On July 8, 2008, Synapse Energy Economics released a report titled “Advanced Metering Infrastructure — Implications for Residential Customers in New Jersey“, commissioned by the New Jersey Department of Public Advocate. The report’s primary focus is an analysis of the cost-effectiveness of investments in Advanced Metering Infrastructure (AMI) from their definition of the point of view of a representative residential consumer. Unfortunately, the report does not ask the right questions to get at the alternatives that would produce better consumer outcomes.
The overly-narrow definition of benefits that the authors employ excludes the benefits that customers would gain by choosing from a portfolio of contracts. Furthermore, the authors focus solely on approaches that are consistent with the top-down control-oriented policy relics of the 20th century, and fail to appreciate the benefits for themselves and for system reliability that individual consumers can achieve when AMI-enabled retail choice empowers them to control and manage their own energy use, by making their consumption and cost information more timely and transparent.
Remainder of analysis below the cut …
According to the Synapse summary, several regulated distribution utilities around the U.S. are proposing making AMI investments and including those assets in the rate base on which they earn their regulated rate of return. The economic justification offered for making these rate-base investments is twofold: reduced utility operating costs, and reduced customer expenditures due to the use of critical peak pricing (CPP) in approximately 50 hours per year.
The AMI functionality on which the Synapse report focuses is limited to distribution automation and a narrow form of time-based dynamic pricing. The report finds that “[t]he AMI filings of utilities in other states, and the studies prepared by New Jersey EDCs, indicate the total cost of AMI … would be greater than the NPV of forecast savings in utility operating costs over the same period.” (p. 1) The cost savings from distribution automation are only expected to be 50-75 percent of the cost of the AMI investment, based on the cases they analyzed in California and Maine.
What the authors fail to report, at least with respect to the AMI investment at Southern California Edison, is that the failure of the distribution automation benefits to justify the AMI expense sent SCE back to the drawing board, to rethink the retail value propositions that they offer to their customers. For that reason, SCE’s business case for AMI explicitly includes various forms of dynamic pricing and other consumer-focused benefits that could not exist without the presence of smart grid technology. Unlike the Synapse report, the SCE UtilityAMI and the associated OpenAMI working groups (including consumer participants) estimated the value of a wide range of utility and consumer benefits, broadening their concepts of the products and services that customers would value. The Synapse report thus misrepresents the actual benefit-cost estimation that has arisen from this process.
The report proposes some alternatives to AMI investment, including automated meter reading (AMR) and targeted investments in customer control technologies as opposed to widespread AMI. The authors assert that “a utility with an AMR system could offer dynamic pricing on a targeted approach …” (p. 4) How? AMR systems are only capable of one-way communication, from the meter back to the utility. With that extremely limited one-way functionality, how is it possible to communicate a price signal from a retailer to a consumer? That requires communication in the other direction, to the consumer, of which AMR is incapable.
The authors further assert that three assumptions are required to make the business case for dynamic pricing, and that these assumptions are dubious: enough customers will respond, each customer will respond enough to make a difference, and their responses will be of sufficient duration to retain system balance and service reliability.
The first assumption relates to the magnitude of demand reduction from each individual consumer. Their main criticism on this ground is that “[u]nlike DLC, an AMI system does not in any way ‘automatically’ reduce customer electricity use.” (p. 7) In other words, demand reduction due to dynamic pricing is not currently 100 percent dispatchable.
In contrast, think of a retail electricity market in which consumers get to choose from a portfolio of retail contracts. Dispatchability is a valuable characteristic, so why not offer a contract that gives the consumer a discount or rebate if they can commit in advance to a specific reduction in reponse to a specific price signal? That would make their reduction dispatchable; furthermore, AMI is an essential technology for allowing consumers to have those kinds of retail choices. Give consumers incentives and they become partners in finding solutions.
The second assumption is about the number of customers who would choose dynamic pricing. Their argument focuses on critiquing some estimates of potential participation made by other analysts, but it does not get at the essential question, which is whether or not a large enough share of total demand (what has historically been called “load”) will participate in dynamic pricing to maintain system reliability and reduce wholesale market price volatility. Answering that question is a combination of the number of dynamic pricing customers and the amount by which they change their behavior. There is abundant evidence, theoretical, experimental, and pilot, showing that 1. dynamic pricing results in 12-20 percent reductions in peak demand, and 2. reductions of that magnitude are sufficient to remove physical strain in peak periods and to reduce price spikes in wholesale power markets. The Synapse critique does not speak to these points whatsoever.
Assumption three is that the reduction in peak demand is sufficiently long-lived that it leads to avoided investments in new capacity. Again, this idea is similar to dispatchability, and if the retailer can offer customers a contract in which they commit to reducing their consumption by a certain amount, or not exceeding a certain amount, without large price penalties, then the capacity benefits of that product dimension should be reflected in the terms on which the retailer offers that contract to the customer. In other words, greater retail choice, and the information transparency that it requires and to which AMI systems contribute, can achieve the capacity benefits that the authors value. Of course, a better way to communicate that intertemporal capacity investment signal is through integrated spot and forward markets and not through capacity markets, but that is a fight for another day …
Given the above skepticism that the authors voice about AMI-enabled dynamic pricing, it is not surprising that the report recommends (yes, you guessed it) … investment in energy efficiency and voluntary residential participation in direct load control. Even voluntary direct load control perpetuates centralized control, and stifles consumer and entrepreneurial response to the incentives that price signals present.
I am, though, grateful that the authors went to great lengths to distinguish direct load control from dynamic pricing (p. 7). Dynamic pricing uses price signals communicated to customers to facilitate decentralized coordination through a network of individual consumers changing their behavior, while direct load control retains the historic top-down centralized control that has been the utility and regulator mindset for a century. The benefits calculation that the Synapse authors performed ignored the benefits that consumers can enjoy and create when they can choose from a menu of contracts, and can use technology to make their price-responsive decisions autonomously.
Throughout the report the author’s use of scare quotes around the word “enable” indicates that they undervalue the transformational role that smart grid technology can play in empowering residential consumers to control and manage their own energy use. Moreover, their subtle ridiculing of the enabling properties of AMI are all the more ironic when you consider that one of their biggest recommendations is direct load control! Direct load control is one of the least empowering, least decentralized, least customer-oriented ways of offering consumer choice. This report does not increase our understanding of ways to enhance consumer welfare by creating opportunities for consumers to make better-informed, more timely, individual electricity consumption choices. Its recommendations do not allow consumers to be partners in the solution instead of being slaves to centralized decision-making.