Political Economy of Responsive Energy Demand in Cyprus (2012)

7/30/2019 Political Economy of Responsive Energy Demand in Cyprus (2012)

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Enabling Responsive Energy Demand in Cyprus:

Shortcomings, Underlying Market Failures, and Policy Solutions

Matthew Bruchon

ESD.103 Political Economy Paper

November 20, 2012


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I. Introduction

To maintain stable operations, a power grid must constantly balance electricity supplied

to the grid and electricity consumed every minute of every hour of every day. This is often

achieved by treating demand as an exogenous, inelastic, unresponsive variable and adjusting

power generation to match it. Underlying this paradigm is the notion that electricity generation

is easily controllable and predictable, whereas demand is not.1 Recent developments in the

island nation of Cyprus challenge that notion, including national plans to bring large amounts of

unpredictable wind and solar power onto the grid in the next decade.2 Also, a catastrophic

explosion at a power plant in 2011 took much of islands electricity supply offline without

warning, providing a reminder that even conventional thermal power generation is not perfectly

reliable.3 One option that has been explored in other power systems around the world is making

demand more responsive to supply-side dynamics; in other words, some amount of energy

consumption could be capable of being curtailed, shifted in time, or increased at a given time to

match the current availability and cost of electricity. Cypruss grid can be made more stable by

this approach.

The growing value of responsive energy demand in Cyprus casts light on failures of the

Cyprus electricity market to enable any sort of dynamism on the demand side of the energy

equation; these market failures are common in many nations,4 and analyzing Cyprus lends some

1 Ilic M., Black J.W., and Watz J.L. (2002). Potential Benefits of Implementing Load Control.IEEE PowerEngineering Society Winter Meetingvolume 1, pp. 177-182.

2 Stylianou, Stelios (2012). The Future Development of the Cyprus Electricity Market on Conventional and

Renewable Energy Sources. Electricity Authority of Cyprus. 2nd Gulf Intelligence Levant Energy Forum.

3 Sharpe, Lorna (2011). Cyprus Over the Worst of Power Crisis. Engineering & Technology 6(8):8.

4Ilic M., Black J.W., Fumagalli E., Visudhiphan P. and Watz J.L. (2001). Understanding Demand: The Missing

Link in Efficient Electricity Markets. Energy Laboratory Publication, MIT, EL 01-014WP.


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general insights. The islands electricity supply is dominated by one firm, the Electricity

Authority of Cyprus (EAC). EAC possesses near-complete market power,5 and likely has little

incentive to enact programs making demand more responsive or to reduce total demand via

efficiency improvements. Even if the electricity market were competitive, thus erasing market

failures due to imperfect competition, a more fundamental market failure from imperfect

information exists. Nearly all consumers pay a flat electricity rate throughout the day and year,

and are not exposed to, nor aware of, the actual cost of producing the energy they consume at

any given time.6 Until a signaling mechanism of some type is created to communicate the cost of

electricity to consumers, demand cannot be made responsive to the needs of the grid. This

problem is made worse due to growing demand; electricity consumption in Cyprus has more than

doubled since 1990, and is forecast to triple in the next 20-25 years.7

In order to enable truly responsive demand, the nation of Cyprusand other nations with

similar concernsshould evaluate policy options to mitigate these market failures. Reducing

market concentration is a challenge, since Cypruss small size makes EAC a natural monopoly.

Fortunately, pragmatic policies can stimulate demand-side innovation regardless of this

imperfect competition. At a minimum, existing energy efficiency subsidies can be expanded to

encourage the use of modern building technologies that allow demand management to be

automated more readily. A more robust policy would go further, addressing imperfect

information by creating signals between the supply and demand via opt-in usage curtailment

programs or a dynamic pricing scheme. These policies are susceptible to regulatory capture, and

5 Zachariadis T. (2010). Forecast of Electricity Consumption in Cyprus up to the Year 2030: The Potential Impact

of Climate Change.Energy Policy 38:744-750.

6 Electricity Authority of Cyprus: Annual Report 2010.

7 Ibid.


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may be challenging to even implement due to collective actions issues, but ideally, the result

could be electricity markets that operate more efficiently and stably.

