What Would You Pay To Stay Cool?

Ashlea Ebeling, 08.15.07, 6:00 AM ET

Washington, D.C. - Tucked in the massive energy bill passed by the U.S. House of Representatives Aug. 4 is a provision that uses $2.25 billion in matching grants to promote an energy-saving idea that appeals to both free marketers and environmentalists.

The idea: smart grid technology. In its simplest form, it lets your "smart" electric meter talk back to the utility and record your usage by hour, so you can adjust your habits to take advantage of lower, off-peak rates.

Maybe, for example, you 'd be ready to put off running your dishwasher until 3 a.m. if you could do it with electricity that costs 5 cents a kilowatt hour, instead of 25 cents. (Today, most residential consumers pay a flat rate--a national average of 9 cents a kilowatt hour, though local rates vary widely.)

The government wants smart grids to help prevent blackouts caused by too many people running their air conditioners and their dishwashers at the same time. Environmentalists like the idea because they believe it has the potential to reduce total energy consumption and thus help to curb carbon emissions and stop global warming.

Utilities, however, are concerned about being able to recover the investment needed to switch to this new technology, and about potential backlash when customers see on their bills that they are paying much more to run their air conditioners on so-called "critical" days--like the dog days of August.

But the utilities need smart grid too because it will help them meet new federal standards for power reliability, argues Sterling Burnett, a senior fellow at the National Center for Policy Analysis in Dallas, a free-market think tank. "In almost every region we're soon to be below the safe margin (for reserve energy) for high energy use days," he says. "This is a quick way of reducing demand," he adds. Burnett, naturally, is a fan of deregulation and argues that it helps spawn innovative ways to control costs and rates, including smart grid technology.

As of now, most residential and commercial customers still pay their electric utility a flat rate multiplied by the kilowatt hours they use. A meter man stops by each house and reads the electric meter, or drives by and picks up the reading. "That 's a dumb grid," says Burnett. (In deregulated states, some commercial customers--for example, a big office building or factory using 500 kilowatts or more at once--already have special pricing deals with utilities, with prices varying by the hour.)

But with a smart grid in place, a utility could restructure rates, and then offer all its customers products that allow either the customer, or the utility, to control usage based on demand and hourly rates. Example: A smart thermostat allows a customer to program it so when the electric rate hits a certain price on a summer day, the target temperature in his house becomes two degrees warmer and the air conditioner doesn't run as much. (Comverge (nasdaq: COMV - news - people ), which has sold 4.5 million of these smart thermostats, went public in April.)

Customers who don't want their thermostat on autopilot could change their habits, by keeping the thermostat higher some days and running the electricity-hogging clothes dryer when off-peak prices are in effect. Or, they could decide not to change their power consumption ways and pay a much bigger bill.

Will customer behavior really change? And how expensive must electricity be to spark a change? In a California test that ran from 2003 through 2005, the average customer reduced his usage by 13% during the hottest summer hours when rates were five times higher. Customers with smart thermostats reduced their usage by 27%, and customers with gateway systems, which adjust the electricity use of multiple appliances, reduced their usage by 43% during the peak hours.

"The pilot showed conclusively what could be done," says Ahmad Faruqui, a consultant with the Brattle Group in San Francisco, who advises utilities on the economics of smart grid technology.

All three big investor-owned utilities in California (serving 85% of Californians) are committed to rolling this out to everyone, Faruqui says. The three are Pacific Gas & Electric (amex: PCG.PR.A - news - people ), San Diego Gas & Electric (amex: SDO.PR.A - news - people ), and Southern California Edison (amex: SCE.PR.B - news - people ), which just filed its intent to go to smart grid with the Public Utilities Commission on July 31. The timing of the roll out should be decided by next summer.

Other states are testing smart grid technology with variable pricing too. In Maryland, Baltimore Gas & Electric will begin a pilot next year in 5,000 homes and plans to roll it out to all its customers if the pilot succeeds. In the Chicago region, Commonwealth Edison, a unit of Exelon (nyse: EXC - news - people ), is now expanding a pilot from 1,100 to 120,000 customers. Potomac Electric Power Co. (nyse: POM - news - people ) in Washington, D.C., is doing a test this year. Hawaiian Electric Co. (other-otc: HAWEL.PK - news - people ) plans one for 2008.

Both the House and Senate versions of the pending energy bill encourage the use of smart grid technology, but don't mandate it. Both call for an updated study of the subject. More significantly, the House bill authorizes a Smart Grid matching grant, which could go to either the utilities or the customers, with total funding of $2.25 billion through 2012. That's at least a start towards the $14 to $26 billion the Federal Energy Regulatory Commission estimates it would cost to install the technology nationwide.

In the meantime, for smart grid technology to succeed, states must lift regulatory barriers to allow variable rates, and more utilities must take the plunge, says Arthur "Bud" Vos, vice president of marketing, products and strategy for Comverge. Regulators are dealing with concerns that smart grids will price poor people out of air conditioning in the summer.