“Electricity Retail Rate Design in a Decarbonizing Economy: An Analysis of Time-of-Use and Critical Peak Pricing”
Paul Joskow (Massachusetts Institute of Technology), Dharik Mallapragada (Massachusetts Institute of Technology), Tim Schittekatte* (Massachusetts Institute of Technology/European University Institute), and Richard Schmalensee (Massachusetts Institute of Technology)
Currently, most U.S. electricity consumers pay a constant price per kWh consumed that accounts for most of their bills. Ongoing developments in the power system, both on the supply and demand sides, increase efficiency gains that can be made from exposing consumers to widely varying wholesale spot prices. This is not popular; consumers (and politicians) value predictability and bill stability. We focus on second-best alternatives: time-of-use (TOU) and critical peak pricing (CPP). TOU rates are predefined, e.g., at least a year ahead, and calibrated on historical price data. Typically, the TOU prices differ by season, type of day (workdays or weekends), and/or time of the day (e.g., peak, shoulder, or off-peak). CPP is designed to induce reductions in consumption during moments of systems stress, either via short-notice price hikes or via consented remote load control. We assess these second-best rate designs using alternative criteria tailored to decarbonizing power systems with high volumes of intraday shiftable loads. For our analysis, we use historical data from CAISO, ERCOT, and ISO-NE (as a control) between 2011-2020. We find that while out-of-sample TOU rates are not fit to mimic absolute spot price levels, they can rather well replicate relative spot price differences (measured using the daily Spearman rank correlation between out-of-sample TOU rates and spot prices). Simulations confirm that as TOU rates can reasonably replicate relative spot price differences, they perform well at approximating the load-shifting incentives provided under spot pricing (up to 60-70% of the potential). The same simulations also illustrate the complementarity of TOU with CPP, needed to induce additional demand response during rare but important scarcity price events. We argue that TOU rates, especially when complemented with CPP via direct load control, can be considerably more socially valuable than previously estimated.