After fifty years, time-of-use rate tariffs are gaining traction

After almost half a century of endless pilots, utilities are permanently implementing time-of-use rates. 

After the passage of President Jimmy Carter’s Public Utilities Regulatory Policies Act in 1978, utilities across the U.S. experimented with different pricing schemes for electricity throughout the 80s and 90s. But customers didn’t respond to the price signals, said Ahmad Faruqui, an economist and expert on rate design.   

At the time, Faruqui was a researcher for the Electric Power Research Institute, where he analyzed 16 pricing pilots across the U.S. and Puerto Rico. The results were surprising. In theory, the concept of charging customers more while demand was highest would reduce strain on the grid — but in practice, it didn’t.

It took the fallout from the California energy crisis in the early 2000s to foster a major breakthrough for time-of-use pricing. The wholesale cost of electricity rose 800% during the height of the crisis, leaving Californians fuming over their bills and regulators committed to building a better market. The resulting market restructuring led to the first major rollout of smart meters in California.

“California became one of the first states in the country to do… a brand new kind of pricing pilot,” said Faruqui during an interview on the With Great Power podcast.

The pilot tested time-of-use rates with 2,500 customers across three utilities, and hinged on the ability of the new meters to track energy consumption hourly. But Californians didn’t respond the way regulators and utilities had hoped.

“We would keep telling them the price is lower during many hours of the day,” said Faruqui. “But they would say, well, but you're charging me a higher price during the most important time of the day, which is my evening hours.”

Faruqui said a real breakthrough didn’t come for another 20 years when the first electric vehicles hit the distribution grid: “About five to 10 years ago, EVs arrived on the scene, and suddenly there was a customer longing for a lower rate, and the time-of-use pricing finally came of age.” 

Customers realized they could lower their charging cost if they charged at night, or off-peak, said Faruqui. This realization led to Californians shifting their energy consumption off traditional peak hours in the early afternoon. 

“For PG&E, the peak period about 30 years ago was from noon to 6 p.m.,” said Faruqui. But as behaviors changed, “it shifted to 2 to 7 p.m., and now it's 9 p.m.” 

The trend lowered energy bills and gave renewables a boost. “The peak will keep on going into the later evening, early nighttime hours, and the off peak will be in the middle of the day when the sun is shining, and you have a lot of solar generation,” said Faruqui. 

Still, “cultural inertia,” as Faruqui calls it, has nonetheless kept many utilities from implementing time-of-use rates.

But there is beginning to be movement: “I believe we are beginning to see change happen that we have not seen in years,” he said, citing projects at PSEG Long Island and NYPA as successful examples.

And Faruqui has shifted his mindset about mandatory time-of-use rates, or so-called “opt-out” programs, since he first started researching the concept.

“For years, I was a big supporter of opt-out pricing," he said. "What that ignored was the fact that for decades we have had flat rate pricing, and so if you go suddenly to time-of-use pricing for every customer…that's a big change. Customers are not going to be ready for it." 

Now Faruqui believes in a combination of opt-in and opt-out programs. He said because opt-in programs are voluntary and customers have to actively enroll, the ratio of on peak to off peak can be something like 5:1. But for opt-out programs, where customers have to actively leave the program, the ratio should be closer to 2:1. 

Ultimately, good rate design comes down to a few key principles, he said: “Keep the peak period short. Make sure the off-peak savings are considerable. Make sure you educate and inform customers on what actions they need to take to benefit from the rate.”

And the most important principle: give customers choices.

“Don't be stuck on just one rate," he said. "I think giving choices is the biggest lesson we have from working on this for years and years…no two customers are alike,” he said. 

For the full conversation with Ahmad Faruqui on effective rate design, listen to his interview on season 3 of With Great Power.

Interested in learning more about how utility rate design could make or break the energy transition? Join Ahmad Faruqui, Scott Engstrom of GridX, and Stephen Lacey of Latitude Media for a Frontier Forum focusing on the importance of good rate design – and the consequences of getting it wrong. The online event is on June 13 at 12pm ET. Register for free.

With Great Power is a show about the people building the future grid, today. It's a co-production of GridX and Latitude Studios. Subscribe on Apple, Spotify, or anywhere you get your shows.

