EU Energy Policy Blog

For decades energy regulators have focused on means to facilitate access to energy supply in order to meet demand and reduce costs. The emphasis has mainly been on liberalisation and removal of market barriers. However, climate change has emphasised that the balance between energy demand and supply is threatened by another risk: excessively high energy demand brings about significantly negative environmental and economic impacts. This is because if a vast number of users is consuming electricity at the same time, energy suppliers have to activate dirty old power plants with higher greenhouse gas emissions and higher system costs.

In response to this problem, energy regulators have started considering various approaches to inform users about the risks of consuming too much energy at peak times. Some of these measures are relatively ‘soft’. They avoid the excessive paternalism of dictating when using electricity and yet introduce elements which are designed to make consumers think twice about their energy consumption. They are based on a combination of libertarian and paternalist philosophies of regulatory intervention. What is more, energy regulators seem to have embraced a new regulatory philosophy, which reconciles libertarian and paternalist approaches, as elaborated by Richard Thaler and Cass Sunstein in their book ‘Nudge’. The nudge approach has been developed on the assumption, drawn from recent cognitive studies, that, from investments to daily actions, people tend to make, regardless of the amount of information at their disposal, sub-optimal decisions. Recent regulatory interventions, including those in the proposed UK Electricity Market Reform, contain several elements aimed at ‘nudging’ energy users. These include (i) the roll-out of smart meters, (ii) differentiated time-of-use tariffs, (iii) incentives for shifting the timing of energy consumption, (iv) consumption data sharing at the community level and (v) capacity payments.

Smart meters have developed from being passive digital meters to nudges. Early smart meters in the 1990a (e.g. the Energy Cost Indicator or The Energy Detective) provided near real-time feedback on aggregate home electricity consumption in terms of kWh and cost and required clip-on current sensors installed into the breaker panel of the home. Subsequent larger scale trials from 2000 onwards used devices such as the PowerCost Monitor, which provides similar feedback but does not require installation in the breaker panel, and instead uses an optical sensor attached directly to the meter. The newest generation of display technologies is able to communicate directly with a smart meter, often using an open standards-based communication protocol such as the Zigbee Smart Energy Profile. This advancement allows for more immediate and accurate feedback and it eliminates the requirement for costly or time-consuming installation processes. Technological advancements like Time of Use screens and more user-friendly Graphical User Interfaces have also increased the appeal of display devices to end-users. Companies with specific, proven expertise in making attractive consumer products are quickly changing the smart metering industry and competition is growing. For example, General Electric recently announced its Brillion suite of home energy management products, including a smart meter. The available evidence on smart meters shows that immediate feedback allows homeowners to more closely link consumption decisions with their associated financial and environmental impacts. Providing feedback on smart meters devices has been shown to reduce electricity consumption by 6-10%, though there is debate on the accuracy and applicability of this figure. Higher functionalities for the smart meters will enable more proactive ‘nudging’ by both regulators and energy suppliers.

Time of Use tariffs provide consumers with certainty about the price of consumption at different periods of the day, unlike tariffs where the price fluctuates following the real time cost of electricity. This becomes a significant advantage, considering the risk-averse attitude to uncertainty on prices of most residential electricity users. For instance, in Italy Time of Use tariffs have gradually been applied to all residential electricity users since the year 2010. The first pilot of Time of Use (“tariffa bioraria”) involved 4 million end users. Lower tariffs are applied to weekends and to weekdays from 7.00 PM to 8.00 AM. The two tariffs (0.09 cent/kwh and 0.07 cent/kwh for peak and off-peak respectively) are designed to yield savings for end-users whose consumption is concentrated for more than 66% during the lower tariff periods.

Incentives for shifting the timing of energy consumption range from dynamic pricing to even more aggressive forms of rewards and penalties. In essence, those consumers who proactively engage in shifting their loads and significantly react to price signals will be rewarded by paying less for their electricity consumption. Because real-time rewards to consumers tend to fail due to the negligible amounts associated with gains (and losses) for a single consumer, in these financial mechanisms regulator determines cumulative benchmarks which are matched against responses to price signals.

Consumption data sharing at the community level entails bills providing comparisons to historical consumption or to other peer groups. Community-level presentations of data are also argued to be more effective than other comparisons because people often resent the household comparison group they are applied to. However, empirical studies show mixed results on the effectiveness of such an approach. Contradictory evidence highlights the fact that people do appreciate normative comparisons, though groups vary widely in what they thought was a good way of presenting this. For instance, the final report by Ofgem of the Energy Demand Research Project in 2011 found that historic and normative comparisons could provide up to 1% reduction in consumption, but that they were highly context dependent and were most effective in conjunction with immediate feedback from smart meters. It has been argued that a zero conservation effect from normative feedback might be attributed to people with lower than average consumption seeing it as a reason to do nothing.

Finally, capacity payments are currently being developed e.g. through the proposed Electricity Market Reform in the UK. Those energy users who have the ability to turn down their energy use based on notifications periods and are not able to take part in the National Grid’s Short Term Operating Reserves program will be able to join a new capacity market. Experience in North America shows that the cost per MW of Demand Response participating in a Capacity program is around €45,000 per year. Especially with large amounts of wind and other renewable generation coming online, capacity payment could save millions of pounds with regard to supporting capacity margins, as well as helping guarantee security of supply. However in Europe, at the moment, there are limited resources in place to take full advantage at the transmission level of the potential benefits of a Capacity Market.

In broader terms, this is a momentous shift in the risk paradigm of energy policy from market optimisation risk to environmental threshold risk. Indeed these new measures can be seen as first generation ‘nudges’ aimed at raising awareness about the risk of peak consumption. However, more interventionist regulatory measures are behind the corner. In the future, energy users might be subject to financial penalties for consuming during peak time and even in some cases be obliged to implement demand side controllers which would cap electricity consumption and compel adoption of microgeneration renewable sources of energy.

Jacopo Torriti, Lecturer in Energy Economics and Policy, University of Reading

This entry was posted on Thursday, April 5th, 2012 at 11:24 am and is filed under Energy Policy. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.