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One if by Wholesale, Two if by Retail

Which path leads to the smart grid?

Fortnightly Magazine - October 2010

A new debate has emerged in electric utility regulation, with battle lines drawn within FERC itself. The debate began innocently enough, back in March, with FERC seeking ways to bring more demand response (DR) into wholesale power markets. The commission chose an incentive approach of paying the market-clearing energy price to successful DR bidders, on the theory that DR represents the virtual equivalent of generation supply. (See Notice of Proposed Rulemaking, FERC Docket RM10-17, March 18, 2010.)

But like all good theories, this idea only begged more questions. The discussion soon became more far-reaching. What’s at stake is nothing less than the future of the smart grid: AMI, appliance manufacturing, metering software, and even retail rate design.

The issue now is whether to build the smart grid on DR programs, or on consumer behavior. Should FERC focus at the wholesale level, where RTOs and market inroads have won grudging acceptance, or should policy makers now take another stab at pushing market ideas on the state-level retail sector, where such attempts so far have met with skepticism (among utilities), reluctance (among politicians), and backlash (from ratepayers).

Facing a backlash of its own, on September 13, FERC convened a technical conference to allow experts to weigh in on how to design a net-benefits test to justify paying the full locational marginal price (LMP) for DR bids that clear the market. The commission had sought comment on the net-benefits idea as middle ground to make peace between opposing viewpoints espoused by two leading industry academics.

On one side was Cornell University Prof. Emeritus Alfred Kahn, endorsing FERC’s proposal to pay full LMP for DR on the grounds that a negawatt is as good as a megawatt. On the other, Harvard Prof. William Hogan argued DR represents only call options on energy—not actual generation supply—and so should earn compensation equal only to LMP minus G ( i.e., the market price minus the generation component of the retail rate), as if the DR provider first had been made to pay a strike price (G) before selling the option.

[Editor’s Note: For more on this dispute, with Web links to previous Commission Watch columns and Fortnightly articles on this topic, see the reporter’s blog post, “The Nutty Professors: Bill, Fred and the Strange Case of Demand Response,” at www.outsmartingthegrid.com.]

Back at the conference, the discussion followed predictable lines until the final five minutes. That’s when FERC Chairman Jon Wellinghoff and fellow Commissioner Philip Moeller squared off in impromptu debate, each taking the opposite position over the future of the smart grid.

This unrehearsed moment began when Ohio Public Utilities Commissioner and panel witness Paul Centolella, without prompting, gave his opinion on why smart-grid policy should focus on the retail sector. That was no surprise, as Centolella had collaborated last year with PJM senior v.p. of markets Andrew Ott in putting together a white paper on how to do just that, through a concept known as price-responsive

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