The smart grid just got smarter. Demand response -- when customers respond to signals about the scarcity of electricity by temporarily reducing their consumption -- is a key tool in efforts to reduce the cost of energy through the use of smart grid technology. As a society (or as a grid), if we can reduce the peak amount of electricity being demanded, we can not only reduce the need for the most expensive marginal peaking generation units, but we can also reduce the need for expensive transmission lines. Demand response thus benefits not only the person reducing consumption, but also all other ratepayers and the grid as a whole. It is a key component of our transition to a smart grid.
On March 15, 2011, demand response took a big step forward through a Federal Energy Regulatory Commission ruling on how people should be compensated for demand response participation. In Order No. 745 (116 page PDF), FERC ruled that organized wholesale energy market operators must pay demand response resources the market price for energy, known as the locational marginal price (LMP), when those resources have the capability to balance supply and demand as an alternative to a generation resource and when dispatch of those resources is cost-effective.
FERC noted that doing so is necessary to preserve and enhance the competitiveness of wholesale electricity markets, something FERC and Congress have promoted across the board. For example, in the Energy Policy Act of 2005, Congress established a national policy of eliminating unnecessary barriers to demand response participation. FERC has long held that active participation by customers in organized wholesale energy markets through demand response helps to increase competition in those markets, but had not previously required all organized wholesale markets to compensate demand response resources in the same manner. For example, PJM has been paying the LMP minus the generation and transmission portions of the retail rate, while ISO New England has paid LMP only when prices exceeded a threshold level. Even within a given market, the continual threat of policy changes resulted in a chilling effect on the full implementation and deployment of demand response.
FERC's Order No. 745 takes away this uncertainty. FERC held that demand resources should be paid at market-based prices when two criteria are met: capability and cost-effectiveness. First, the demand resources must have the capability to balance supply and demand as an alternative to a generation resource. To be paid at market prices, demand resources must be effective at displacing the need for bringing additional generation online. Second, the demand resources must be cost-effective alternatives to generation, based on a "net benefits test". In essence, this test is satisfied when the overall benefit of the reduced energy price resulting from dispatching demand response resources exceeds the cost of dispatching and paying LMP to those resources. If both of these criteria are satisfied, organized wholesale energy market operators must pay demand response resources the market price for their energy value.
Demand response has long had great potential to transform the way our power grids work. To reach its full potential, people must be compensated fairly for the value they provide through interrupting their consumption of electricity. With FERC's Order No. 745, that value has been established clearly.