Real-Time Pricing and Demand Side Participation in Restructured Electricity Markets

This chapter presents some results of an econometric analysis (developed in Patrick and Wolak 2001b) of customer-level demands for electricity of large and medium-sized industrial and commercial customers purchasing electricity under half-hourly spot prices and demand charges coincident with system peaks in the England and Wales (E&W) electricity market. These estimates can be used to forecast customer-level price responsiveness, design alternative time-of-use and fixed retail pricing options, and develop demand side bids. Here, we focus on how customers respond to real-time prices and how this response can be used in designing demand side bids. A significant price response in the market price determination process will reduce the magnitude and volatility of spot prices in restructured electricity markets. Day-ahead price elasticity estimates vary substantially by time-of-day, industry, and firms within industries; with sample mean averages ranging from essentially zero to 0.86 in absolute value. Regardless of demand side bids, real-time pricing customers in the E&W market can significantly reduce their electricity costs relative to fixed price contracts. 1.0 Introduction All of the wholesale electricity markets operating in the US and abroad lack the price-responsive wholesale demand necessary to achieve the full benefits of a competitive market. Without a significant fraction of final demand responding to the half-hourly or hourly wholesale price, load-serving entities cannot credibly submit demand-side bids into the half-hourly or hourly spot market for wholesale electricity. These demand-side bids can increase the incentive generators have to bid willingness to supply curves closer to their true marginal cost curve, and therefore set wholesale electricity prices closer to the perfectly competitive market price. Throughout the US, very few retail consumers face prices that vary with the halfhourly or hourly wholesale price of electricity. For this reason, these customers have no incentive to reduce their consumption during hours when the wholesale price of electricity is extremely high and substitute into hours when the price is very low. Because they pay according to the same fixed price regardless of the current wholesale price of electricity, any incentive is to reduce consumption is when it is lowest cost to them, not when it is most beneficial to the efficient operation of the transmission grid. Retail pricing schemes that do not vary with hourly system conditions result in a virtually inelastic hourly demand for electricity. This can have adverse consequences for system reliability and increase the incentive generators have to withhold capacity from the market to drive up the prices, particularly during peak demand periods. Final customers purchasing according to real-time prices imply a price-responsive wholesale electricity demand for electricity and ancillary services. These customers benefit retailers and all other consumers because their actions reduce the level and variability of spot market prices. This, in turn, decreases the prices that all customers must pay for fixed-price forward contracts for electricity deliveries. The ultimate success of electricity industry restructuring depends on formulating market rules which encourage all customers to manage real-time price risk either through forward contract purchases or by managing their consumption in real-time in response to half-hourly or hourly wholesale prices. This chapter presents the results of an econometric analysis of the customer-level demand for electricity of large and medium-sized industrial and commercial customers purchasing electricity under half-hourly spot prices and demand charges coincident with system peak in the England and Wales (E&W) electricity market. These customer-level demand estimates can be used to forecast customer-level price responsiveness, and design alternative time-of-use and fixed retail pricing options. This chapter summarizes some of the results developed in Patrick and Wolak (2001b). In particular, we focus on how customers respond to real-time prices and how this response can be used in designing demand side bids. First, we present some background on the E&W electricity market and describe the pool-price contract under which customers purchase electricity according to the half-hourly spot price of electricity. 2.0 The England and Wales electricity market March 31, 1990 marked the beginning of an evolving economic restructuring of the electric utility industry in the United Kingdom. This process privatized the government-owned Central Electricity Generating Board and Area Electricity Boards and introduced competition into the generation and supply sectors of the market. In England and Wales, the Central Electricity Generating Board, which prior to restructuring provided generation and bulk transmission, was divided into three generation companies and the National Grid Company (NGC). National Power and PowerGen took over all fossil fuel generating stations, while nuclear generating plants became the responsibility of Nuclear Electric. The twelve Regional Electricity Companies (RECs) were formed from the Area Electricity Boards, which provided distribution services and retail electricity to final consumers. NGC maintains the transmission network, manages the spot electricity market, and coordinates the transmission and dispatch of electricity generating units. This basic market structure has served as the template for all electricity industry re-structuring worldwide. That is, competition is generally viewed as feasible for structurally or functionally separated firms generating (wholesale) and/or supplying (retail) electricity, while network services (transmission and distribution) are most efficiently provided by regulated monopolies for a single geographic areas. RECs are required, with compensation for distribution services provided, to allow competitors to transfer electricity over their systems. The RECs' electricity supply prices for all customers with no alternative choice of suppler (so called franchise customers) were regulated by RPI X + Y, where Y is an adjustment factor which passes-through