Operations Policy Sep 8, 2015

Why Pow­er Com­pa­nies Love Smart Meters

Smart meters pro­vide rich­er data, enabling smarter pric­ing strate­gies and a smoother elec­tric­i­ty sup­ply chain.

Yevgenia Nayberg

Based on the research of

Özge İşlegen

Barış Ata

Asligul Serasu Duran

Firms are awash in new­ly acces­si­ble data that promis­es to make their oper­a­tions more effi­cient. The elec­tric­i­ty indus­try is no excep­tion: enter the smart meter.

Before smart meters, there was only one data point per con­sumer per month,” explains Ozge Isle­gen, an assis­tant pro­fes­sor of man­age­r­i­al eco­nom­ics and deci­sion sci­ences at the Kel­logg School. Every month, util­i­ty com­pa­nies received a sin­gle update about a household’s usage — and cus­tomers received a sin­gle bill. But smart meters, installed in cus­tomers’ homes, can mon­i­tor usage in inter­vals of an hour or less.

Learn more about lead­ing with big data and ana­lyt­ics at the Kel­logg Exec­u­tive Edu­ca­tion pro­gram.

Crit­i­cal­ly, the rich tem­po­ral data allows util­i­ty com­pa­nies to exper­i­ment with charg­ing more for elec­tric­i­ty used dur­ing peak hours. Such pric­ing strate­gies have the poten­tial to increase the effi­cien­cy of the entire sup­ply chain.

Util­i­ty com­pa­nies believe that giv­ing cus­tomers finan­cial incen­tives to shift their usage from peak hours to off-peak times will flat­ten the demand curve for elec­tric­i­ty — with cus­tomers wait­ing until night to run the dry­er, for instance. For util­i­ty com­pa­nies, this means a need for few­er expen­sive gen­er­a­tors, some of which cur­rent­ly run only dur­ing peak times. If the demand curve was flat­ter and there wasn’t a sig­nif­i­cant peak, then the invest­ments for the cost­ly peak-load pow­er plants would decrease,” says Islegen.

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So, how does time-based pric­ing affect the elec­tric­i­ty sup­ply chain? In recent research, Isle­gen — along with col­leagues Asligul Sera­su Duran, a PhD stu­dent at the Kel­logg School of Man­age­ment, and Baris Ata of the Uni­ver­si­ty of Chica­go Booth School — explores the impact of time-based pric­ing schemes on elec­tric­i­ty con­sumers and elec­tric­i­ty providers — as well as on the car­bon emis­sions from elec­tric­i­ty generation.

Util­i­ties pro­mote these strate­gies by say­ing they’re envi­ron­men­tal­ly friend­ly, but we find that’s not nec­es­sar­i­ly the case.”

What the researchers find is that peak use does in fact go down — though not nec­es­sar­i­ly over­all use. And a time-based pric­ing scheme need not be com­pli­cat­ed to be effec­tive. How­ev­er, the short-term impact on cus­tomers’ bills is min­i­mal, so util­i­ty com­pa­nies and pol­i­cy mak­ers who want to reap the long-term ben­e­fits of a flat­ter demand curve should con­sid­er mak­ing time-based pric­ing an opt-out affair. The envi­ron­men­tal impact of these pric­ing strate­gies, more­over, depends heav­i­ly on local mar­ket conditions.

Sim­ple Time-Based Pric­ing in Ire­land Reduces the Peak Load

The lure of a more effi­cient elec­tric­i­ty sup­ply chain is unde­ni­able. The U.S. is scram­bling to adopt advanced meters that enable time-based pric­ing strate­gies. As of 2013, elec­tric util­i­ties had over 46 mil­lion advanced meters installed for res­i­den­tial con­sumers,” the researchers report, which accounts for 36% of all res­i­den­tial con­sumers.” Move­ment is sim­i­lar­ly fren­zied else­where in the world. The Euro­pean Union, for instance, aims to equip 80 per­cent of house­holds with smart meters by 2020.

In their inves­ti­ga­tion of time-based pric­ing, Isle­gen and her col­leagues turned to data from a field exper­i­ment in Ire­land. We want­ed to know if these pric­ing schemes — charg­ing a high­er price dur­ing peak times and low­er price in off-peak times — actu­al­ly change cus­tomer behav­ior and shift demand,” Isle­gen says.

Data from near­ly 3,500 Irish house­holds was col­lect­ed by the Irish Com­mis­sion for Ener­gy Reg­u­la­tion. To get a bench­mark for elec­tric­i­ty use, house­holds ini­tial­ly paid a flat rate of 14.1 cents per kilo­watt hour (kWh). Then, homes were divid­ed into groups, each of which was assigned a dif­fer­ent time-of-use tar­iff (with prices rang­ing from 20 to 38 cents per kWh for peak elec­tric­i­ty, and 9 to 14.1 cents per kWh for off-peak elec­tric­i­ty). The Com­mis­sion also includ­ed a con­trol group that con­tin­ued to pay a flat rate of 14.1 cents per kWh. Through­out 2010, the house­holds’ elec­tric­i­ty use was mon­i­tored every 30 minutes.

