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Negawatt Pricing

Economists take sides in the battle for DR’s soul.

Fortnightly Magazine - December 2009

Ron Belbot, of the Severstal Sparrows Point steel plant in Baltimore, explaining how the plant managers decide on whether to submit a DR bid: “When loads are forecast to be high, with correspondingly high LMPs, the operation of each of the facilities is reviewed … Information like where a unit is in a particular production run, and if that run can be interrupted without affecting quality or damaging equipment … If a product is being produced for shipment at a later date, it is much easier to delay and reschedule.

“Factors such as inefficiencies and quality impacts of stopping and starting an operation, the ability to perform needed maintenance during the curtailment … are all considered.

“Once this is established, the actual real-time price is monitored and when it is high enough … the curtailment notification is sent to PJM and the appropriate units are shut down.” (See, Affidavit of Ron Belbot, Protest of Demand Response Supporters, Sept. 16, 2009.)

Adding his voice in support of DR advocates is legendary economist Alfred Kahn, who also furnished an affidavit on behalf of the Demand Response Supporters, and who argued that while PJM’s rationale for its proposed DR incentives is perhaps “mistaken” from the point of view of theory, that “serendipitously, its proposed incentive payments are economically correct.”

In his testimony, Kahn gave what appears to be two distinct reasons for favoring an incentive payment of full LMP for retail demand response, without a G-style offset for avoided energy charges. Or, in his words, “why the mere prescription of equating the price of power to marginal supply cost is not a sufficient recipe for maximizing economic efficiency.”

First, Kahn appeared to suggest that DR incentives might well be politically necessary—that is, needed to overcome “the typical unwillingness of state commissions to subject customers to genuine marginal cost pricing.”

Second, Kahn asserted that “as output gets closer and closer to physical limits of generating capacity,” thus increasing the likelihood of shortages or load losses, that “the true marginal costs of energy far exceed LMP,” thus suggesting that DR payments of LMP – G might well prove insufficient to elicit the desired market response from customers.

When asked whether the incentive payments that some see as subsidies will distort economic behavior and produce market inefficiencies, Kahn answered that for his former constituents in New York State, where he once served as chairman of the public service commission, “a sufficient response to your question would probably be subsidy, schmubsidy.”

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