Time-of-use comes of age

The announcement by British Gas of an innovative time-of-use tariff marks the shape of things to come, not a temporary sales ploy, says Simon-Kucher & Partners.

British Gas’s recent announcement of plans to introduce an innovative time-of-use based tariff –offering free power between 9 am and 5pm on Saturdays – is a natural consequence of the ongoing rollout of smart meters across the UK. The move was denounced by the head of rival supplier Npower as a “gimmick”, but the use of price as a lever to manage demand has an important role to play in the future energy landscape.
However, the direction of current debate around energy pricing to consumers – including the proposals contained in Ofgem’s Retail Market Review – has arguably had a tendency to overstate concerns over equity and fairness impacts, which may act as a brake on widespread tariff innovation.
Unless these obstacles to more dynamic pricing are overcome, its potential to facilitate better management of energy demand will be missed, and along with it the opportunity to save unnecessary capital expenditure on grid infrastructure investment and to cut greenhouse gas emissions.
British Gas’s free on Saturdays power tariff could come into action by the middle of next year and will be available only to those customers with a smart meter. The devices, which monitor real-time power consumption, have been installed by British Gas in over a million homes already and are due to be installed in every home in Britain by 2020.
While it is still a concept, the impact of free power Saturday on consumers’ ability and willingness to alter consumption patterns remains unknown, but it is a positive sign that energy companies are starting to test the potential of smart meters to vary how they charge their customers. Whether “free” is the really right messaging, however, remains to be seen as it could cause consumers to not value and to misuse the energy they consume on Saturdays as they bear no extra cost. This aspect needs clear communication to be consistent with wider initiatives around energy saving.
Smart meter deployment was always intended to facilitate demand response – the ability to charge differential prices to customers at different times of the day or week leading to changes in usage patterns, as well as providing more accurate billing and saving on meter readings. It appears that this is beginning to become a reality.
Smart meters are potentially the catalyst to a fundamental change in how consumers are charged for energy, which will have substantial wider benefits if new time-of-use pricing models can be used as a tool to optimally manage demand on the grid. These benefits are both financial and environmental, with lower peaks in load requiring less investment in infrastructure and generating assets and also leading to the use of less peak generation, which is both more costly and more intense in greenhouse gas emissions than baseload power.
Time-of-use pricing already exists to some extent with Economy 7 tariffs, lower night time rates and higher daytime rates, but British Gas’s free power on Saturdays represents an evolution of this and would be the first tariff of its kind in the UK.
Dynamic pricing is potentially the biggest tool at utility companies’ disposal to manage customer energy consumption patterns, and a 10 per cent shift in daily peak load achieved through dynamic pricing could lead to substantial infrastructure savings, according to Ofgem’s report Demand-side Response.
The savings come in three forms (see table): a daily wholesale cost saving, annual capital cost savings and annual network investment savings. The savings will accrue to all consumers in the form of lower bills.
Whereas the potential benefits of dynamic pricing as a way to manage demand are clear, for it to work in practice, energy retailers must communicate effectively with consumers and gain their consent.
The current direction of travel suggests this will not be straightforward. Ofgem’s Retail Market Review requires more transparency from suppliers and fewer tariffs, not more. With tariffs supposed to be getting simpler, to permit comparison between suppliers, how will companies convince customers and government to let them adopt a charging mechanism that is likely to be considerably more complex?
In addition, the industry will need to address concerns about the equity impacts of a time-based approach to pricing, because some groups of consumers will inevitably benefit more than others. As an example, those customers who are able to switch their energy use to cheaper times of the day or of the week would likely benefit most. Those who are less able to consume energy at different times – possibly groups such as the elderly or families – would potentially end up paying relatively more than other customers.
For dynamic pricing to successfully alter demand patterns, the incentives also need to be sufficiently material to change consumer behaviour. Marginal discounting of energy outside of peak times may not be adequate to generate the response required, necessitating an extensive period of customer research.
Dynamic pricing has the potential to revolutionise the energy retail battleground but the need to engage customers and appease restless stakeholders such as consumers and the government implies a stern battle to come. If it can be made to work, though, dynamic pricing would result in benefits for all consumers, including those who might remain on traditional tariffs.

Thomas Haller, partner; Richard Greenwood, director; Matthieu Vallin, consultant; and Christopher Peacock, consultant – all Simon-Kucher & Partners