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Letters to the Editor

Fortnightly Magazine - August 2011

Buyer’s Remorse

Constantine Gonatas’s article “ A Buyer’s Market (May 2011) takes the view that the March 15 Federal Energy Regulatory Commission (FERC) Order 745 on demand response compensation is “flawed.” However, many of the arguments Gonatas advances to support this view are, themselves, flawed.

Gonatas asserts that “it isn’t obvious how a wholesale tariff could make explicit distinctions among end-user customer classes, taking into consideration retail rate questions FERC studiously finessed.”

In fact, however, there is no way under the current regulatory regime. Ignoring this reality is an exercise in fantasy confusing retail regulation with wholesale regulation. Of course, stating that “these restrictions are essential to avoid market distortions” is a recipe for doing nothing or simply—again possibly fantasizing—having states develop DR programs at retail that will somehow mysteriously solve all of the other inefficiencies that exist at retail to arrive at the economically efficient outcome.

Gonatas also claims that “full LMP compensation for industrial customers results in curtailing economic output worth more than the power saved.”

This repeats an assertion based on a hypothetical with no measure of its occurrence in the real world. It also ignores the benefits to the other customers on the system from reduced LMP, which will swamp any loss if it actually is an issue.

The article also cites a Brattle Group study for ISO New England that “indicates that with (LMP-G) compensation there’s only one-third as much peak load curtailed compared with full LMP compensation.” But there is no consideration of the economic effects of this finding. The FERC’s process began with a PJM filing to pay LMP for DR because PJM was not getting an economic amount of DR. The anecdotal evidence seems to suggest that LMP-G is inadequate to attract an efficient level of DR. Given the highly asymmetric cost effects of too much resource vs. too little, this cavalier approach seems much more “indefensible.”

Furthermore, the author’s argument has the underlying economics incorrect. The article invokes the “lively debate between Profs. William Hogan and the late Alfred Kahn,” but doesn’t discuss how Prof. Kahn demonstrated that economics requires that verifiable DR be paid more than LMP-G and that the market price is the correct price.

Gonatas also argues that “considering the disparate compensation for demand responders versus a real-time pricing customer, this rule creates a preference for one retail rate over another.”

Of course, FERC sets (or approves) wholesale rates, not retail rates. Retail rate issues are none of their concern. Plus, the notion of “setting a preference for one retail rate over another” is simply rate-setting. The whole purpose of rate setting is to treat different classes of customers differently. Of course, the DR compensation rule doesn’t do this at all. It doesn’t treat you differently according to who you are. It treats you differently according to what you do.

Finally, Gonatas says, “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