Transcript

Brad Langley: Back in early 2004 years after California deregulated its energy supply, electricity prices started soaring.

News anchor 1: The California Public Utilities Commission says it wants to know what many of us have been asking for weeks. Why have utility bills skyrocketed?

Brad Langley: It wasn't known at the time, but new energy traders in the deregulated market were manipulating prices by creating artificial imbalances in supply and demand. By the end of the year, the situation was totally out of control. There were rolling blackouts across the state and skyrocketing wholesale prices rippled into neighboring states. It was a complete disaster.

News anchor 2: From April to December of 2000, we saw an 800% increase in wholesale energy prices, and that was the start of months of rolling blackouts across the state that put lives at risk and hurt the economy.

Brad Langley: In the aftermath of the crisis, California restructured its market again and that new market called for better ways to charge customers for electricity.

Ahmad Faruqui: The California energy crisis of 2000, 2001 shook up the world quite a bit, the world of electricity, and that's when smart meters began to finally be considered and rolled out.

Brad Langley: After 20 years studying dynamic rates, Ahmad Faruqi finally saw an opportunity to test out innovative billing schemes. Unlike analog meters, smart meters could track electricity consumption every hour, which meant utilities could charge different prices each hour based on overall demand. This is a concept known as time of use pricing.

Ahmad Faruqui: And California became one of the first states in the country to do a pricing pilot, a brand new kind of pricing pilot, with 2,500 customers and three utilities working jointly in that pilot along with the two commissions.

Brad Langley: But the pilot wasn't a hit with customers. They didn't understand why electricity seemed to be getting more expensive, not less.

Ahmad Faruqui: You would keep telling them the price is lower during many hours of the day, but they would say, "Well, but you're charging me a higher price during the most important time of the day, which is my evening hours, my dinner time, my TV time, my family time."

Brad Langley: And Ahmad, a trained economist, didn't understand why customers are not responding to the price signals. So he set out to understand why.

Ahmad Faruqui: I would talk to taxi drivers and waiters in restaurants, the person sitting next to me on a plane, friends and neighbors and relatives, all of those, and it took another 10 years for us to learn those lessons.

Brad Langley: This is With Great Power, a show about the people building the future grid today. I'm Brad Langley. Some people say utilities are slow to change, they don't innovate fast enough, and while that might not always seem like the most cutting edge industry, there are lots of really smart people working really hard to make the grid cleaner, more reliable and customer-centric. This week I'm speaking with Ahmad Faruqi, a former principal at The Brattle Group and an expert in rate design. Ahmad started researching electricity rates in the late 70s, right around the time President Jimmy Carter passed a Public Utility Regulatory Policies Act, also known as PURPA. The legislation led to time of use pricing pilots across the country.

Ahmad Faruqui: We had 16 pricing pilots throughout the US, including Puerto Rico, but nobody had smart meters. And so, the biggest barrier in the '80s and '90s was the absence of smart meters.

Brad Langley: But those wouldn't come for another two decades. And during that time, Ahmad continued to research smart rates. And then, the California energy crisis happened.

Ahmad Faruqui: Suddenly put pricing in the spotlight. And so, smart meters were just a prerequisite to having smart rates.

Brad Langley: After he wrapped up the California Pricing Pilot in 2006, Ahmad joined The Brattle Group where he worked with utilities across the country and the world on smart rates until officially retiring in 2021. So I started our interview by asking Ahmad how pricing pilots evolved in the years following the energy crisis.

You worked on projects in Maryland, Connecticut, Illinois, Florida, Ontario, lots of places with different demographics. How did these projects change over the 20 years you worked on them? Did you see a steady evolution?

Ahmad Faruqui: I have to say there was definitely some change in those experiments, the pilots across the different regions that you mentioned. I also worked on some of these issues internationally. There was a common thread though, which is will customers really want to be on these rates? What do we need to do to customers on the rates? Because unless the customers take the rates, it's not going to do anything to peak demand or electricity cost, et cetera.

