Are subsidies the best way to achieve smart grid goals?
Dr. Sam Newell is principal at The Brattle Group. He acknowledges the contributions of Ahmad Faruqui, Peter Fox-Penner, Attila Hajos, and Kathleen Spees of The Brattle Group. The views in this article are Newell’s and not necessarily those of The Brattle Group or its clients.
In a notice of proposed rulemaking (NOPR), the Federal Energy Regulatory Commission (FERC) proposes to require all regional transmission organizations (RTOs) to pay demand response (DR) providers the full locational marginal price (LMP) for load reductions.1 It shouldn’t be a matter of economic debate that this would allow DR providers to earn more than the value they directly provide to the market. Because customers pay their retail providers only for the energy actually consumed, their ability to sell load reductions as DR into the wholesale market is like reselling energy they never bought in the first place. Thus, full LMP compensation would allow them to earn the wholesale energy market price plus the avoided retail rate for every kWh reduced.
The embedded subsidy would inefficiently distort behavior and would provide compensation that isn’t comparable to the compensation generation receives.