when hourly energy price is $0/MWh leads to same monthly savings as same demand reduction when hourly price is $250/MWh. • Want consumer to realize maximum benefit from reducing consumption when wholesale price is highest • Real-time pricing is the only way to guarantee this will occur • With time-of-use pricing limited or no incentive for this to occur

9. Limited Benefits of Restructuring Without Involving Demand • US has privately-owned, profit-maximizing firms facing cost-of-service price regulation or incentive regulation plan • Detailed prudence review of investment • Hard to argue there are large deviations from minimum cost production • Vertically integrated ownership and centralized dispatch should be able to improve on bid-based dispatch on true production cost basis

10. Markets use prices to allocate scarce resources • Competitive market should be able to get by with lower level of capacity and serve same customers • This implies lower capacity costs for market at large • If dispatch costs are close to the same, then average price in competitive market should be less than average price in regulated market • A necessary condition for this to occur is a sufficient number of price-responsive consumers

11. Optimal Capacity Choice Under Regulation versus Competition Kreg >> Kcomp

12. Example--US Airline Industry • Load Factors = (Seats Filled)/(Seats Total), • In regulated regime highest load factors approximately 55% in 1976 • Currently Load Factors are close to 73% • This increased capacity utilization rate allows real average fare per passenger-mile to be significantly less than under regulated regime • Regime works because of large number of sophisticated price-responsive consumers.

13. Real-time pricing contracts • All England and Wales retail customers have option to purchase hourly consumption according to hourly pool price plus transmission charge • Many large industrial customers purchase according to this pool price contract • “Estimating the Customer-Level Demand for Electricity Under Real-Time Market Prices” Patrick and Wolak • Estimate half-hourly price responsiveness of a sample of large industrial and commercial customers in England and Wales • Significant price response from all classes of industrial customers--water suppliers, industrial process plants, retail stores • Even with a small fraction of these customers bidding into demand side of pool, market power can be mitigated.

14. Qd . Qd(p) 1 2 3 4 5 6 7 8 9 10 Quantity Market Power Problems withoutPrice-Responsive Demand Price