The region’s retail and wholesale electricity markets should be linked via dynamic pricing.
Henry Yoshimura is manager of demand response at ISO New England, Amr Ibrahim is senior analyst of market and regulatory practices at the ISO, and Robert Laurita is supervisor of demand response at the ISO. Contact Yoshimura at 413-540-4460.
The time has come to start the transition from the current economic demand-response programs to demand response that arises naturally through market-based retail pricing.
Over the past few decades, utility sponsored conservation and load-management programs have helped thousands of customers better manage their energy costs. While these programs have helped lower overall electricity use, they generally have not provided an economic incentive for customers to reduce their consumption at specific times in response to wholesale electricity prices.
Customers who can reduce their electricity consumption in response to changing wholesale electricity prices often are referred to as “price-responsive demand.” As many are aware, by lowering overall demand at times of high wholesale electricity prices, these customers proactively can reduce their own electricity costs and help to lower electricity costs for all customers in their region. For this reason, many state regulators, electric utilities, competitive suppliers, customer groups, and independent system operators (ISOs), such as ISO New England, are advocating more innovative retail rate designs that encourage price-responsive demand.
With most products, retail prices directly reflect the balance of supply and demand in the wholesale markets. All customers, at one time or another, have experienced the price impacts resulting from shortages of various consumer products. Following hurricanes Katrina and Rita, customers experienced gasoline prices changing daily (and sometimes hourly) in response to rapidly changing wholesale prices. Many customers became “price responsive” by changing their driving habits and reducing their consumption.
However, the electricity markets are atypical in this respect. For the most part, retail electricity prices do not reflect the daily and hourly changes in wholesale prices. Instead, they change slowly over time. Retail electricity prices generally are set either by a state commission order or through a long-term contract with an energy supplier. Under these fixed rates, unit prices remain stable for months or even years. For most customers, the retail price (per kilowatt-hour) they pay remains the same, sending a message that the cost of providing electricity service is the same regardless of the time of day or season. The fact is that customers who consume during times of peak demand or supply shortages collectively contribute to driving up the wholesale price for everyone. It has been well documented that while a customer’s fixed-price rate or contract may protect them from an immediate price increase, their consumption behavior contributes to higher wholesale price volatility, which ultimately will result in higher wholesale prices and retail rates for everyone. Inevitably, all customers will end up paying for the choices made by them and their neighbors.
Why is encouraging price-responsive demand important to retail customers? Reducing electricity demand by even a modest amount at times of high wholesale prices can help lower prices