The change that came was through a technology. Not digital meters, but through electric cars. Electric cars or EVs as they're called, or the defining moment. Customers finally realized that they can lower their charging cost if they just charge during the off-peak hours, which typically were in the nighttime. So I think now, so this is about five to 10 years ago, EVs arrive on the scene and suddenly there is a customer longing for a lower rate. And the time of use pricing finally came of age, I would say just about 21 years after the experiment in California.

Brad Langley: Do you see another killer application emerging? I know we hear a lot about heat pumps. Do you think heat pumps might have the same impact, to get people more towards dynamic pricing?

Ahmad Faruqui: So, heat pumps actually came up for discussion about five years ago. I was talking to a person in Illinois who was asking me, "Can time of use prices help promote heat pump penetration?" And I thought hard about it and I concluded it by itself cannot because a heat pump, which was an air conditioner in the summer and a heat source in the winter, will be running precisely when there is a peak situation in the summer or a peak situation in the winter. Actually, it'll create a peak demand in the winter that currently doesn't exist.

So, a heat pump and time of use rates will not necessarily, it won't be a good marriage so to speak, but what will make a difference, and this is not time of use rates, but it is a marginal cost pricing rate that I have in mind. So, what you would do is for a customer who buys a heat pump, you would say, "We're going to give you a lower price for just using the heat pump. Your bill for everything else will stay unchanged, but you're adding a new beneficial electrification load. So we are going to price that at marginal cost." And with today's digital technologies and AI, they can easily track how much electricity the heat pump is using.

So if the average rate, like for example here in California in the PG&E service area is 40 cents on average for the typical house, for the heat pump, usage will be 10 cents. And you could add a time of use layer on it too, but it'll be a substantially lower price just for the heat pump.

Brad Langley: If you pull out your crystal ball. How do you see this influx of DERs continuing to impact rate design?

Ahmad Faruqui: So DERs, by which I guess for me energy efficiency is a DER, demand response or load flexibility is a DER, and so is solar and batteries and electric cars. So all of these new technologies lumped together are DERs. Some of them will raise load growth, EVs and heat pumps certainly being those two. But then there are other DERs which will lower load growth, like energy efficiency, demand response, and certainly solar.

So, what will be the net effect of those is anybody's guess at this point in time. So, there are some people who are saying it'll lead to incredible load growth and some are excited about it, they're salivating on the prospects of more revenue coming in. But the customer is equally smart and digital and they will undertake steps to manage their bill. So, I have a hunch it may cancel out, but it may not cancel out. And right now, the crystal ball is very fuzzy.

Brad Langley: The other major issue, especially in California, is a duck curve and peak demand in general. Talk a little bit about the nexus of peak demand and dynamic rates.

Ahmad Faruqui: Yes, the duck curve has become more pointed with the passage of time, and if you look at places like Australia or Hawaii, it is even more pronounced. So, what we will see happen, let's say with time of use pricing and maybe dynamic pricing as well. Dynamic pricing is just a more sophisticated version of time of use pricing.

In Australia, they have introduced what they call the sponge tariff, and it is basically the off-peak period is now in the afternoon as opposed to at night. And that's what we would begin to see happen is time of use pricing will still be there, but the periods will shift from, like for example, for PG&E, the peak period about 30 years ago was from noon to 6:00 p.m. then it shifted to 2:00 to 7:00 p.m. and now it's shifted to 4:00 to 9:00 p.m. The peak will keep on going into the later evening, early nighttime hours, and the off-peak will be in the middle of the day when the sun is shining and you have a lot of solar generation, both supply side and customer side.

Brad Langley: Maybe for the benefit of our audience, taking a quick step back using different terms here. In your expert opinion, what's the difference between time of use pricing and dynamic pricing?

Ahmad Faruqui: Time of use pricing simply means that prices vary across the time periods of a day. So there's a peak period, a mid-peak period, and an off-peak period. They're the same hours every day and they're the same prices every day. Dynamic pricing says, "Well, but on 100 to 200 hours of the year the system, the power system, has a critical condition." There might be outages because it's a shortage of supply and therefore in those few hours, 100 to 200 hours, we have to have even higher prices. And that's what creates a dynamic price. It's kind of like surge pricing that Uber has.

Brad Langley: So, we've seen success of use rates across the country. Here in California, Southern California, Edison, PG&E, SCE even, showed that time of use rates could shift peak demand. Utilities like PSEG Long Island have rolled out a really successful pilot that leads to bill savings and load shift, and there's so many more examples of utilities that are doing this successfully.

