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A Buyer's Market

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

Fortnightly Magazine - May 2011

argued that higher (full LMP) compensation is essential to overcome a market barrier for them, as curtailing power results in revenue loss and business disruption. To this, numerous commenters gave specific examples proving that full LMP compensation for industrial customers results in curtailing economic output worth more than the power saved. It’s simply indefensible to disrupt economic activity during a recession by providing an inappropriate incentive.

However, a true barrier exists for residential, many commercial and even large institutional customers: indifference and lack of focus on energy conservation. Greater incentives would motivate action resulting in benefits to society through fuel savings, especially during critical peaks when the least efficient power plants operate. Furthermore, incentive compensation could stimulate innovation in smart grid technology. Today, LED manufacturers and building controls vendors are developing electronics and software to interface with DR signals. The ultimate goal is automating energy conservation and building management so intervention by distracted humans won’t be needed. These innovations will take time, and do require incentives to catalyze them.

On the other hand, the cost of aggregating customers and managing DR programs is often cited as a market barrier that requires incentive compensation. In fact, the costs of sales and administration can consume from one-third to one-half of DR payments. If implementation overhead exceeds (LMP – G), energy conservation benefits are simply outweighed. Therefore, DR programs must be automated and dis-intermediated wherever feasible. While aggregators have a useful transitional role, in the long run, the smart grid must facilitate transactions with residential and commercial customers at low cost.

In the short run, regional markets could implement electronic bulletin boards so participants could interact directly with bids in the day-ahead markets. A consumer who wished to avoid the forecast peak LMPs could opt to schedule curtailment of his load and receive compensation directly from the market clearing mechanism. While regional markets might object to the administrative burden, this builds on information systems in operation today that meter production and register renewable attributes from small-scale distributed generation.

Successful DR implementations must target the real, not perceived barriers and avoid subsidies that distort economic outcomes. They must focus on the commercial, institutional and even residential customers where motivation barriers exist. By contrast, because full LMP compensation for industrials encourages them to curtail production worth more than electricity saved, this customer class should be on a real-time pricing or wholesale tariff instead. They should be disqualified from DR programs with full LMP compensation.

Because full LMP compensation for customers with backup generation also creates a perverse incentive, this class must be disqualified from receiving full LMP as well. Backup generation is usually inefficient, not economical at LMP except in critical reserve conditions, and typically emits high levels of pollutants (SO x, NO x). So allowing this customer class to participate in full LMP demand response programs, other than at system-critical times, harms both air quality and fair markets.

In conclusion, the rule’s economic analysis is troubling, confusing comparability between “negawatts” and megawatts. It represents a covert policy decision. Yet, economic and social benefits will