Your house has an older natural gas hot water heater which develops a small leak, so you naturally decide that it is time to replace it. Because the leak is small, you have time to research the most efficient replacement for your home.

You discover that you have two choices.

Choice 1

Your electric utility is offering a rebate to switch to a more efficient electric heat pump water heater. It could save you money by heating water at off-peak times when electricity is less expensive.

But your electric rate plan has a large fee, known as a demand charge, that cuts into the savings you might experience with off-peak rates. Will you make the switch?

Probably not, because you know that every electric appliance you add to your household would raise your maximum kW demand, and you are trying to minimize it, as the demand rate encourages.

Choice 2

Your electric utility is offering a rebate to switch to the same water heater; however, the rebate program also requires you to pay a rate that reflects different costs of electricity throughout the day. This plan encourages you to shift your water heating to periods when electricity costs are low. Will you make the switch?

You probably would because you could save money, especially if you could enroll your smart thermostat, heat pump or electric vehicle (EV). This electrification program might allow you to meet your other values too, such as reducing your carbon footprint and using new technologies.

These two scenarios are exactly what the Smart Energy Consumer Collaborative (SECC) studies in its consumer research. The hypothetical described above depicts recent findings from thousands of survey responses:

• Consumers do not want demand charges.
• Consumers care about reducing carbon emissions.
• Consumers want to explore new energy technologies.
• Consumer interest in time-varying rate plans is high.

Electrification as a solution to climate change

Among the many changes taking place behind the meter, one of the more striking is the opportunity for beneficial electrification — electrifying end uses historically powered by fossil fuels.

Electrification is only beneficial if it achieves one of society's goals without harming another. Generally, this means reducing costs, enhancing grid flexibility and reducing carbon emissions.

Beneficial electrification provides the opportunity to convert space and water heating, which accounts for more than two-thirds of U.S. home energy use, to electricity. Likewise, EVs have the potential to lower the nation's transportation costs and emissions, which account for about 30% of U.S. greenhouse gas emissions.

Unlike traditional electricity load, much of the new electrification load from water and space heating and EVs possesses flexibility in when it needs to draw power from the grid. When connected with smart thermostats, heat pumps can provide load-shifting capacity, and EVs can be programmed to charge in the middle of the night.

Instead of simply placing demand on the grid, these loads are pliable and can provide system operators with a bigger toolbox for managing grid stability, which is of great value to utilities. Furthermore, some of the end uses being electrified provide storage capacity that can assist power system operators in accommodating more low-cost renewable energy on the grid.

Such innovative opportunities that benefit both utilities and consumers don't come along very often.

Beneficial electrification promises greater efficiency, flexibility and a significant path for reducing carbon emissions. However, understanding consumers' needs and ensuring consumer involvement is essential, since they will be making the investments required and must be willing participants for this transition to happen.

Getting rate design right is also critical; as SECC's research shows, it can encourage or end consumer involvement.

Demand charges enter the scene

At the same time the path toward beneficial electrification has begun, there has been a significant push from utilities toward adopting demand charges for residential customers. This has been initiated by electric utilities reacting to actual or potential reductions in sales, revenue and cost recovery.

The standard demand charge is a monthly fee composed of dollars per kW times the customer's highest kW usage in a short (e.g. one-hour) period during the billing month.

This rate design is a legacy of the 19th century, when utilities imposed demand charges on large business customers to differentiate customers with fairly stable loads from those who used lots of energy in a few hours, but much less the rest of the month. Utilities recognized the latter were more expensive to serve per kWh, and monthly maximum demand was the only other measurement available at the time.

Demand charges for commercial and industrial customers are common, and are easily understood and managed by professional energy managers.

However, demand charges for the residential rate class, either mandatory or default, are rare — in fact, with one recent exception, no state regulatory commission has granted approval for either mandatory or default residential demand charges despite dozens of requests from investor-owned utilities (IOUs) filed every year.

Does Bonbright's guidance support residential demand charges?

When creating rate tariffs, one of the most enduring and respected authorities is James Bonbright, whose "Principles of Public Utility Rates" lists criteria for a desirable rate structure with detailed attention to cost allocation and rate design.

Bonbright set out eight principles regarding fairness and equity of cost allocation that continue to provide guidance today. Residential demand charges appear to offer several violations of Bonbright's principles.

1. One of Bonbright's principles is that electricity rates should offer simplicity and understandability. This is difficult to achieve when a demand charge fee of $7.90/kW, for example, is calculated using the maximum kW usage during a customer's bill period for a 15-minute (or one-hour) interval up to a maximum of 13 kW. How can a residential customer understand such units and calculations? Consumers are not able to know the exact time when maximum demand for their bill period was hit, and in fact the maximum may occur during the last hour of the bill period.
2. Proponents claim residential demand charges are more appropriate than traditional two-part billing rates because they more fairly allocate fixed capacity costs. But do they? Bonbright lists "Fairness of specific rates in apportionment of total costs of service among the different customers" as a guiding principle. The Regulatory Assistance Project's "Smart Rate Design" research shows that apartment residents, particularly low-income consumers, would be disadvantaged because utilities serve the combined diversified demand of multiple apartments in a building or complex, rather than the much higher sum of individual apartment loads. In fact, very little of utility capacity costs are associated with the demands of individual small consumers.
3. Finally, most residential demand charges are non-coincident peak (NCP). Bonbright's "efficiency of discouraging wasteful use of service" principal seems in violation here. Even with traditional rate plans, expensive peak energy costs are integrated into a total fuel cost bucket and then divided among all consumers which adds hundreds of millions of dollars per year to overall costs. Large single-family homes with pool pumps and large HVAC systems consume more energy at peak than small users or apartment dwellers do. Thus, not only do NCP demand charge fees not address this legacy unfairness, they exacerbate it because consumers may refrain from using multiple appliances at once to avoid maximizing their demand, but shift usage to expensive peak energy.

The silver lining: Consumers are ready to engage

The transition toward electrification is well underway and likely to continue.

Many cities are adopting natural gas hookup bans to meet carbon emissions goals. The electrical grid is the cleanest it has ever been and is getting cleaner every day. The utility industry is well positioned to lead the way with clean electricity as a solution to climate change, and this new growth means the end of talk of a "death spiral" from distributed energy.

The slowness of regulatory bodies to approve residential demand charges may be a good thing.

We know from SECC's research that 62% of consumers would be interested in a time-varying rate plan with the right attributes, 78% believe more should be done to protect the environment and 70% are interested in switching to electric water heating. These high numbers indicate that consumers are ready to electrify with the right incentives.

Rate designs that customers can understand and allow them to save money are critical to this engagement.

Conversely, consumers on a demand charge tariff who may have been willing to electrify would likely choose not to, knowing that every electric appliance added will increase their demand. Demand charges introduces risk to consumers in the form of a new monthly fee without a benefit to them.

SECC's research shows that consumers avoid risk more readily than they accept new opportunities. Thus, demand charges and beneficial electrification appear to be mutually exclusive.

Energy providers are striving to become more than a commodity provider of electrons to consumers. Most IOUs now have staff dedicated to finding new business opportunities and offer new ways to provide energy services to their customers. SECC's research shows consumers are interested.

If we give consumers what they want, the future is bright indeed.