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A Buyer's Market

Getting the most from demand response—despite a flawed FERC rule.

Fortnightly Magazine - May 2011

during weak markets by these casual demand responders. If in implementing this rule, capacity payments are provided to an unlimited quantity of demand responders when reserve margins are high, then incentives to invest in new generation will be lower when reserve margins are tight.

This rulemaking also featured a lively debate between Profs. William Hogan and the late Alfred Kahn on whether “negawatts” are truly comparable to supply. 2 Commissioner Moeller supported Hogan’s view in his impassioned dissent, asserting that the ruling would distort power markets and violate the commission’s statutory obligation to provide just, reasonable and non-discriminatory rates. In this view, full LMP compensation is a subsidy to DR providers.

Straightforward economic analysis supports this view. Considering the disparate compensation for demand responders versus a real-time pricing customer, this rule creates a preference for one retail rate over another. It further creates an overt preference for load over generation by instituting a price suppression mechanism.

To say the least, paying customers full LMP for load they switch to a backup generator is troublesome. Here, customers receive full LMP by apparently reducing their load, and they avoid paying for power at the retail rate for the load they continue to operate—but just take off the grid. This discriminates in favor of behind-the-meter generation. For these reasons, full LMP compensation appears to be a subsidy.

However, there are valid reasons to support a carefully targeted subsidy. Commissioner LaFleur made the key point that in her experience leading a utility, DR has an important role and that her vote represented a practical decision. A Brattle Group study for ISO New England indicates that with (LMP – G) compensation there’s only one-third as much peak load curtailed compared to full LMP compensation. How much DR is the right amount? EnerNOC commented “there can never be enough DR,” but generators had other views. The ruling itself stated that it wasn’t following “textbook economics” but aimed for a practical result.

Because most load isn’t aware of real-time prices—consuming more power than it would in a transparent market—paying some load to consume less drives load and price as a whole closer toward the ideal market equilibrium. Second, although above-market payments for reducing demand and LMPs for the remaining load do institute a buyer’s cartel, buyer market power might balance generator market power during peak periods if allowed hours are selected judiciously. Third, although real-time pricing tariffs at a retail level are the economically ideal way to drive demand bidding, experience has been adverse for all but the most sophisticated customers, and progress is lagging.

Overcoming Indifference

In Order 745, FERC held that full LMP compensation was necessary to overcome market barriers, citing the costs associated with smart metering. This is hardly the case for large users, for whom smart meters represent only a small expense. This isn’t a good justification for small customers either: it would take 50 years to recover the cost of a $1,000 smart meter for a 500 kwh/month consumer who would save $2 a month from load shifting, subsidy or not.

Many industrial users