Reliable Power Grid: Long Overdue Alternatives to Surge Pricing

Hala Ballouz, Joel Mathias, Sean Meyn, Robert Moye, Joseph Warrington

This paper takes a fresh look at the economic theory that is motivation for pricing models, such as critical peak pricing (CPP), or surge pricing, and the demand response models advocated by policy makers and in the power systems literature. The economic analysis in this paper begins with two premises: 1) a meaningful analysis requires a realistic model of stakeholder/consumer rationality, and 2) the relationship between electric power and the ultimate use of electricity are only loosely related in many cases. The most obvious examples are refrigerators and hot water heaters that consume power intermittently to maintain constant temperature. Based on a realistic model of user preferences, it is shown that the use of CPP and related pricing schemes will eventually destabilize the grid with increased participation. Analysis of this model also leads to a competitive equilibrium, along with a characterization of the dynamic prices in this equilibrium. However, we argue that these prices will not lead to a robust control solution that is acceptable to either grid operators or consumers. These findings are presented in this paper to alert policy makers of the risk of implementing real time prices to control our energy grid. Competitive equilibrium theory can only provide a caricature of a real-world market, since complexities such as sunk cost and risk are not included. The paper explains why these approximations are especially significant in the power industry. It concludes with policy recommendations to bolster the reliability of the power grid, with a focus on planning across different timescales and alternate approaches to leveraging demand-side flexibility in the grid.

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