What Makes Time-Of-Use Electricity Pricing Successful? Getting the Incentive Right.

With the installation of “smart meters” at homes throughout much of the United States and other countries, governments and utilities can now track how much electricity a home uses each hour of the day. Having this data presents an opportunity to encourage consumers to reduce their electricity use by charging them more during hours when a lot of people are consuming electricity and it costs more to produce, instead of charging a flat fee. But because of political constraints, many countries do not mandate and rely on voluntary participation in such a “dynamic pricing model.” A new study evaluates which types of consumers conserve the most, and what role an upfront financial incentive plays in cutting electricity use.

“To successfully reduce emissions and transition to clean energy sources, it’s critical that we find ways to cut electricity use during peak times,” says Koichiro Ito, an associate professor at the University of Chicago Harris School of Public Policy. “One way to do this is to charge consumers more during peak hours along with a reduced price for off-peak hours, encouraging them to respond by using less electricity during peak hours. But not all consumers will behave as we would expect. Our study helps policymakers identify strategies to optimize the success of these programs.”

Ito and his co-authors, Takanori Ida from Kyoto University and Makoto Tanaka from the National Graduate Institute for Policy Studies, conducted a field experiment in Yokohama, Japan, where the government provided smart meters to more than 3,000 households. The researchers randomly distributed $60 upfront to a segment of these households to encourage them to take up a dynamic pricing program. They also calculated how much each household could be expected to save if they decided to switch based on their past electricity usage patterns and used this information to further encourage households to switch to dynamic pricing.

The researchers found that consumers who would expect to save money were more likely to choose to opt into the new pricing scheme. Fifty percent of those expected to save joined the program, whereas only 15 percent of those told they would not save unless they changed their behaviors joined. Offering the latter the $60 incentive to join boosted their take-up of the program to around 30 percent.

“But the key to the program’s success is not getting consumers to join, but getting consumers to join who will indeed change their behaviors and use less energy. Who are those consumers? That’s what we sought to find out,” says Ito.

Ito and his co-authors found that the consumers who changed their behaviors varied widely demographically but shared one thing in common: their eagerness to join the program. Those who showed eagerness to join conserved up to 1 kWh per hour per household each peak-hour day. Those who were reluctant to take up the dynamic pricing conserved very little after joining.

“This is where the financial incentive for take-up becomes so important,” says Ito. “If the take-up incentive is too high, it will encourage consumers to join who are excited about the incentive and not the program itself.”

The researchers tested different financial incentives and found that the $60 incentive was actually pretty successful. It improved the take-up rate of the policy from 31 to 48 percent, leading to an improved welfare gain of $18 to $23 per consumer per year. The most optimal take-up design, they say, would boost the welfare gain from the program to $33 per consumer per year.

“This research can help policymakers or utility companies structure dynamic electricity pricing  in a way that will encourage the participation of customers who are most likely to save electricity,” says Ito. “Fundamental to that structure is identifying and targeting key consumer types, leading to the largest and most efficient electricity reductions.”

This article originally appeared at the Energy Policy Institute at the University of Chicago.