The Long-Run Effects of
Real-Time Electricity Pricing

Severin Borenstein, UC Berkeley, UC Energy Institute

 

ABSTRACT:

Retail real-time pricing (RTP) of electricity — retail pricing that changes hourly to reflect the changing supply/demand balance — is very appealing to economists because it “sends the right price signals.” There is, however, frequent confusion between the economic efficiency gains that would result from RTP and the wealth transfers that RTP would create. RTP-induced wealth transfers from producers to consumers were the primary focus of RTP advocates during the 2000-01 California electricity crisis. In this paper, I abstract from such transfers and focus on the long-run gains in economic efficiency that would result from adopting RTP in a competitive electricity market. Using simple simulations, I demonstrate that the magnitude of efficiency gains from RTP is likely to be significant even if demand is not very elastic. Even with demand elasticity of -0.025, the efficiency gains from RTP-adoption for the largest customers is almost certain to exceed the cost of implementing such a system. The simulations indicate that the efficiency gains are increasing, but concave, in the share of demand on RTP and in the elasticity of demand. Also, preliminary analysis of the demand patterns of some large customers indicates that RTP in a competitive market would induce very significant wealth transfers among customers.