II. Motivations for Enabling Responsive Demand

In order to understand the value that responsive energy demand can provide to Cyprus, an

examination of the context of Cypruss energy supply is necessary. Cyprus has historically dealt

with less than ideal security of its energy supply. Like any island without a connection to a

mainland power grid, all electricity must be generated locally in Cyprus. 95% of this electricity

currently comes from burning fuel oil, which is imported from international sources at high cost.8

One source of supply-side insecurity comes from the availability and price of oil from its

international suppliers; most imports come from Syria and the Russian Federation.9 The

historical impact of this insecurity has been largely limited to high electricity rates, but the

impacts of two new developments on the supply sidea catastrophe at the Evangelos Florakis

Naval Base power plant, and growing solar and wind generationare more drastic.

On July 11, 2011, a large stockpile of explosive munitions stored at the Evangelos

Florakis Naval Base self-detonated suddenly and unexpectedly. The explosion killed 13 people,

injured 62, and damaged every house in a nearby village.10 The nearby Vasilikos Power Station

was severely damaged, thus taking roughly half of Cypruss generation capacity offline. For the

following month, widespread rolling residential blackouts were necessary due to supply

shortages. For a longer period of time, Cyprus also had to lease very expensive temporary

8 Stylianou,supra note 2.

9 Pilavachi P.A., Kalampalikas N.G., Kakouris M.K. et al (2009). The Energy Policy of the Republic of Cyprus.

Energy 34:547-554.

10 Cyprus Mail (2011): The Victims of the Naval Base Tragedy. Cyprus Mail.


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generators from Israel.11 This cost, coupled with the repair costs for the Vasilikos plant of nearly

one billion US dollars, drastically raised the cost of generation; the total economic impact of the

catastrophe has been estimated at 2.83 billion US dollars.12

More broadly, the Vasilikos catastrophe demonstrated that building a power system under

assumptions of exogenous demand, and thus a reliance on supply being fully controllable and

reliable, is risk-laden. Power systems are typically built to meet the peak level of aggregate

demand required at any instant, plus some safety margin; because it is an island, Cypruss safety

margin is stressed more easily. If Cyprus were connected to the European power grid, for

instance, a much larger safety margin would exist and blackouts may have been avoided, but the

costs of building a long-distance underwater grid interconnect are likely to be prohibitive, and no

such plan has been seriously considered.13 If a small amount of energy usage could be delayed

or brought forward in time to lower the peak demand level, more of the existing generation

capacity would exist purely to meet that safety margin, rather than being used every day; in the

case of Cyprus, the scale of the rolling blackouts might have been reduced. The value of

responsive demand as a partial mitigation for low safety margins is high in Cyprus because it is

an island; this is also true in other isolated power systems.14,15

11 Hajipapas A. and Hope K. (2011). Protests Follow Cyprus Navy Fire Deaths.Financial Times.

12

Al Jazeera (2011): Cyprus Ruling Coalition Partner Drops Out.

13 Pivalachi,supra note 9.

14Busche S., Connors S. and Critz D.K. (2012). Power Systems Balancing with High Penetration Renewables: The

Potential of Demand Response in Hawaii. National Renewable Energy Laboratory draft report.

15Livengood D, Sim-Sim F.C., Ioakimidis C.S., and Larson R. (2010). Responsive Demand in Isolated Energy

Systems.Island Sustainability 130:197.


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A second source of unpredictability in Cypruss energy supply is both expected and

planned. In order to meet European Union regulations, Cyprus plans to generate at least 16%

percent of its energy from renewable sources by 2020.16 The island currently generates roughly

5% of its energy from renewables, the majority of which comes from an 82 megawatt (MW)

wind farm at Orites that opened in 2010 and is the largest in the Mediterranean region. 17 By

2020, the island plans to increase its total wind capacity from 135 MW to 300 MW and its total

solar capacity from 9 MW to 267 MW.18 Compared to the slow and steady evolution over many

decades that characterize many power systems, these transformations are relatively rapid and

drastic. Solar and wind power are inherently intermittent, and also subject to forecasting errors.

This increasing unpredictability of supply may stress the grids ability to balance supply and

demand. As in the case of unexpected outages, this problem is exacerbated by the inability to

connect to a larger mainland power grid.

The typical method of mitigating this intermittency is to run very expensive, inefficient

peaking thermal generators on standbythe most inefficient output levelso they can react

quickly to fluctuations.19 This is sometimes complemented by the use of storage in the form of

pumped water, batteries or flywheels to smooth power supply fluctuations.20 Unfortunately,

Cypruss resources for large-scale pumped water storage are minimal; severe water shortages are

16Stylianou,supra note 2.

17 Ktisti, Sarah (2009). Cyprus Unveils Mammoth Wind Farm. Reuters.

18Stylianou,supra note 2.