Along with this data, the researchers used house­hold demo­graph­ic data, as well as con­sump­tion data, to build a mod­el that iden­ti­fied opti­mal retail prices for sev­er­al time-based pric­ing strate­gies. The strate­gies under con­sid­er­a­tion were real-time pric­ing and time-of-use pric­ing. Real-time pric­ing allows util­i­ties to update elec­tric­i­ty prices in response to fluc­tu­a­tions in the whole­sale elec­tric­i­ty mar­ket. With time-of-use pric­ing, on the oth­er hand, prime-time elec­tric­i­ty usage — between the hours of 5 to 7 P.M., say — is set at a pre­de­ter­mined rate that is high­er than the rate for off-peak usage.

Isle­gen and her col­leagues found that time-based pric­ing strate­gies do indeed reduce peak loads in Ire­land, from about 0.5 to more than 11 per­cent, depend­ing on the sea­son and the sever­i­ty of the peak elec­tric­i­ty sur­charge. Time-based pric­ing did not, how­ev­er, sig­nif­i­cant­ly change over­all elec­tric­i­ty consumption.

Inter­est­ing­ly, the researchers found that sim­ply charg­ing cus­tomers a high­er rate for prime-time usage was just as effec­tive at reduc­ing peak loads as adopt­ing the more com­pli­cat­ed real-time pric­ing schemes. This came as a pleas­ant sur­prise to Isle­gen, as the time-of-use tar­iffs let cus­tomers avoid price spikes with­out hav­ing to con­stant­ly track prices.

For Ire­land, where elec­tric­i­ty usage drops dra­mat­i­cal­ly in the sum­mer but spikes dur­ing the win­ter hol­i­days, time-of-use prices should vary depend­ing on the sea­son. In Decem­ber, for exam­ple, the peak load is real­ly sig­nif­i­cant — approach­ing the capac­i­ty con­straint of the gen­er­a­tors — while in the sum­mer, there’s no sig­nif­i­cant peak load at all,” says Islegen.

This par­tic­u­lar pric­ing scheme is opti­mized to Ireland’s envi­ron­ment and social demo­graph­ics. For exam­ple, air con­di­tion­ing doesn’t play a sig­nif­i­cant role in Ire­land, but 13 per­cent of the res­i­den­tial elec­tric­i­ty con­sump­tion in the U.S. comes from space cool­ing,” Isle­gen says. But using the frame­work devel­oped in this research, sim­i­lar stud­ies could iden­ti­fy the ide­al pric­ing scheme for oth­er markets.

Impact on Cus­tomers and the Environment

Although peak load was reduced when time-of-use pric­ing was adopt­ed, greater effi­cien­cy in the sup­ply chain did not nec­es­sar­i­ly trans­late to low­er bills for cus­tomers. For this rea­son, the researchers are skep­ti­cal that cus­tomers will vol­un­tar­i­ly flock to the new pric­ing schemes. They sug­gest instead that util­i­ties and pol­i­cy mak­ers offer time-of-use pric­ing as the default mod­el. Indeed, the researchers report that this default time-of-use pric­ing mod­el has been adopt­ed by Ire­land and oth­er elec­tric­i­ty mar­kets such as Ontario, Cana­da, and Italy.

Time-based pric­ing, the researchers find, is also no panacea for curb­ing green­house gas emis­sions. In Ireland’s case, emis­sions remained about the same when time-based pric­ing was applied. But whether emis­sions are reduced, remain the same, or even increase will like­ly vary by region. The envi­ron­men­tal impact large­ly depends on the pre­cise mix of elec­tric­i­ty gen­er­a­tors that are used for han­dling base-load ver­sus peak-load pro­duc­tion — as well as oth­er fac­tors like the dis­patch deci­sions of these gen­er­a­tors, the elec­tric­i­ty mar­ket struc­ture, and the con­sump­tion pro­file and demo­graph­ics of the region under study.

Util­i­ties pro­mote these strate­gies by say­ing they’re envi­ron­men­tal­ly friend­ly, but we find that’s not nec­es­sar­i­ly the case,” Isle­gen points out. There is a pos­si­bil­i­ty that, depend­ing on the ener­gy mix in the region, these pric­ing schemes can have a neg­a­tive envi­ron­men­tal impact.”

If base-load pro­duc­tion is pow­ered by coal but peak load is han­dled by green­er” pow­er plants like nat­ur­al gas plants — as is typ­i­cal in many parts of the U.S. — then a shift in demand from peak load to base load would trig­ger more emissions.

Featured Faculty

Özge İşlegen

Assistant Professor of Operations

Barış Ata

Member of the Department of Managerial Economics & Decision Sciences faculty until 2013

About the Writer

Rachel Nuwer is a freelance science journalist who contributes to venues such as The New York Times, Scientific American and Smithsonian. She lives in Brooklyn.

About the Research

Islegen, Ozge, Baris Ata and A. Serasu Duran. 2015. “An Analysis of Time-Based Pricing in Electricity Supply Chains.” Working paper.

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