PowerFacts
Experts Have Concerns With FERC Proposal To Pay Demand Response Full LMP, Offer Options
A number of highly regarded experts have analyzed the Federal Energy Regulatory Commissions (FERC) proposal to establish a generic compensation approach for all types of demand response (DR) resources participating in organized wholesale electricity markets. Specifically, FERC proposes that these markets be required to pay DR, in all hours, the full locational marginal price (LMP). These experts oppose compensating all DR at the full LMP in all hours, which they view as an unnecessary subsidy, leading to inefficient market outcomes, among other concerns, while offering alternative compensation mechanisms.
- "[T]he Commission's proposed policy is incorrect. Even if we assume...that appropriate product definitions or limitations are in effect to assure comparability with respect to reliability and adequacy, the Commission's proposed policy ignores the fundamentals of markets in general, and many of the details of the organized wholesale markets in particular, and mischaracterizes the consumer's decision-making process about when to consume energy. As a result, the Commission's proposal, rather than setting the right incentives for demand response, will create a material, grossly inefficient subsidy for wasteful conduct." Affidavit of Dr. Roy J. Shanker, Independent Consultant, on behalf of the New England Power Generators Association, p. 2.
- "Therefore, compensation for [DR] at full LMP constitutes a significant subsidy, contrary to the statement articulated by Order 719 that "Commission policy does not favor granting preference for demand response." Conversely, the compensation FERC proposes for demand response services would reward [DR] program participants far more than savings they could achieve from participating in real time pricing programs, discouraging innovative market based approaches. FERC's proposal creates market distortions, promotes excessive disruptions for insufficient benefit and reduces incentives for new peak shaving technologies." Comments by Constantine P. Gonatas of CPG Advisors, Inc., p. 11.
- "First, with regard to the question of comparable value, an investment in economic DR provides less value to the RTO or ISO than an investment in dispatchable generation. The economic DR provides value in balancing supply and demand in a particular hour in which the demand provider chooses to reduce load. However, because of economic DR's voluntary nature, it provides far less benefit than dispatchable generation to the RTO or ISO in meeting the NERC planning reliability and operational security standards. Second, economic DR providers should only receive as much compensation as generators when their value approximates the value provided by generation. Further, the compensation must consider all sources of revenue, including from the load-serving entity (LSE) that provides retail service to the DR provider. A payment of LMP from the RTO or ISO to the economic DR provider, without consideration of the effective "payment" it receives from the LSE (i.e., the reduction in payment to the LSE by the DR provider), provides an unwarranted subsidy to the DR provider." Affidavit of Jeffrey Tranen, Senior Vice President of Compass Lexecon and former President and CEO of the California ISO, pp. 2-3, Attachment A to Comments of the PJM Power Providers Group.
- "[T]he best incentive for demand response is a dynamic retail rate that "automatically" reflects the value of used or saved energy. However, when such dynamic retail rates are unavailable, appropriate wholesale incentives for DR can be used to create an efficient incentive for curtailment. At a wholesale level, the economically efficient level of compensation for load reductions (not load shifts) is the LMP minus the avoidable generation portion of the retail rate, resulting in a net savings equal to the LMP. The efficient compensation for any load that shifts from one hour to another is the LMP difference between the two hours. Providing more would distort incentives and lead to inefficient system dispatch... Any compensation above the LMP minus the retail generation rate, or the LMP differential in the case of load shifting, represents a higher payment to DR than is appropriate given generation prices." Comments of Dr. Samuel Newell, Principal; Dr. Kathleen Spees, Associate; and, Philip Q. Hanser, Principal, The Brattle Group, pp. 2-3.
- "These comments attempt to explain the overlapping regulatory relationship between state PUCs and the Commission, as well as the differences between MWHs and NWHs [i.e., "negawatthours" or energy efficiency measures]. None of this is too complicated to resolve in an economically efficient manner. At the same time, simply paying LMP for NWHs at wholesale seems too simple. I am sorry to conclude this would, by itself, be insufficient to cause the nation to achieve even a reasonable amount of truly cost effective energy efficiency." Comments of Dr. Charles J. Cicchetti, Senior Advisor to Navigant Consulting Inc. and to Pacific Economics Group and former Jeffrey J. and Paula Miller Chair in Government, Business and the Economy at the University of Southern California, pp. 31-32.
- "To get retail customers to make economically efficient consumption decisions the DRR [Demand Response Resources] must pay prices that provide each customer with the same total monetary gain as that customer would enjoy from the load reduction if it purchased its energy at the real-time wholesale market prices. To achieve this parity the price paid to the customer must equal the wholesale market price minus the rate in the customer's retail tariff at which the customer would have purchased the curtailed energy, i.e., the customer's Marginal Foregone Retail Rate (MFRR). To incent the DRR to pay its customers these economically efficient prices the DRR must be paid those same prices for its demand reductions, i.e., LMP minus MFRR (or the market price minus MFRR where the wholesale market has not implemented locational marginal pricing)." Comments of Robert L. Borlick, Energy Consultant, Borlick Associates, p. 4.
- [W]hile the principle of equivalent treatment is valid, the Commission's policy for treatment of imputed demand response does not follow from the principle. An imputed demand response compensation policy like LMP - G or some other variant that emulated explicit contract demand response by charging for the imputed purchase would adhere more closely to the Commissions principles." "Demand Response Pricing in Organized Wholesale Markets," Dr. William W. Hogan, Raymond Plank Professor of Global Energy Policy, John F. Kennedy School of Government, Harvard University and a Director of LECG, LLC., p. 5, Prepared for the ISO/RTO Council.
- "[T]he Commission's proposal is grounded in a misunderstanding of the outcomes that one would expect to observe in markets in which all demand response resources were able to participate on an equal footing with generation. As a result, adoption and implementation of the proposed rule could produce outcomes that are inconsistent with economic efficiency. Certain consumers would be paid subsidies for reducing their consumption that exceed the payments that are necessary to induce them to consume electricity in an efficient manner. The cost of these subsidies would, in all likelihood, be shouldered by other consumers, who would thereby be charged amounts that are unrelated to the cost of the electricity they consume or any other service that is rendered to them." "Implications for Consumers of the NOPRs Proposal to Pay the LMP for All Demand Response," Dr. William W. Hogan, p. 2, Attachment 1 to EPSA's comments.
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EPSA is the national trade association representing competitive power suppliers, including generators and marketers. These suppliers, who account for nearly 40 percent of the installed generating capacity in the United States, provide reliable and competitively priced electricity from environmentally responsible facilities serving global power markets. EPSA seeks to bring the benefits of competition to all power customers.