19 Critz D. K. (2011). Power System Balancing with High Renewable Penetration: The Potential of Demand

Response. SM thesis, Massachusetts Institute of Technology.

20 DeAmicis P. (2011). Seasonal and Diurnal Variability of Wind and Hydro Energy Sources on the Azores,

Portugal and the Effectiveness of Utilizing Energy Storage to Achieve Maximum Penetration. SM thesis,

Massachusetts Institute of Technology.


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responsive demand draws attention to structural failures in Cypruss electricity market that form

obstacles to any meaningful demand-side innovations.

III. Market Concentration as an Obstacle to Innovation

The concentrated nature of Cypruss electricity generation may be one obstacle to

enabling more responsive demand, although the evidence available suggests this obstacle may be

secondary. This market concentration is not universal, but it is also not rare. Massive economies

of scale are needed to create the capital-intensive infrastructure to supply electricity, and natural

monopolies often arise,27an effect one might expect to see in small-scale or isolated power

systems such as Cyprus. In fact, this is why the European Union has exempted Cyprus from

certain aspects of liberalization.28 Still, even if these natural monopolies exist for perfectly valid

reasons, there is a risk that they may opt to exploit their market power in an unfair manner. At

any rate, their market dominance may reduce their incentive to invest in demand-side

innovations that could reduce the cost of providing electricity by allowing the grid to function

more efficiently.

The concentration of electricity supply in Cyprus is clear. Until 2004, EAC was the only

seller in a closed electricity market; at that point, 35% of the market was officially opened. In

2009 the market was opened with the exception of residential households, and plans exist to fully

liberalize the market by 2014 (Cyprus obtained an exemption from the European Commission

allowing it to delay full liberalization until that date). Despite this de jure liberalization, the

market is still largely de facto concentrated. EAC completely owns the transmission and

27 Black J.W. (2005). Integrating Demand into the U.S. Electric Power System: Technical, Economic and

Regulatory Frameworks for Responsive Load. PhD dissertation, Massachusetts Institute of Technology.

28 Cyprus Energy Regulatory Authority (2010). Report to the European Commission in Line with the Electricity

and Gas Directives for the Period July 2009 to July 2010.


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distribution networks; a recently established independent transmission system operator (TSO)

exists, but EAC operates the distribution network. In other words, electricity provision is largely

vertically and horizontally integrated. Cyprus has no functioning market for electricity in the

day-ahead or intraday time frames, and purchase agreements must be negotiated bilaterally

between EAC and the independent TSO.29

There is a current controversy in Cyprus regarding the question of whether EAC

exercises its market power in an undue fashion. Electricity is expensive in Cyprus, and

frustrated citizens have alleged that the high rates are due to EACs monopoly.30 On the other

hand, EAC has argued via press releases that high rates are reflective of the high costs

throughout the energy supply chain: imported oil is extremely costly, the national government

has been slow to allow creation of a less costly natural gas supply, and a fraction of the monthly

bill is a surcharge to cover a government-mandated rate paid to independent producers of

renewable generation.31 Furthermore, a precise formula approved by regulators links electricity

prices to the cost of imported oil.32 It is not obvious from available data that the EAC has been

exercising its market power unfairly; it could simply be operating as efficiently as it can in a

highly constrained position.

A more general, and perhaps less controversial, concern related to EACs market

dominance is their resulting lack of incentive to innovate in new demand-side innovations. If the

29

European Commission (2007). Cyprus Internal Market Fact Sheet.

30 Psyllides, George. Fed Up Consumers Call for End to EAC Monopoly. Cyprus Mail.

31 Electricity Authority of Cyprus (2012). The Cost of Electricity Generation in Cyprus-29/2/12.

32 Zachariadis,supra note 4.


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market functioned with perfect competition, EAC would undertake various economically rational

actions to reduce generation costs and maintain market share. Studies have shown that modest

levels of responsive demand can easily pay back the required investments by allowing existing

conventional thermal generation to run more efficiently, and by allowing renewables to be used

to their maximum potential.33 Without the threat of competition to motivate EAC to attempt

such a strategy, the utility may be unlikely to be a leader of any such demand-side innovation; a

business-as-usual strategy yields an equally captive market.

