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Negawatt Pricing

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

Fortnightly Magazine - December 2009

would pay a flat DR incentive of $75 per megawatt hour, a figure said to approximate the typical retail cost of energy paid by fixed-rate customers.

Sensing the issues at stake, PJM’s new proposal has drawn the policy glitterati out of their ivory towers. Weighing in on PJM’s proposal are none other than the celebrated utility economists Alfred Kahn of Cornell University and William Hogan of Harvard, who each have filed opposing affidavits, pro and con, on the subsidy question. ( See, FERC Docket EL09-68, filed Aug. 26, 2009. )

This remarkable disagreement stems, perhaps, from a lack of a common vision as to what demand response really is, or ought to be.

Is DR a virtual physical resource—an electric capacity asset dedicated to the public good—or rather a tool available to market operators to moderate power prices, temper the market-power of generation suppliers, and ameliorate some of the well-recognized flaws in today’s wholesale power markets?

Under the first view, DR pricing should be geared primarily to give access to retail ratepayers to the huge consumer surplus that can be mined during high-priced hours at a relatively low cost (see Figure 1.)

Others warn, however, that too-generous payments for DR actually will destroy consumer welfare by eroding market efficiency.

Joseph Bowring, president of Monitoring Analytics and PJM’s independent market monitor (IMM), argues together with his general counsel, Jeffrey Mayes, that the highest purpose of an economic DR program lies in offering a price signal to retail electric customers—a price signal that now is missing because today’s retail ratepayers pay averaged rates that bear only a very tenuous relationship to the dynamic wholesale LMP market price.

In this view, administrative DR programs run by utilities and system operators serve only as a temporary transition vehicle on the road to an ultimate destination known as “price-responsive demand,” whereby retail customers would be exposed to dynamic energy prices that reflect real-time power prices in regional wholesale spot markets. Electricity would become a simple everyday consumer product; you buy what you can afford, and what you can’t afford, you do without.

PJM CEO Terry Boston explained the idea in a statement he issued to the PJM board of managers on June 26: “PJM’s long-term vision is that ‘Price-Responsive Demand,’ which allows more customers to respond directly to market prices and to voluntarily reduce their consumption when wholesale prices rise, is the ultimate solution to demand participation.”

In fact, PJM has asserted that a key reason for resurrecting incentive payments for DR providers is to “facilitate the move toward an ultimate goal of more extensive price-responsive demand at the retail level.”

And where does FERC Chairman Wellinghoff stand?

At FERC’s technical conference on DR in RTOs and organized power markets, convened in May 2008 before he became chairman, Wellinghoff hinted that he still saw DR as a public good, and worthy of incentive payments of the sort that economists define as “subsidies.” The moment came when he dueled with expert witness Robert Borlick, a Maryland-based consultant advising the Midwest ISO in developing its own economic DR program,