Blog: Dynamic electricity pricing plans are coming. Who’s going to switch to them?

by CMD Associate Director of Research David Byrne

In the coming years, Australians will experience substantial reforms in electricity pricing. Historically, we have faced flat rate plans where there is a fixed price for each kilowatt hour of electricity consumed in the day. This will change, however, with the introduction of dynamic pricing plans, where the price of electricity changes throughout the day to reflect the time varying cost of supplying electricity.

It is well understood among energy economists that dynamic pricing, if implemented, can drastically improve electricity market efficiency (see here). A substantially less well understood issue is whether households will actually adopt dynamic pricing plans in lieu of their fixed rate plans. For policymakers this question is important since the efficiency gains from dynamic pricing requires that people adopts such pricing plans and adjust their electricity consumption to them.

This question is addressed in a recent research paper from the Commonwealth Scientific and Industrial Research Organisation (CSIRO). Their study involved 1181 electricity customers who voluntarily responded to a survey asking them about the likelihood they would choose a hypothetical dynamic pricing plan over a fixed-rate plan.

They find evidence to suggest, perhaps not surprisingly, that households said they would want to stick with their traditional fixed-rate plans. They were particularly averse to complex real-time pricing dynamic plans (where retail prices move in throughout the day with fluctuating wholesale costs), and were less averse to simpler dynamic pricing plans, such as time-of-use pricing (where retail prices adjust less frequently throughout the day with peak and off-peak rates that differ across weekdays and weekends). If households were hypothetically offered a money-back guarantee on losses from dynamic pricing plans relative to fixed-rate plans, or alternatively if they were offered an automation device that would help them exploit dynamic prices to save on their bills, then they would be more likely to choose a dynamic pricing plan.

Why might these high-level results be expected? While the article mentions that behavioural economics might matter, standard microeconomic paradigm may in fact explain much of the aversion to dynamic pricing. If people are risk averse, then they will want to avoid pricing plans that involve volatile prices and hence bills. Moreover, they may simply be information-constrained and find it difficult to stay informed about the evolution of prices hour-to-hour or day-to-day in making their decisions. Indeed, research from David Rapson and Katrina Jessoe (see here) shows that people can actually make correct electricity pricing decisions if they are provided with the right information about the evolution of prices day-to-day.

Regardless of interpretation of the underlying rationales for peoples’ hypothetical choices of fixed-rate plans or dynamic ones, the paper takes steps toward providing empirical evidence on peoples’ unwillingness to adopt dynamic pricing plans. Given major changes in dynamic pricing are yet to come in Australia, there is little data to study these decisions, hence the hypothetical approach taken.

That being said, the empirics need to be taken with a grain of salt. It is hard to believe that the numbers from paper will translate into what we might expect if dynamic pricing plans were actually implemented. Economists tend to believe in what people actually do, and not what they say they would do. We tend to take more seriously evidence based on peoples’ decisions when they have a stake in the game; that is, when they are making actual pricing plan choices and where those choices have financial consequences. Such field experiments, where households have financial incentives to carefully make the right electricity pricing plan choice for them, are precisely what the energy economics group is currently working on at the Centre for Market Design. With any luck, we will be able to build on the CSIRO study to help inform policymakers on the degree of risk aversion and ignorance among consumers when considering flat rate and dynamic plans in the coming years.