One promising development in favor of competitive electricity generation lies in the

national policy for integrating distributed generation from renewables. The independent TSO is

obligated to offer a grid connection to independent renewable generators if they meet certain

technical requirements, and the feed-in tariff ensures a return on investment for the independent

generators. These incentives, coupled with a climate conducive to renewable generation

including very strong potential for solar generation compared to the rest of Europe34should

help bring online distributed renewables. However, a recent study indicated that bureaucratic

hurdles are a major impediment to distributed generation; approval is needed from 19 different

offices simply to get a building permitthe first of many steps in gaining a grid connection

and while no licenses have been rejected by the TSO, delays are severe.35 It is not clear that

there is any kind of nefarious institutional motivation behind these delays, so it is reasonable to

believe they are simply due to lack of resources to process applications quickly.

33 Critz,supra note 19.

34 Koroneos et al, supra note 21.

35 Maroulis, G. (2011). RES-Integration Country Report Cyprus. Eclareon gmbh and Institute for Applied

Ecology.


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Regardless of licensing and permitting issues, some studies indicate that large-scale wind

farms and new natural gas plants may decrease market concentration in the long term. But even

if this does not occur, a concentrated market is not necessarily the market failure of most concern

to developing responsive demand. Even if the electricity markets were fully competitive, more

fundamental aspects of the markets structure creating imperfect information on the demand side

would still hinder development of responsive demand. This problem of imperfect information is

the crux of the issue of largely unresponsive demand, in Cyprus and in other electricity markets,

and it warrants further examination.

IV. Obstacles due to Imperfect Information

In Cyprus, as in many energy systems worldwide, the end consumer is not made aware of

the real cost to create the electricity they consume at any given time. Rather, the consumers

monthly bill is based on the total energy usage that month, regardless of when the energy was

consumed. If the consumer uses a given amount of energy heavily during peak hoursrunning

an air conditioner in the late afternoon, for examplethey are charged the same amount as if

they had used that energy during the middle of the night, when very few other people are

consuming much energy. There are two tariff scheme alternatives for consumers who wish to

opt into coarse, two-tiered time-of-use tariffsone in which there is a special low rate for

overnight hours, and a separate rate structure option in which there is a special high rate for

midday peak hoursbut flat pricing is the default, and the plan used by 96% of consumers .36 It

is not clear from available evidence whether the lack of participation in alternate tariff schemes

is due to poor publicity on the part of EAC, consumer risk-aversion, or other factors.

36 Electricity Authority of Cyprus,supra note 6.


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This flat pricing structure is far from optimally efficient, because the real costs of energy

are not flat. During peak hours, generators are operating at full capacity (sometimes including

extremely expensive peaking generators). At other times, transmission lines may be

congested. At still other times, there may be a surplus or deficit of generation from renewables

which cause an excess or shortfall of available electricity supply. Aside from these effects at a

relatively short, hourly timescale, the power system must operate more or less efficiently

different days of the week, since energy is consumed differently on weekends than on weekdays.

There are also seasonal variations in power system operation due to climate and tourism

patterns.

37

An additional factor in Cyprus is the variation in imported oil costs. None of these

effects are communicated in a flat rate price, and many of them are not conveyed via the optional

two-tier pricing schedule.

In an idealized electricity market operating in a fully efficient manner, generators and

consumers would negotiate the price of each kilowatt-hour exchanged to reflect the current costs

of supplying electricity and the current demand level. When costs of generation were higher, the

market price would reflect so, and the consumer would either consume less or pay more money

to consume the same amount. Similarly, when costs were low, market prices would also be low

(or negative in some cases, such as if the utility prefers to raise demand rather than quickly ramp

down a large generator), and the consumer would be more inclined to consume. A flat electric

rate, as used in Cyprus at present, is the antithesis of this market structure. The consumer simply

pays a rate determined by the regulatory authority and EAC. The relatively opaque translating of

ones energy usage habits into a monthly bill helps explain the publics frustration with EAC.

The lack of such price information is a form of imperfect information: the consumers monthly

37 Black,supra note 27.


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bill should be proportional, at least in theory, to the costs of running the Cyprus power system to

generate the power they used, but there is no signaling mechanism (price-based or otherwise) to

inform them of the impact their behavior has on the system operation costs.

The value of fixing this lack of signaling is clearer in a hypothetical scenario. If a person

were to arrive home from work at 5 P.M. and then start a load of laundry to prepare for the next

workday, they would be consuming energy at the least efficient time of the day, when the

expensive peaking generators must be utilized. If they were to start the laundry at 8 P.M.

instead, when overall demand levels are lower, there might be no negative impact on their

personal welfare. The power grid could operate more efficiently by relying less on peaking

generators and more on relatively cheap base load generation, thus lowering total system costs.

