A pilot program in Chicago could help make variable rate pricing for electricity a reality for consumers. The idea is straightforward: Because the demand for electricity varies from day-to-day, as well as by time of day, electricity prices should reflect this fact. This would encourage consumers to shift some electricity use, such as running the dishwasher, from peak daytime hours into the evening. Some industrial users already purchase electricity this way, but the benefits of implementing such reforms could be signficiant -- and would move retail electricity service in the direction of an actual market in which prices provide information about supply and demand.

The NYT reports:

Most people are not aware that electricity prices fluctuate widely throughout the day, let alone exactly how much they pay at the moment they flip a switch. . . .

Just as cellphone customers delay personal calls until they become free at night and on weekends, and just as millions of people fly at less popular times because air fares are lower, people who know the price of electricity at any given moment can cut back when prices are high and use more when prices are low. Participants in the Community Energy Cooperative program, for example, can check a Web site that tells them, hour by hour, how much their electricity costs; they get e-mail alerts when the price is set to rise above 20 cents a kilowatt-hour.

If just a fraction of all Americans had this information and could adjust their power use accordingly, the savings would be huge. Consumers would save nearly $23 billion a year if they shifted just 7 percent of their usage during peak periods to less costly times, research at Carnegie Mellon University indicates. That is the equivalent of the entire nation getting a free month of power every year.

Meters that can read prices every hour or less are widely used in factories, but are found in only a tiny number of homes, where most meters are read monthly.

The handful of people who do use hourly meters not only cut their own bills, but also help everyone else by reducing the need for expensive generating stations that run just a few days, or hours, each year. Over the long run, such savings could mean less pollution, because the dirtiest plants could be used less or not at all.

At The Knowledge Problem, economist Lynne Kiesling discusses the NYT article on variable-rate electricity pricing I highlighted Monday. As she sees it, there is a problem of asymmetric information.

In the case of electricity, retail customers do not see price changes until after those changes have taken effect, because under existing regulation they pay averaged rates and only receive information about the prices they face at the end of the month when they receive their bill. However, underlying costs of serving those customers can change hourly, so with customers paying averaged prices there is a mismatch between the prices they pay and the costs of serving them.

We could improve efficiency (and thus enable conservation and lower costs) if we had pricing that allowed for a better match of the price the customer pays with the cost, but unless the customer has some way of gaining information about prices in advance, but if we don't do that, then we have the aforementioned asymmetric information problem.

As Kiesling explains, the solution is not purely technological. Having gizmos that provide information about price changes is important, but so is rate reform.

The technology can't create all of these benefits on its own: rate redesign to allow dynamic pricing is imperative. What good is having technology to enable responsive demand if the meter just gets the same old, same old averaged price signal? Not much. Digital technology and dynamic pricing are symbiotic. Furthermore, the most significant benefits of digital technology and dynamic pricing are largely unseen by us in advance, which is why it's so bloody hard to get them enacted in regulation!

The most substantial benefits of the retail competition that technology + pricing enable come from product differentiation and innovation in the products and services available to customers. Think about telecom: we got some benefit from the reduction in prices for long-distance service, but the real value proposition has been in the proliferation of new products and services that have transformed our lives. There are entrepreneurs out there thinking about ways to do that in electric power retail service, and the potential exists, if we will but let it happen.

In other words, to truly take advantage of technological innovation and price information, there must be regulatory reforms that allow for retail electricity competition. The cost savings from time shifting would be only a portion of the resulting economic benefits.