March 18, 2011 - FERC's ruling on demand response compensation

Friday, March 18, 2011

This week, a ruling by the Federal Energy Regulatory Commission opened the door to the broader use of demand response to lower society's energy costs.  This ruling, called Order No. 745 (116 page PDF), has the potential to transform energy markets across the country and to provide electricity consumers a tangible benefit.

Part of the nation's smart grid strategy, demand response -- when customers respond to signals about the scarcity of electricity by temporarily reducing their consumption -- helps us reduce the height of the peak demand for electricity.  If we can reduce the height of those peaks, we can minimize the need for expensive peaking generation units that only run during the few hours a year when the grid is most stressed.  Demand resources can thus function much like generators, by creating "negawatts" instead of megawatts.  Because most electricity markets are designed so that power from marginal peaking generators is more expensive than baseload generation, it can often be cheaper to pay a demand resource to curtail its load than to pay a marginal generator to start up and run for several hours.

The value of demand response is clear, but until Tuesday's FERC ruling, how people should be compensated for demand response was up in the air.  The United States' electric grid is made up of a number of interconnected but distinct organized wholesale energy markets.  Each of these markets has been compensating demand response resources differently.  Some markets, like the Midwest ISO and California ISO, paid the same wholesale energy price to demand resources for their negawatt-hours as generators received for their megawatt-hours.  Other markets, like mid-Atlantic grid operator PJM, paid demand resources a reduced price for their negawatt-hours.

In Order No. 745, FERC found that this lack of uniformity of compensation across the nation's energy markets created barriers to reaching demand response's full potential.  FERC also found that other barriers to demand response existed under the status quo, including a disconnection between the wholesale and retail rates for energy.  By establishing a nation-wide policy that -- as long as they are cost-effective and capable of displacing the need for generation -- demand resources should be paid just like generators in organized wholesale markets, FERC hopes to eliminate these barriers.

So what does this mean?  In the wake of Order No. 745, we are likely to see greater use of demand response as a tool to save energy and lower its cost.  A number of businesses already help consumers participate in demand response, providing the technologies and strategies needed to make consumer participation a success.  Through the elimination of uncertainty and the establishment of a clear and fair compensation standard, these companies may see their businesses grow.  End-use consumers will also see a benefit, whether or not they participate in demand response.  Those consumers who do enroll in demand response programs will now know that they will be compensated fairly for their negawatts, a strong incentive to help the grid by curtailing their load during peak demand.  Even for those consumers who don't directly participate, greater implementation of demand response will lower everyone's electricity costs by displacing expensive marginal peaking generation.  Smart grid technologies are touted as capable of saving consumers money; through Order No. 745, the potential consumer savings have become more real.

2 comments:

Chuck said...

This ruling seems to be a boon for the DR Aggregator and a bad deal for the rest of us. The DR Aggregator seems to have a well defined and well compensated revenue stream for the DR the Aggregator. The compenstaion is considerably larger than the implementation and operating costs of the aggregation program. For the utility, the program means that the Aggregator is going to be paid for energy the utility never generated. The effect is that some of the utility's existing generation investment will be idle and revenues will be reduced. Further the utility's customers will pay a higher rate (somebody has to pay the Aggregator) and the rate increase will not flow to the utility. For the general consumer the rates will increase and the energy bills will be higher.
You say "Those consumers who do enroll in demand response programs will now know that they will be compensated fairly for their negawatts, a strong incentive to help the grid by curtailing their load during peak demand." I beg to differ with you. The consumer involved in a DR Aggregator's program will be compensated based on the agreement between the consumer and the Aggregator. In these programs so far the compensation is a small percentage of the revenue the Aggregator gets. Fair compensation for these participants is not part of this ruling.

Todd Griset said...

Interesting perspective Chuck. DR aggregators will benefit from this ruling, but consumers as a whole should too. FERC has a congressional mandate to promote competitive wholesale markets. Whether a given utility investment in generation gets idled depends on the cost-effectiveness prong of FERC's test; under Order No. 745, demand resources aren't entitled to be paid at the locational marginal price (LMP) unless the overall benefit of the reduced energy price resulting from dispatching DR exceeds the cost of dispatching and paying LMP to the displaced generation resources. Also, in restructured competitive markets, it may not be utility ratepayers who feel the impact of idled generation, but rather the pressure will be on all market participants to bid in prices as low as they can -- a competitive market. If marginal merchant units are displaced by cheaper alternatives -- either generation or DR -- consumers as a whole can save.

What that means for end-use consumers will depend on the rate structure for those consumers, and (for those participating in DR) their deals with their aggregators. Any consumers on real-time pricing, even those who aren't doing DR themselves, will see the benefit in the form of reduced LMP. While real-time pricing may currently be the exception, one of the possible avenues of the "smart grid" may be increased implementation of real-time pricing -- adding to the value this order could create for consumers. Other consumers may see value in the form of lower overall energy pricing through a more competitive market.

If you were in the regulators' seat, what would you recommend to bring end-use consumers greater value?

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