This transaction would be a Pareto improvement; overall welfare would be improved without

reducing any individuals welfare. However, the lack of complete information prevents the

transaction from being carried out. The result is essentially a cross-subsidy in which the

consumer who does laundry during peak hours is subsidized by the consumer who does laundry

power later in the evening.38 The negative or positive impacts of different energy consumption

patterns are pricing externalities, and fixing the imperfect information problem on the demand

side could allow for those impacts to be internalized into the market price.

To be clear, the shielding of the consumer from the actual cost of generation has a valid

historical basis. Traditional economic analyses often assume transactions are frictionless,39 an

assumption that does not apply to energy usage transactions. The consumer would tire quickly

38 Borenstein S. (2005). The Long-Run Efficiency of Real-Time Electricity Pricing.Recent Work, Center for the

Study of Energy Markets, University of California Energy Institute, U.C. Berkeley.39 Golove W.H. and Eto J.H. (1996). Market Barriers to Energy Efficiency: A Critical Reappraisal of the Rationale

for Public Policies to Promote Energy Efficiency. Energy & Environment Division, Lawrence Berkeley National

Laboratory, U.C. Berkeley.


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of having to adjust their consumption patterns minute by minute to match the whims of the

power grid and many households are empty (or the occupants are asleep) much of the day.

Having to do so may well decrease his overall personal economic welfare. It is also a technical

challenge for a fair market price to be set rapidly when there is no truly functional market, and

no two-way communication between buyers and sellers; even calculating the cost of generating

the electricity at a specific instant may be hard for the utility to do. Furthermore, exposing the

end user to instantaneous price fluctuations might be unfair, since distributional effects arise

when certain consumers can react more efficiently than others. There may be a risk that dynamic

prices would encourage suppliers to change prices faster than consumers could react, although

this concern is tempered by the fact that flat-rate designs also offer a temptation for generators

to manipulate the market in various ways.40 In all of these respects, flat rate pricing does

appear to insulate consumers from volatility.41

However, much recent work has explored technological systems to enable automated

communication and transactions between suppliers and consumers, and automated

responsiveness of demand to signaling. For example, Daniel Livengood and Richard Larson

explored a household energy management system, dubbed the Energy Box, which could act as a

proxy for the houses inhabitants. The inhabitants could input their personal temperature

preferences, for example, and the Energy Box could automatically react to price signals by

changing the thermostats set point.42 Woei Ling Leow extended this work to include per-room

automation of thermostats, automatic learning of individual occupancy patterns, and remote

40 Spees K. and Lave L. (2007). Demand Response and Electricity Market Efficiency.Electricity Journal 2007,

20(3):69-85.

41 Black, supra note 27.

42 Livengood D. and Larson R. (2009). The Energy Box: Locally Automated Optimal Control of Residential

Electricity Usage. Service Science 1(1):1-16.


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updating via smartphones.43 There are also various real-world building energy management

systems currently in use, with varying levels of usability and intelligence.

These technological developments are promising, since they enable dynamic pricing

schemes without requiring constant consumer attention. Viewing the problem from a behavioral

science standpoint, more advanced energy management systems make passive consumption,

such as simple thermostats with little direct human intervention, relatively more active on the

part of the consumer by incorporating their preferences; studies dating back to 1983 note a

general need for systems and policies favoring less passive energy consumption patterns.44 Still,

without a market structure creating an incentive for demand to respond to supply-side signals,

many demand-side management technologies are largely impotent.45

V. Policy Solutions and Complications

Cypruss current policy strategy to address the demand side of the energy equation is

minimal, consisting largely of subsidies and mandates to encourage the introduction of more

energy efficient electric appliances and the improvement of the energy behavior of buildings in

the residential and service sectors.46 For example, in 2009 the governments policy included

providing five free compact fluorescent lamps to every household and providing subsidies to

improve insulation. There are also several command-and-control style mandates in place; for

example, installation of solar thermal water heaters is mandatory in new houses (due to strong

43 Leow W. L. (2012). Zoning and Occupancy-Moderation for Residential Space-Conditioning under Demand-Driven Electricity Pricing. PhD dissertation, Massachusetts Institute of Techhnology.

44 Dholakia R.R. and Dholakia N. (1983). From Social Psychology to Political Economy: A Model of Energy Use

Behavior.Journal of Economic Psychology 3:231-247.

45 Federal Energy Regulatory Commission (2009). A National Assessment of Demand Response Potential.

Federal Energy Regulatory Commission Staff Report.

