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Rethinking Prices

The changing architecture of demand response in America.

Fortnightly Magazine - January 2010

New York ISO, and has been discussed at their stakeholder meetings. It also has been discussed by the Supply Adequacy Working Group of the Midwest ISO. In December 2008, the Midwest ISO published a report that outlined three ways in which demand response could be brought into the marketplace. 7 In the first approach, dynamic pricing would be offered by the load-serving entities and be assimilated into their load forecasts. Such an approach is practiced currently in Australia. In the second approach, negatively sloping demand curves would be bid into the wholesale market. This is price-responsive demand. In the third approach, DR would be bid in as negawatts. This does not rely on retail dynamic pricing and is currently the most widely-used approach.

Three academics who serve on the Market Surveillance Committee of the California ISO have published a paper that calls for a shift in emphasis toward dynamic pricing programs and away from traditional, rebate-based programs, which they refer to as the “weak” form of DR:

Any paradigm that sells “reductions” from an exogenous baseline will crowd-out the adoption of direct pricing options such as critical peak and real-time pricing. Thus, we fear that the adoption of this weak form of demand response will ultimately work against the adoption of a truly symmetric treatment of load and generation that is an essential component of an efficient wholesale electricity market. There is a significant risk of creating conditions that will crowd out true price response by focusing too much on DR programs with unverifiable baselines and reliability-based rather than price-based mechanisms for obtaining consumption reductions.

This crowding out also can occur by inflating the attractiveness to consumers of such DR programs relative to responsive pricing by overpaying for reductions that don’t actually occur. Even customers who are fully capable and willing to participate in dynamic pricing programs might prefer to instead participate as DR customers, simply because the baseline problems could work to their advantage. Thus, the current paradigm of DR, if it comes to dominate industry practice, could become the single largest barrier to truly price-responsive demand.  8

Regulatory Concerns

Today, outside of pilot programs, fewer than 50,000 residential customers receive service using dynamic pricing tariffs, and they are located in a few states, such as California, Florida and Illinois. A major reason why dynamic pricing hasn’t been offered to residential customers is the absence of advanced metering infrastructure (AMI), which is a technological prerequisite.

The picture is changing rapidly. A FERC survey published in December 2008 showed that five percent of the 145 million meters in the United States were part of an AMI system, up from 1 percent just two years earlier. 9 Citing published reports by utility and metering companies, it projected that 52 million AMI meters would be rolled out during the next five years.

With the AMI train rolling down the track, can the dynamic pricing train be far behind? The answer depends on how effectively some intervenors that have an inveterate opposition to dynamic pricing can raise the specter of calamity in proceedings before state