Renewables solve climate issues, but they also create new challenges. In the times of mostly conventional power sources, energy generation and consumption were able to align themselves quite neatly, as furnaces could be turned up or down according to respective consumption patterns. Times of excess power or a lack of power were dealt with through pricing incentives.
Cheaper night tariffs and more expensive peak hours acted as the gatekeepers on both pricing ends. But since renewable energy sources like wind and solar can’t be turned up on cue to meet the actual demand, this way must be reconsidered. As the efficiency of renewable energy sources is steadily increasing and governments are strongly promoting them, they will deliver a higher share in total energy generation, which will lead to an even bigger fluctuation.
Decentralization is one way to deal with this issue; having the generation of energy physically close to its consumption helps avoid major grid imbalances. But energy supply can only be decentralized so much. An additional way to close the gap between consumption and generation is to give energy suppliers tools to read customer consumption in real-time, making use of a combination of smart meters and direct incentives via dynamic pricing contracts. But what’s in it for end consumers?
Starting in 2018, an overhaul of the rules for the EU electricity market was agreed upon not only to enhance cross-border electricity trade, but also to introduce dynamic pricing to address the difficult task of integrating renewable energy. What followed was a new EU directive mandating all EU states to implement dynamic pricing into national law by 2025.
The directive defines a dynamic electricity pricing contract as “a contract between a supplier and a final customer that reflects the price variation in the spot markets, including day-ahead and intraday markets”. The law entitles end users to be offered at least one contract that includes the dynamic pricing of their electricity usage and obliges energy companies with more than 200,000 clients to offer at least one dynamic pricing option. Widespread use of this method would not only have a positive impact on energy efficiency and lower emissions, but it would also make the EU’s electricity market a more competitive and consumer-oriented environment.
Dynamic pricing is needed to steer consumption behavior to align with actual energy generation. Achieving this will benefit both the electricity providers and consumers. By providing consumers with dynamic price signals, energy providers encourage customers to use power during sunny or windy periods, away from typical system peak hours. This will potentially reduce the need for investing in additional generation, distribution, and related expenses. To do so, dispatchable energy must be held in reserve for times of low wind or solar energy generation. It is widely discussed if offering dynamic pricing should be made an obligation for energy suppliers. The liberal approach would be to still let companies have a free hand in designing offers for consumers. On the other hand, offering dynamic pricing contracts should generally be in the best interest of retailers, as it gives them a chance to reduce their hedging and sourcing costs.
"The more prices and pricing periods correspond to the prices on wholesale markets, in a timeframe that provides incentives to shape energy consumption behaviors according to the way wholesale prices evolve, the more ‘dynamic’ they are." Source: Dynamic pricing in electricity supply (A EURELECTRIC position paper, p.2)
From the customers' perspective, dynamic pricing is not particularly controversial, as it allows them to reduce their electricity bills by managing and adjusting their consumption in response to price signals. At the beginning of 2019, dynamic pricing contracts were available in seven EU member states. Today, most dynamic pricing contracts are signed by businesses, but residential customers are also recognizing the associated cost-saving potential.
All companies in the retail energy sector basically have a limited range of options for their business plans. But one factor where they differentiate from each other is how they design their pricing. Looking closer, retailers effectively pass through the charges for network, taxes, and levies. This leaves them to only be creative when it comes to designing the pricing of the energy component. On the other hand, a customer would want to have a diversified price list so they can choose an optimal plan that exploits price volatility while taking into account their flexibility potential and minimizing risk. The two different categories for pricing offers are basic fixed-priced and dynamic pricing offers:
Providing more control over the electricity bill, it is no wonder that dynamic pricing with real-time spot-based pricing has been commonly adopted by industrial customers. But in several countries, household and small commercial customers have only been offered simplified forms of ToU and CPP. So far, only Nordic, Estonian, and Spanish residential consumers have access to real-time pricing.
A smart meter is an intelligent electricity meter. It communicates electricity consumption throughout the day via a communication link to the respective network operator and can also remotely limit or shut off the power supply. This technology facilitates dynamic pricing contracts, resulting in lower bills for consumers.
Smart meters enable consumption readings for specific time intervals according to electricity market intervals (15-60 minutes) and offer all the benefits of dynamic pricing. If metered individual consumption load curves based on smart meter readings are used, retail and wholesale markets can be linked more efficiently, allowing consumers to have more agency and leverage flexibility. Lastly, the deployment of smart meters will promote innovative pricing beyond the existing ToU and CPP tariffs.
As the most economically viable option, dynamic pricing is suited for widespread implementation, but, as with other innovative products, some challenges can be obstructive. Dynamic pricing plans should be well-designed, easy to use, and keep consumers well-informed. The exposure to price volatility needs to be transparent so that consumers can adjust to price increases.
The energy component represents only one-third of the average EU retail consumer's bill, while regulated charges make up the remaining share. Increased tax and other policy costs could weaken the benefits of dynamic pricing and incentivize consumers to switch to other forms of energy, harming decarbonization goals in the process. Insufficient volatility of wholesale market prices is also a potential risk.
Another factor that could slow down the progress of dynamic pricing is the consumption pattern. Model regions like the Nordic countries have specific consumption patterns (higher than average consumption and exceptional consumption in winter) that go particularly well with dynamic pricing. In France, for example, most business clients operate electrical devices for both indoor heating and water heating. In other countries, it will depend on how well residential consumers take to electrical heat pumps and electric vehicles (EVs). These technologies are key to operating dynamic pricing profitably, as they can provide shiftable load potential.
Innovation in household technology can make dynamic pricing tariffs more attractive to end users with the use of smart devices. By automating the process, these devices allow capturing more potential savings and spare end users the trouble of actively monitoring and responding to changes in tariffs.
Thanks to these innovations and the development of efficient wholesale markets, electricity retailers have the possibility to provide customers with a wider variety of pricing offers, allowing them to optimize their electricity bills and tap into potential reward schemes as flexibility providers.
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