46 Pilavachi,supra note 7.


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sunlight and historical reasons, one in every five existing houses has a solar thermal water heater

rather than a gas- or electricity-powered one), and periodic maintenance and inspection of air

conditioning systems is required.47

These efficiencies and mandates are sensible policies, and a strong first step in enabling

energy consumers to behave more optimally in the larger power system. A recent study showed

that much of the islands energy usage surge in recent history has been due to more widespread

use of electric applianceslargely those used for heating and cooling buildingswhich are not

designed for efficiency.48 This surge is largely driven by increasing temperatures, and one study

found that global warming alone may cause an increase of 95 MW in demand levels by 2030.49

Implementing measures to make these appliances more efficient, and to make buildings better

insulated, will lower total and peak demand levels. This will have the effect of increasing the

safety margin of generation capacity with existing infrastructure, and potentially help stem the

long-term growth in demand which will require large investments in new generation. Reducing

the amount new generation required will make it easier for renewables to meet the 16% of total

generation as mandated by the E.U., and one study found that bringing the growth of

consumption under control is crucial to meet those E.U. requirements.50 Furthermore, due to

recent disproportionate increases in consumption during hot summer months, literally every

generator on the island has been running at a level which violates E.U. emissions quotas.51

47 Cyprus Institute of Energy (2009). Energy Efficiency Policies and Measures in Cyprus.Monitoring of Energy

Efficiency in EU 27, Norway and Croatia (ODYSSEE-MURE).

48 Zachariadis T. and Pashourtidou N. (2007). An Empirical Analysis of Electricity Consumption in Cyprus.

Energy Economics 29:183-198.

49 Zachariadis T.,supra note 5.

50 Maroulis,supra note 35.



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These efficiency standards fall largely into the category of passive efficiency; that is, they

simply favor common-sense designs which use less energy to allow the same status quo behavior

and comfort level. However, efficiency is only one part of the equation, since a recent study

found the rise in household appliances has decreased the potential to respond to prices.52 The

subsidies should be modified to include new standards requiring (or at least subsidies to

encourage) installation of automated energy management devices. This is a broad category of

technologies which could include anything from thermostats that can be scheduled to turn off at

certain hours to the more advanced integrated management systems described by Livengood,

Larson and Leow.

53

These devices are a crucial first step to reducing peak demand levels (which

generation must be built around) and, more broadly, enabling energy demand to be more

responsive to the dynamic state of the grid. These building management technologies dont

necessarily need to be rolled out to entire sectors at once; in fact, if they are introduced to a

smaller number of households first, lessons can be learned as their use spreads. One idea is to

offer a subsidy for all houses, but a stronger subsidy (or perhaps a mandate) to new construction.

The specific type of energy management technology to subsidize depends on the policies

regulating electricity markets; this is why efficiency and building management technology

policies should be coupled with changes to the market structure. As noted above, market

restructuring policies to address imperfect information issues and the related pricing externalities

due to flat electricity rates are of the most importance; increasing competition should be

considered secondary. Top-down command-and-control policies to regulate energy demand are

likely to be politically infeasible. They clearly have a rolesuch as when rolling blackouts were

arranged following the Vasilikos catastrophe, and targeted at residential users to minimize

52 Ibid.

53 Livengood D. and Larson R.,supra note 43; Leow W.L.supra note 44.


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overall economic impactbut seem inadvisable in the day-to-day grid operations. Robust

policies to make demand more responsive should focus instead on dynamic pricing schemes

which essentially enable Coasian transfer payments between energy users at different hours of

the day. Aside from this ambitious goal, policies should at least use taxes or subsidies to

incentivize the good behavior of responding to the conditions of the grid.

The most direct way of addressing the externalities arising from imperfect information on

the demand side is to expose energy consumers to prices more reflective of actual grid

conditions. This could take the form of real-time pricing (RTP), in which the independent TSO

could send pricing signals directly to households. This could take various forms; typically,

prices are published no more often than once per hour, and price forecasts are typically provided

to customers in advance of the hourly updates. This is perhaps the most efficient type of pricing

scheme, since it most closely ties electricity price to generation costs and captures a far larger

share of the variation in supply-side costs compared to other schemes.54 However, the setup

costs are high compared to other options; RTP participants must have a meter capable of

receiving instantaneous pricing signals, whether via a cellular antenna, the Internet, or some

other communications method. Ideally, such a program participant would also have an

automated energy management system responding to those price signals and adjusting each

appliances usage in real time.55

If such a program were deemed impractical due to the need advanced metering in houses,

a less capital-intensive but also less optimal option is to institute time of use (TOU) pricing. In

54 Borenstein S., Jaske M., and Rosenfield A. (2002). Dynamic Pricing, Advanced Metering, and Demand

Response in Electricity Markets.Recent Work, Center for the Study of Energy Markets, University of California

Energy Institute, U.C. Berkeley.

