Inducing flexibility of household electricity demand: The overlooked costs of reacting to dynamic incentives

Flexible electricity demand through dynamic pricing11We use the term ‘dynamic pricing’ to describe electricity tariffs that are continually adjusted to (partially) reflect the current price at the spot market or at the day ahead market such as real-time pricing. Time of use pricing is not covered by our use of the term because time of use tariffs are pre-declared and not continually adjusted to reflect current market conditions. Note that the term dynamic pricing is sometimes defined more broadly e.g. as any tariff structure different from a flat tariff. is becoming more critical for net-balancing as the share of intermittent wind and solar electricity production increases. However, people are prone to habits and regularity, so this kind of dynamic pricing schemes may also impose a greater cost of reacting to price incentives. In a randomized field experiment we compare the household consumer welfare effects of reacting to dynamic electricity price incentives to those of reacting to time of use incentives. We utilized smart-metered hourly electricity consumption data to unobtrusively measure treatment effects. We found that a dynamic incentive of 1 DKK/kWh induced an average change in electricity consumption per household of 0.182 kWh during the 3-hour target period. The corresponding time of use incentive induced an average change in electricity consumption of 0.351 kWh. This implies that dynamic incentives reduce consumer surplus from reacting by half, compared to reacting to corresponding time of use incentives and therefore that households derive a substantial welfare benefit from the regularity and predictability provided by time of use pricing. This suggests that the tariff structure that optimally balances demand flexibility and the associated consumer welfare costs is likely a combination of time of use and dynamic pricing incentives.