On March 18, the day after this issue went to press, FERC was scheduled at its decisional meeting to open a new formal inquiry on the role of demand response in regions that already have competitive wholesale power markets.
In particular, how much money should grid operators pay to electric customers who promise not to buy wholesale power?
While this new initiative presumably will cover the entire country, its purpose clearly is to settle a canard of a dispute that arose last August, when PJM proposed a new tariff for “economic” demand response—i.e., DR provided for profit, as opposed to reliability.
The case was reported in depth previously in this column, and in fact appeared ripe for decision as far back as December of last year. (See “Negawatt Pricing,” December 2009.) Yet the commission mysteriously failed to act, choosing to postpone its ruling indefinitely and prompting all manner of speculation on why the delay. Had something or someone turned the chairman’s ear?
The issue proper was whether to reward DR with a payment equal to the full wholesale market price (e.g., the LMP, or locational market price), the theory being that when a customer promises not to buy power, it’s like selling customer-owned generation into the market. But some say a full LMP payment means double-dipping—that consumers get paid twice.
These opponents would offset any DR payment by the retail price of generation (LMP – G) because ratepayers who decline to buy already receive compensation by avoiding the purchase price and, moreover, because ratepayers who decline to buy never had title to power in the first place (so how could they be viewed as having sold it?), and because DR providers, unlike generators, won’t first have incurred fuel costs to produce that make-believe generation, and so, lacking any real cost of goods sold, the argument goes, consumers will enjoy a windfall if paid the full going market price.
The December column went on to explain that the debate attracted some heavy hitters in the world of regulatory economics, with Professor William Hogan of Harvard squaring off against Fred Kahn of Cornell, but that the weight of authority seemed to swing toward Hogan, with others arguing that LMP - G was the way to go.
Nevertheless, the real story here isn’t so much the economic theory of DR, but rather, how FERC was flummoxed by a threefold series of white papers, comments, and protests, and so fell into a decisional paralysis. These audacious arguments, presented by attorney Donald Sipe, representing the American Forest and Paper Association (AFPA) and an ad hoc group known as the Consumer Demand Response Initiative (CDRI), seemed to steer the conversation far afield of the smart-grid vision, and back toward a sort of revisionist theory—a 1930s-style of populism, where the power industry is seen as a public-purpose entity, like a government enterprise, and where the purpose of ratemaking is to pool public resources across society at large for the greater good. Under this theory, DR acts not as a stepping stone on the way to the smart grid, but as an end in itself, as a sort of utility service in its own right.
Maybe it’s the tenor of the times. Perhaps the economy and the severity of the “great recession” have colored FERC’s thinking. The fear is that FERC might be taking a step backward.
The economist and blogger extraordinaire, Lynne Kiesling, famously describes today’s electric power industry as “one hand clapping.”
Kiesling, who wasn’t first to use this metaphor,* sees the solution in terms of individual and digital entitlement:
“The technology is like one hand clapping, which is why regulatory reform to allow dynamic pricing, and ultimately retail competition, is necessary for creating the potential value from digital energy technology.” (See knowledgeproblem.com, May 28, 2009, Want better electricity information? Do it yourself!)
FERC, while ostensibly touting the smart grid like Kiesling does, still continues to promote traditional, top-down, administrative DR programs as a key to wholesale power competition and open access. And therein lies the conflict.
In 2008 for example, in its landmark Order 719, setting out mandatory improvements for grid system operators with regional power markets, FERC took a strong stance in favor of traditional DR (a promise not to consume) as a key market enabler. For example, it instructed ISOs and RTOs to remove barriers that might make it difficult for the demand side of the market to bid and offer DR as virtual power supply to provide ancillary services. (Order 719, Docket RM07-19, Oct. 17, 2008, 125 FERC ¶61,071.)
More recently, FERC released for comment its draft “National Action Plan on Demand Response,” an unfortunate chore mandated by section 529 of the Energy Independence and Security Act of 2007. The action plan must help states maximize deployment of DR, help design a national PR program for customer education, and help provide model contracts and regulatory provisions for utilities, regulators, and DR providers. (FERC Docket AD09-10, Mar. 11, 2010.)
But is that where the future lies? It’s rarely a good sign when an idea needs its own “action plan” to get off the ground.
To its credit, small investments in traditional DR sometimes can produce huge dollar savings. One example was given in the December column, when PJM in August 2006 reportedly created more than $650 million in market-wide energy savings (from lower overall prices), simply by paying $5 million to wholesale customers to induce them to curtail their purchases.
Yet the traditional DR plan comes with a full set of baggage. There’s the baseline problem, the free-rider problem, and the inescapable fact that customers don’t like being told what to do. If the DR resource isn’t dispatchable (i.e., controllable) by operators, then elaborate rules are required for measurement and verification. And customer loads generally still cannot see real-time dynamic prices, nor are ratepayer actions integrated with price-setting algorithms. Consumer sovereignty isn’t fully served. The grid isn’t smart.