55 Mohsenian-Rad A. (2010). Optimal Residential Load Control with Price Prediction in Real-Time Electricity

Pricing Environments.IEEE Transactions on Smart Grid1(2).


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this scenario, each hour of the day would have a pre-determined price regardless of the day of

year; for instance, rates at 5 PM of every day could be set at a certain level. Under TOU pricing,

pricing schedules are set based on historical average, and need only be communicated once via

mail or some other low-tech method, so no two-way communication is needed.56 There are

variations on this; for example, one TOU pricing schedule with drastically higher prices could be

used for the hottest, most energy-intensive weeks of the summer and another could be used for

the rest of the year; there could also be different weekday and weekend pricing schedules.

However, there is a basic tradeoff between the number of different pricing schedules and the

ability of the consumer to understand and respond to them. Because costs are not simply

dependent on the day of the week or the hour of the day, this is still less optimal than RTP

schemes. After all, wind and solar can fluctuate, both on an hourly and a daily timescale; these

effects on generation costs would not be internalized and the benefits of the program would be

reduced.

A third class of responsive demand policy could focus on load curtailment programs. In

these programs, participants often pay a reduced (but still flat) electricity rate in exchange for

consenting to curtail load at peak hours; the number of hours per year a given customer will

curtail usage is typically agreed upon in advance. In another type of load curtailment program,

consumers tell the TSO the level of reimbursement at which they are willing to cut energy usage;

when prices rise above this level, the TSO can request or instruct the consumer to curtail usage.

These strategies are designed not to improve the overall market efficiency in a continual manner,

as in an RTP scheme, but rather to meet the more targeted goal of shaving demand at the highest

peak hours. One issue with load curtailment programs is that there is often a rebound effect in

56 Critz D.K., supra note 19.


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which curtailing energy demand at one hour leads to even higher energy usage later, as the

energy use makes up for lost time (as in the case in which an air conditioner is switched off).

Peak demand levels are reduced, but average demand levels may actually increase.57

Each of these classes of policy has been attempted in various electricity markets around

the world, often as small-scale pilot programs to begin, which allows for learning and

improvement via experimentation.58 Cypruss own coarse two-level TOU pricing options, with

4% enrollment thus far, likely have provided lessons from which Cyprus can learn, although

relatively little data is currently publicly available. Pricing the program well is vital, particularly

in terms of how drastic pricing differences are hour-to-hour and in terms of the payments given

for responding to signals to curtail or shift load. For example, if subsidies for participating in a

load curtailment program are too low, then the reduction in total system costs caused by the

program participants is not fully internalized by the program, and there is a free rider effect

due to those who opt to keep flat rate pricing. On the other hand, if pricing variations from hour

to hour are too high, consumers could conceivably all increase or decrease usage in unison,

which can cause system instability.59

A 2009 study examined 50 years worth of demand data in Cyprus to analyze the

behavioral aspects of energy consumers, both residential and commercial, on the island. One

key finding was that demand is mostly dependent on weather and outside temperature, and that

large price fluctuations will have small influence on electricity consumption.60 At first glance,

this seems to suggest that a dynamic pricing scheme is likely to be ineffective. However, the

57 Ibid.58 Federal Energy Regulatory Commission (2011). Assessment of Demand Response and Advanced Metering.

Federal Energy Regulatory Commission Staff Report.59 Black J.W.,supra note 29.



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consumers analyzed in the 2009 study did not have the ability to see price fluctuations, nor did

they have devices to automatically adjust electricity usage of appliances, so the finding is not

directly indicative of dynamic pricings potential. In fact, a FERC analysis of a responsive

demand program in the Washington State found that program participants (who manually

adjusted their power usage, without automated devices) were initially overly eager to adjust their

load in response to even very weak price signaling. Because of this, they quickly grew tired of

the program when their monthly savings were too small to justify the inconvenience.61 Finding a

happy medium between weak and strong price signals is challenging but possible.

