Electricity Consumers Prove Their Smarts

Customers respond to price changes, choice

On Friday I attended an important event in Chicago that shines an optimistic beacon into the stagnant state of electricity policy. The event was the announcement of the first year's results of the Community Energy Cooperative's residential demand response program. This program's results are exciting, and should open our thoughts to a wider range of choices and business models when we think about selling electricity, even to the smallest customers.

Demonstrations that residential customers will respond to electricity price changes are thin on the ground. Common wisdom typically suggests that residential customers are very unresponsive to price changes, and that the price inelasticity of their electric demand would make any residential demand response minimal. In light of this common belief, and in this current state of regulatory limbo and risk aversion, the demonstration of residential demand response from Chicago in 2003 is particularly welcome and refreshing.

The Energy Smart Pricing Plan is a joint effort between the Center for Neighborhood Technology's Community Energy Cooperative and Commonwealth Edison. In its first year, the program had over 750 participants in a variety of neighborhoods and types of homes, from large single-family homes to multiple-unit buildings. Commonwealth Edison provides the hourly prices, on a rate tariff approved by the Illinois Commerce Commission.

The keys to the Energy Smart Pricing Plan are simplicity and transparency in the transmission of information to residential customers. Participants receive a simple interval meter, and can either call a toll-free phone number or visit a website to see what the hourly prices will be on the following day. Furthermore, if the next day's peak prices are going to exceed 10 cents/kilowatt hour, customers receive a notification by phone, email or fax. Customers will never pay a price above 50 cents/kilowatt hour, which the Community Energy Cooperative implemented by buying a financial hedge at 50 cents.

Friday's event included a presentation of the independent evaluator's report on the program. In the first year of the program, customers saved an average of 19.6 percent on their energy bills. They generally joined the program expecting to save $10/month on average, and were not disappointed. Surveys indicate that the participants found the price information timely, and that with this small inducement to save money on their energy bill by making small behavioral modifications, they actually became more aware of their energy use overall, not just in the approximately 30 hours last summer that had higher prices. They also said that their personal contributions toward reduced energy use and improving the environment by participating in this plan really mattered to them.

The most remarkable outcome is that even though it was a mild summer, participants did respond in the few hours that prices rose. Most responded by increasing the temperature on their air conditioners or shifting their laundry time to off-peak hours. The econometric analysis of the results showed a price elasticity of demand in those hours, at the margin, of -4.2 percent. In other words, when price rose by 100 percent, participants reduced their electricity use by 4.2 percent. For residential electricity customers, this is a healthy response, particularly given the lack of severe weather conditions. And that 4.2 percent reduction in use is a reduction at the margin, a margin that can often see prices go up by more than 100 percent in peak hours on hot days. So although the elasticity number may sound low, because it is at the margin and at the right time, it can take strain off of the system and contribute to grid stability and service reliability in those hours. And taking strain off of the grid at the margin in peak hours is crucial, as we saw last August in the Northeast blackout.

Customer response to price changes benefits not only those who respond, but also other customers and the system as a whole. Reducing peak use reduces wholesale market prices and long-run investment requirements that affect all customers, not only those who choose to see price changes. This widespread consequence of customers having the right to say "no" is the most powerful tool for public interest that comes out of demand response.

Utilities can also benefit from such demand response programs. The historic development and regulation of the industry has led to a culture in which the prevailing business model for a utility is "sell more power, make more profit." In this world, utilities are prone to perceive the load reduction that can come from demand response as a direct assault on their profits. But what demand response shows us is that electricity can be sold as a differentiated product according to time, not just as homogeneous electrons. Furthermore, that differentiated product can be priced in ways that reflect the true cost of selling it in that hour.

In other words, demand response opens up the possibility that utilities can make more profit by selling less power. But they have to see it as a viable business proposition, and regulators have to show leadership in enabling utilities to offer their customers a portfolio of contracts from which to choose, even those that include choosing to pay higher prices some of the time.

Customer choice and demand response can also reduce the utility's costs in the long run. Investment in generation and transmission assets is determined by the level of peak demand, and the more extensive programs like the Energy Smart Pricing Plan become across all types of customers, the longer is the timeframe between costly and unpopular investments. Unfortunately, in the current regulatory environment that is based solely on cost recovery and profit as a rate of return on assets, neither the utility nor the regulator has incentives to provide the means for saving on future investment.

Hopefully results from projects like the Energy Smart Pricing Plan will change these counterproductive incentives. Empowering customers to choose when and how they consume and pay for power is good public policy, good for getting the most out of costly investments, and good for the environment.

The Energy Smart Pricing Plan's evaluation report is available here at and I encourage you to read it. Its thorough, quality analysis contributes a lot of insights to the potential for customer choice to improve resource use and electric system reliability.

Lynne Kiesling is an adjunct scholar at Reason Foundation and director of applied energy research at the International Foundation for Research in Experimental Economics.





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