Last fall, Frank Wolak, chair of the California ISO Market Surveillance Committee, joined with co-authors James Bushnell (Iowa State) and Benjamin Hobbs (Johns Hopkins) in a widely cited paper questioning FERC’s emphasis on traditional DR. (Bushnell, Hobbs & Wolak, “When it comes to demand response, is FERC its own worst enemy?” CSEM WP 191. Also published in Electricity Journal, Oct. 2009, Vol. 22, No. 8, pp. 9-18.)
The Wolak paper, first released by the Center for the Study of Energy Markets, University of California Energy Institute at Berkeley, argues that FERC’s DR efforts were “likely to work against the ultimate goal of increasing the benefits that electricity consumers realize from formal wholesale electricity markets.”
The authors even suggest that traditional DR programs are so complex that customers (and one assumes this reference points to large-scale C&I loads) might be able to game DR programs and take advantage of FERC’s largesse:
“There is an important distinction,” the authors explain “to be made between traditional demand response programs and dynamic pricing.
“Traditional [DR] programs typically pay customers to reduce their consumption relative to an administratively set baseline level of consumption. Unfortunately, individual customers will always know more about their true baseline than the administrator of a DR program, and can likely profit from that knowledge.”
The opening salvo was fired back in May of last year, when Sipe and CDRI challenged ISO New England’s ideas on how to comply with FERC Order 719, including the notion (see last September’s column) that an RTO need not strive to ensure just and reasonable rates. Sipe articulated his vision in his audacious 89-page white paper, “Defining the Product: Market Theory for an Essential Service and the Proper Role of Demand Response.” (See Comments of CDRI, FERC Docket ER09-1051, filed May 24, 2009.)
That’s the white paper that begins with a retelling of Jonathan Swift’s 1729 satire suggesting that Irish farmers should eat their children as the most economically efficient means of staving off famine. The paper critiques the market-centric goal of maximizing the value of trade in electrons, along with the smart grid and its vision of consumer choice through real-time dynamic pricing, which Sipe simplifies as, “If it costs too much, don’t buy it.”
Seven months later, in the PJM tariff case, came a rebuttal to William Hogan’s theory that proper compensation for demand response requires an offset for the retail power price (LMP – G) in order to maximize overall societal welfare, which Hogan defined as the sum of producer and consumer surplus.
“The notion of ‘social welfare,’ as used by Professor Hogan, is not a real world guidepost for action,” wrote Sipe, explaining that market proponents engage in circular reasoning by assuming at the start that LMPs are perfect reflections of social utility. In this way, Sipe explained, market proponents engage in a “quest to accidently stumble upon social welfare by assuming you have already found it.” (See, Comments of AFPA. FERC Docket EL09-68, filed Dec. 14, 2009.
The final third missive surfaced in January when, on behalf of CDRI, Sipe’s comments assumed a more formal, conventional tone, and asked simply for policy guidance from FERC in resolving the impasse that has emerged in New England, concerning the ISO’s effort to develop a regime for price-responsive demand. (See, Request of CDRI for Policy Guidance, FERC Docket ER08-830, filed Jan. 28, 2010.)
In this case, ISO New England described how the regional policy debate boiled down to two alternative program designs—a demand-side option by which energy is priced on an hourly, real-time basis, and a supply-side option by which market participants could offer load reductions into the wholesale energy markets in a manner similar to supply offers from generators, in that offers would be integrated into the market-clearing, price-setting, and resource-scheduling algorithm. (See, Report of ISO New England and NEPOOL, FERC Docket ER08-830, filed Dec. 18, 2009.)
What makes this story especially interesting is that, before he became FERC chairman, the then-commissioner Wellinghoff engaged in some theoretical musings on the true essence and purpose of DR. (See, J. Wellinghoff and D. Morenoff, “Recognizing the Importance of Demand Response: The Second Half of the Wholesale Electric Market Equation,” 28 Energy Law Journal 389.)
In that article, Wellinghoff acknowledged the fact that FERC has no direct authority to regulate generation or its antilog, DR. Thus, Wellinghoff suggested that the most compelling jurisdictional justification for FERC to be able to promote DR as an essential component of a market structure lies in the effect that DR can have on rates.
That interpretation might not be so far off from Sipe’s vision. In fact, a trusted source tells this columnist that some of Sipe’s comments both confounded and intrigued FERC’s leadership at the very highest levels, leading one commissioner to ask a prominent FERC staffer to call Sipe and ask him what the heck he was trying to say.
The answer reportedly came back that the true purpose of DR is to drive power prices down as far as possible, rather than to smarten up the grid by adding a second clapping hand to otherwise imperfect power markets.
* First to draw this analogy may have been Eric Hirst and Brendan Kirby, in a study they put together in 2001 for the Edison Electric Institute and the Project for Sustainable FERC Energy Policy. (See, E. Hirst, B. Kirby, Kirby, Retail-Load Participation in Competitive Wholesale Electricity Markets, Jan. 2001, available from the Maryland Pub. Serv. Comm’n.)