Any policy implemented to make demand more responsive has the potential to reduce

generation costs, lower prices, reduce pollution (by reducing the need for inefficient peaking

generators), and increase overall welfare. However, virtually any policyin this context or

elsewhereis susceptible to capture, as described by Stigler.62 As Jason Black notes, electricity

utilities profits rise as more energy is consumed at more expensive, inefficient hours, so they are

likely to favor demand-side programs that have a strong appearance of efficiency and green-ness

but a low degree of actual efficacy.63 In the case of Cyprus, it may help that the TSO is

independent and designed to lower total system costs; however, the political influence of EAC,

as the owner of all electricity infrastructure, may outweigh all other concerned parties. Various

new players may enter the electricity sector in Cyprus, including manufacturers of building

management technologies and telecommunications providers responsible for enabling

communication between homes and the TSO. If policies are designed in a way that requires the

61 Federal Energy Regulatory Commission, supra note 49.

62 Stigler G.J. (1971). The Theory of Economic Regulation. The Bell Journal of Economics and Management

Science 2(1):3-21.

63 Black J.W., supra note 29.


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government selecting winners, the potential for Stiglerian capture and rent-seeking exists. There

are mitigations for these risks, such as open bidding processes for new infrastructure work and

more generally a transparent policymaking process, but they are not foolproof.

Because of its near-complete ownership of Cypruss electricity infrastructure, EAC is in

all likelihood the largest employer of electricity specialists on the island. Accordingly, for those

specialists who work at the Cyprus Electricity Regulatory Authority, EAC is likely to be one of

the most appealing job alternatives. Because of this, EACs dominance may have a chilling

effect on development of potential regulationswhether via regulatory capture or influence of

the legislative processeven if it hasnt traditionally been exercised in a nefarious manner.

EAC is likely to be resist policies that give any other parties an interest in gaining the power to

affect Cypriot electricity markets. Some of the new players in a responsive demand-equipped

electricity market may have interests aligned with, or at least orthogonal to, EAC, but others may

have conflicting goals. For example, automated energy management systems may reduce total

demand, and thus the total generation sold by EAC. Regardless of whether the overall effect is

negative or positive for EAC, the degree of market uncertainty would rise for EAC versus the

status quo. Also, since responsive demand programs tend to reduce the cost of integrating

intermittent generation by helping balance the grid, producers of wind and solar might be able to

enter the market more easily, thus reducing EACs market share even more than existing

renewable feed-in tariffs alone will. Resistance to these changes on the EACs part seems

logical. Various policy options exist to limit a large firms influence on policymaking. For

example, limitations could be placed on jumping from public sector work to a regulated

company, or political contributions from heavily regulated institutions could be limited.


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Aside from these issues of regulatory capture by affected institutions such as EAC, a

broader political failure problem associated with new responsive demand programs is that of

collective action. As described by Olson, collective action problems arise when the costs of an

action or policy are concentrated but the benefits are dispersed.64 There is not any single

institution on the ground in Cyprus which would benefit greatly from more responsive demand.

Rather, the benefits would be dispersed among the populace in the form of somewhat lower

electricity bills and a more stable grid. Put another way, the options are to continue the status

quobuilding more generation capacity owned and operated by the utility, thus increasing its

total profitsor to implement demand-side policies and build slightly less new capacity. The

latter option represents a sacrifice on the part of EAC, and benefits that are widely dispersed. In

the absence of a top-down impetus from the Cypriot government or EU, it would require political

support, and organization, of the populace at large to advocate for those dispersed benefits,

which Olson considers quite difficult. If the case can be made to the public that demand-side

investment pays for itself by lowering the high cost of electricity in Cyprus, then perhaps public

support and advocacy for such investments can grow.

Even if these policies are open to capture, and difficult to even implement due to

collective actions issues, they are still worth exploring. There is a wide body of evidence

showing the potential economic value of responsive demand programs, particularly on islands

such as Cyprus, and the technology exists. While real-time pricing may be the most optimal

policy in terms of absolute efficiency, time-of-use pricing or load curtailment incentive programs

would also increase the grids ability to balance supply and demand. If these responsive demand

programs are deemed infeasible, simply extending existing efficiency subsidies and standards to

64 Olson M. (1982). The Rise and Decline of Nations: Economic Growth, Stagflation, and Social Rigidities. Yale

University Press.


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include automated energy management devices would lay the groundwork for future demand-

side policy. Given that supply of electricity in Cyprus is far from fully predictable and

controllable, and that demand is increasing at an unsustainable rate, the incentive to start

assessing responsive demand policies sooner rather than later is growing.

Documents

Political Economy of Responsive Energy Demand in Cyprus (2012)