Court overturns FERC Order 745 on demand response

A federal appellate court has overturned the Federal Energy Regulatory Commission's key ruling on demand response -- when electricity customers respond to signals about the scarcity of electricity by temporarily reducing their consumption -- and how it should be compensated.

A smart grid technology, demand response can be a key tool in reducing the cost and environmental impact of society's electricity needs.  In most US markets, as the demand for electricity rises (such as during a summer heat wave), grid operators turn to increasingly expensive generating units for new supply to meet that demand.  Those "peaking" units -- used primarily to supply energy during times of peak demand -- are thus relatively expensive.  In many cases, they also rely on fuels like oil that lead to increased emissions of pollutants and carbon dioxide.

Demand response offers an alternative solution.  Customers participating in demand response programs agree to reduce their consumption of power from the grid when so instructed by the grid operator.  For example, an office building might commit to temporarily reduce its air handling load, or a factory to reduce or pause its manufacturing operations.

This can provide much the same benefits as generation, by balancing electricity supply and demand, for a lower cost than generation solutions and without causing incremental air emissions.  Demand response can also avoid the need to develop new or upgraded transmission lines, because it solves the problem through reduced energy flows.  Demand response programs therefore provide benefits to the entire grid, and have been established by both organized wholesale markets and vertically integrated utilities across the country.

While demand response's value to the grid is clear, how to compensate customers for their curtailment remains a key question.  In 2011, the Federal Energy Regulatory Commission issued a landmark order known as Order No. 745.  In Order No. 745 (116 page PDF), the Commission 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.  Order No. 745 thus represented a major step forward for both demand response providers as well as all customers in markets with demand response program.

But some energy industry associations did not like the rule, and challenged the legality of Order No. 745.  The Electric Power Supply Association appealed the Commission's order to a federal court.  Meanwhile, other groups supported the rule, including industrial energy consumers and environmental advocates.

Today the D.C. Circuit Court of Appeals agreed with the appellants, holding that the Commission overstepped its jurisdictional bounds by encroaching on the states’ exclusive jurisdiction to regulate the retail market.  The court ruling, issued in the case Electric Power Supply Association v. Federal Energy Regulatory Commission (44-page PDF), vacates Order No. 745 and remands it back to the Commission.

If the Commission is to require fair compensation for demand response providers, it will have to find a new way to do so -- and one that would survive renewed judicial challenge.  In the meantime, grid operators are faced with a challenge (and an opportunity): whether and how to revise the way they pay customers for demand response.  As demand response's value remains beyond debate, the economic and environmental pressures that led to Order No. 745 remain strong, so expect this issue to continue to play out over the next year.