Why do you think it's taking so long for the utility industry to adopt dynamic rate structures or TOU rates en masse? It just feels like a no-brainer. What's stopping utilities from doing this?

Ahmad Faruqui: Part of it is cultural inertia. It's something new and different. They haven't done it. There's also a very strong engineering and financial mindset that is concerned that there will lead to revenue loss. And that concern, by the way, has been there since 1979. Revenue loss, only the free riders will take these rates, the ones who see immediately a lower bill without taking any action, even though there is so much empirical evidence that that is not the case.

You mentioned PSEG Long Island. That is absolutely a sterling example, a successful example. I believe LIPA is doing something very similar also in New York. And in New Jersey, PSE&G is introducing optional time of use rates, which I helped design. I testified in that case, one of the exceptions I had in my retirement. So I believe we are beginning to see change happen that we have not seen in years.

Actually, the person who reached out to me from PSE&G, New Jersey, he said to me, "We have waited for 10 years to reach out to you. Now you're retired, now you're ready to do it. Can you please make an exception?" So I said, "Yes, I'll make an exception."

And in places like the state of Washington, even in Nova Scotia in Canada, they have ... so people in these new areas still continue to think that their customers are different. So everyone feels the need to do their own pilot, which is fine, but let's not get stuck in doing pilots forever. Let's try to actually move to actual implementation.

And my advice is, you don't really need to do a pilot because we already have 400 pilots across the globe. People do respond. Not everyone responds, but you don't need everyone responding.

Brad Langley: How do we make this simple for customers? How do we get them to understand very complex topics so they're more inclined to take advantage of these types of programs?

Ahmad Faruqui: I think every customer understands the benefits of a sale. Macy's, Nordstroms, They all have sales. Everyone knows that. Everybody also knows terms like rewards and rebates. People don't like to think about higher prices, so let's stop emphasizing the higher price. Let's start emphasizing the lower price.

And I know there's a bit of a bait and switch trap that we could fall into, so we have to do it carefully and honestly, but why should we not lead with the lower price as the attraction? That's what worked with EVs, it worked like a charm. The fact that your charging cost will fall by more than half if you have off-peak charging.

That's what we need to use for all of these innovative new pricing options. Using terms like real-time pricing, terms like locational marginal cost real-time pricing, I mean, that's guaranteed to fail.

Brad Langley: While we're talking about different kind of compare and contrast topics, I'd love to get your opinion. A lot of conversation around time of use specifically is opt-in versus opt-out? Maybe spend a few minutes talking about the difference between opt-in and opt-out. And if you fall on one side of the fence for which one you think is better for the industry and for customers.

Ahmad Faruqui: So for years, I was a big supporter of opt-out pricing. My view was that is the cost of service. Our job is to convey accurately the cost of service to customers. But what that ignored was the fact that for decades, we have had flat rate pricing.

And so, if you go suddenly to time of use pricing for every customer, in other words opt-out, that's like a big change. Customers are not going to be ready for it. So, if you are interested in doing ultimately cost-based opt-out pricing, do it gradually.

Begin with opt-in, begin with word of mouth kicking in, customers saying, "Hey, this is really good. I'm saving money," to their neighbors and friends. Let the opt-in open the road towards opt-out. Don't suddenly go to opt-out.

So, I support both of them and you could have both of them at the same time. You could have an opt-out default rate, which has let's say, a differential of two to one between peak and off-peak. So off-peak is 50% lower or you could say peak is two times higher. That's the default. Don't make it any sharper than that.

If you want to have sharper differentials, make them opt-in. And those opt-in differentials will appeal to people with electric cars and solar, but don't come in with a peak price that is five times higher and your default rate. One utility tried it, actually once state tried it with Missouri, and then they rejected it because of the political crisis that they were about to precipitate.

We continue to have somewhat of a mindset that again, is more economic and engineering-tinted than customer-focused. So you can have both, but you have to have different price ratios.

Brad Langley: So what's the optimal recipe for good, dynamic rate design? What are those key components that will lead to success?

