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Optimization of Time-Varying Electricity Rates

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Abstract:
Current consensus holds that 1) passing through wholesale electricity clearing prices to end-use consumers will produce maximal efficiency gains and 2) simpler forms of time-varying retail rates will capture only a small portion of potential benefits. We show that neither holds in the presence of capacity costs typical in U.S. wholesale markets. Using an optimization model describing the short-term problem faced by an electricity retailer, we find hourly prices that optimally pass through capacity costs. We estimate benefits for a retailer using these prices as well as optimal configurations of a number of time-varying rate structures. Testing a range of realistic assumptions, we find that in the absence of a well-designed demand charge, passing through clearing prices may miss up to three quarters of the benefits possible from optimal hourly prices. By contrast, a simpler critical peak pricing structure enables retailers to achieve approximately two-thirds of the total possible benefits.

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Keywords: Rate design, time-of-use rates, critical peak pricing, real-time pricing

DOI: https://doi.org/10.5547/01956574.38.5.jmay

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Published in Volume 38, Number 5 of The Quarterly Journal of the IAEE's Energy Economics Education Foundation.