Innovation in Efficient Rate Design for Electricity Pricing

Arthur van Benthem, Business Economics and Public Policy, The Wharton School

Abstract: For innovative energy-efficiency and home-energy software to reach its full potential of time-shifting peak electricity demand, we also need innovation in the way in which electricity is priced. With current near-flat pricing schedules, consumers have little financial incentive to reduce power consumption when it matters most. Using data over the period 2000-2020 for all seven wholesale power markets in the United States, we show that time-of-use electricity pricing schemes are poorly correlated with real-time wholesale market prices and that this phenomenon is widespread across space and time. Prices thus deviate widely from marginal cost, creating a substantial inefficiency. We consider alternative pricing policies such as more sophisticated pricing schemes and critical peak pricing that can save consumers money and avoid costly investments in peak power plants that are seldomly used. We quantify the financial gains of moving from current, mostly-flat pricing to more flexible pricing schemes. This research should prove useful to the ongoing debate about electricity rate design, and the prospects of smart energy software innovations.