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Negawatt Pricing

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

Fortnightly Magazine - December 2009

on whether incentive payments for DR might be warranted to help integrate the massive influx of wind power in the MISO region.

Commissioner Wellinghoff : Wouldn’t it be appropriate for us to look at perhaps payments over the level that you are discussing for demand response, to ensure reliability in the MISO grid?

Mr. Borlick: I would say no …

Commissioner Wellinghoff : To the extent that wind power generation could increase volatility, as it has in Texas … couldn’t additional quick demand response reduce that volatility, and in fact make that MISO system more stable and more able to take more wind? … Wouldn’t that be appropriate?

Mr. Borlick: Yes, but you don’t pay them a subsidy …

Commissioner Wellinghoff : Wouldn’t it, in fact, be appropriate, if we needed to get significant wind into the system quickly, to take care of the carbon problem, to perhaps pay demand response more?

 

Realm of Collusion

In a white paper prepared for the Electric Power Supply Association and filed at FERC with EPSA’s comments in answer to the PJM proposal, Bill Hogan provides numerous charts and graphs to show why economists believe it’s inefficient to pay full LMP for DR, but instead should offset any LMP payment by a value equal to the variable energy charge as reflected in retail rates that the customer avoids by reducing consumption. They identify this offset as “G” and give a simple equation to express the proper price of DR service: LMP – G .

As Hogan explains, this price is the most market-efficient because it produces the maximum level of social welfare, defined as the sum of consumer surplus plus producer surplus. Such surplus represents economic rent—the degree to which the market-clearing price is both below what some consumers would be willing to pay, and higher than what some producers would be willing to receive. ( William H. Hogan, “Providing Incentives for Efficient Demand Response,” Oct. 29, 2009 .)

Opponents are quick to point out, however, that DR is functionally equivalent to self-generation by retail customers, who should receive a full LMP payment, without any offset. So why not the same payment for DR?

The economists agree, but counter that a retail customer providing DR service also avoids the retail energy charge—G—the same as a direct payment equal to G. So to design a DR program that compensates providers in an amount equal to LMP, the payment should include an offset, as follows: (LMP – G) + G = LMP.

As for large-scale C&I customers, many of whom have interval meters and take service under variable retail rates that capture dynamic movements in the wholesale LMP price, the economists favor no DR payment at all, since such customers already earn an implied payment of full LMP when they curtail consumption, simply by avoiding payment of an LMP-based retail rate. In this case, Hogan would treat the entire amount of PJM’s proposed DR payment of $75/MWh as an unjustified incentive or subsidy, incompatible with an efficient market.

A group of DR advocates, including Comverge, EnerNOC, EnergyConnect,