Ahmad Faruqui: Keep the peak period short, make sure the off-peak savings are considerable. Make sure you educate and inform customers on what actions they need to take to benefit from the rate. And if you want, offer both opt-out, mildly differentiated rate like a two-to-one ratio and opt-in with a five-to-one ratio. Give them choices. Don't be stuck on just one rate.

I think giving choices is the biggest lesson we have from working on this for years and years. As you know, no two customers are alike. I mean, even within the same house you'll find the spouses have different preferences, neighborhoods have different preferences, so give them choices.

Brad Langley: You've mentioned a couple utilities during our conversations, of examples of how this is successful. What utilities or states do you think are getting this right, these innovative new rate structures? And if you're so inclined to put on your controversial hat, who has struggled? Are there certain states or utilities that have struggled more so than others?

Ahmad Faruqui: So the ones that have succeeded, I mentioned smart, you mentioned PSEG, Long Island. There are a few others as well. Oklahoma Gas & Electric, actually about 10 years ago I discovered that Oklahoma was ahead of California when it came to dynamic pricing. And thankfully, they hired me to help them out on a couple of issues.

So, I went there and what I discovered was the reason they were successful is because they talked the customer's language. They had videos, they even had murals on their headquarters building showing four different families and how they're living their life with dynamic pricing rates. So that made a huge difference.

Paying attention to the customer makes a difference, doing it gradually makes a difference and having the right kind of rate design also makes a difference. Those are good examples.

The ones that didn't work out were either the ones that did it too quickly, whose rates were unfriendly, the peak period was very long, or the peak price and the off-peak price didn't differ much at all.

And so, even though the customer shifted load expecting to save money, they ended up not saving much. This was Puget Sound Energy in the state of Washington. Again, 20 years ago. They rolled it out to 300,000 customers as an opt-out time of use rate, but the differential was just 30% between peak and off-peak.

A year later, when customers got their shadow bills showing how much they had saved, most of them had saved just about nothing. And one person was quoted in The Seattle Times. She said, "I shifted half my load from the peak to the off-peak period because that's what the utility asked me to do. And here's what I end up paying is just more, not less, despite the shifting." Who knows what the story was. But those kinds of setbacks, I think we have learned from them.

Puget Sound itself has learned from them. They have a new pilot. I was part of their pilot and they showed good results. I don't know what the next steps are, but I believe people are learning by doing.

Brad Langley: How do you expect to see rates change in the next few years? Will the democratization of power generation or the distributed grid push more utilities to adopt these modern rate structures, whether dynamic pricing, or TOU, or others?

Ahmad Faruqui: Absolutely. I think the culture has changed. Part of it is with demographic. New generation of people are coming into the utilities and the commissions. And also, the customers are now the millennials and so on, very different preferences.

They want choices. They want more green power and they want more control over their energy lifestyle. Plus, they're acquiring these new technologies, all the DERs that we have been discussing. Small is beautiful. Emphasis is shifting from the power plant to the consumers all around and therefore, rates will have to change. And if they don't change, those utilities that don't change them, they'll go bankrupt.

Brad Langley: So we call this show With Great Power, which is a nod to the power industry. It's also a famous Spider-Man quote, "With great power comes great responsibility." So tell us, what superpower do you bring to the energy industry?

Ahmad Faruqui: I don't think I bring much personally to the energy industry, other than lessons learned. I have made every mistake possible, and yes, I have changed my views on certain topics, but I think we learn by doing, and I think I'm a living example of that. Some people don't like the new positions that I have on many issues, but that's the new life that we all have to live. We can't just be, as I put it, rigid like an ox.

Brad Langley: Well, Ahmad, you are a rate design expert and rockstar, and I appreciate you coming on the show with us. Thank you very much.

Ahmad Faruqui: Brad, it was a pleasure.

Brad Langley: Ahmad Faruqi is a freelance economist and former principal at The Brattle Group. With Great Power is produced by GridX in partnership with Latitude Studios.

Delivering on the clean energy future is complex. GridX exists to simplify that journey. GridX is the enterprise rate platform that modern utilities rely on to usher in our clean energy future. We design and implement emerging rate structures and we increase consumer investment in clean energy, all while managing the complex billing needs of a distributed grid.

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