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Demand Response & Reliability: Follow the Fed Model

Regional demand resource banks, based on the Federal Reserve Bank system, would make for greater use of customer demand response mechanisms while ensuring long-term resource adequacy.
Fortnightly Magazine - May 1 2003

Regional demand resource banks, based on the Federal Reserve Bank system, would make for greater use of customer demand response mechanisms while ensuring long-term resource adequacy.

Demand response is the only resource available to electricity markets that is not plagued by long lead times, severe regulatory scrutiny, and environmental concerns.

In a perfect world, retail prices would moderate electricity markets, and a fair amount of demand response would happen naturally. However, as the 2001 California power crisis demonstrated, regulatory and political bodies are sometimes unwilling to allow price to do its job. This unwillingness has two outcomes:

  • Very little liquidity is induced into the market for approaches like demand trading (negawatts for megawatts).
  • In an infrastructure that has few viable physical storage mechanisms, preventing price from performing will lead to boom/bust cycles in reliability.

But just how do we ensure long-term resource adequacy, especially if demand grows? Plain common sense would seem to imply that any member of the electricity value chain today should seek demand response as a mechanism for competitive differentiation, price-risk mitigation, and reliability enhancement. However, the uncertainty and intermittence in demand response valuation devastate the business case for widespread inclusion in electricity markets at this time. And, given that there is currently little to no financial incentive to even maintain the market's current inventory of demand response mechanisms, and the regional ISO/RTO rules are going to find a new home for only a portion of them, it seems almost certain this critical infrastructure resource will atrophy while the profit motivation for the development of new resources continues to suffer.

Market forces generally are not considered adequate to ensure reliability in critical infrastructures because the communication of price opportunities might not have sufficient advance timing to provide adequate resources in response. As a result, criteria, such as some level of reserves, generally have been used to preclude worst-case scenarios. However, adequate reserve margins are questionable future prospects.

The long-run benefits of customer demand response participation are clear, but market uncertainty is a real problem. Forecasts for a cooler than normal summers and adequate regional supplies spawn disinterest and encourage energy companies to go "naked." Then, when prices spike, few customers are engaged, and the valuation seems obvious. The next summer, when everyone is ready to take advantage of these price spikes, there may be none.

This boom-bust cycle is not a surprise, but customers want some level of annual benefit assurance to stay involved in demand response. This can be accomplished through regulation and free markets.

The regulatory answer, a familiar one, uses the traditional least-cost planning model to determine avoided costs in the long run and the benefits of customer participation. A free market solution involves a risk-taking body that understands the long-run value proposition for customer demand response and underwrites the acquisition and coordination of this resource in anticipation of a rightful future reward (the long-term market signal).

Regional Demand Response Resource Banks

This sets the stage for regional demand response resource banks. Liquidity in our currency is maintained by the Federal Reserve Bank system. Reserves are