When the D.C. Circuit Court of Appeals vacated FERC Order 745 by ruling demand response wasn’t tradable in wholesale energy markets, it left a vacuum of strategies to properly value and compensate demand response. 

Since then, the ground has shifted as companies and large customers adjust to an uncertain future where demand response (DR) may be restricted to retail energy markets. Since the Supreme Court has held oral arguments in the case’s appeal and final resolution is imminent, we must contemplate how DR will fare and how the market might evolve.

Below, Eric Gimon and Mike O’Boyle discuss a scenario where the Supreme Court refuses to overturn the D.C. Circuit’s decision and bars DR trading in wholesale energy markets, but where utilities can still use DR to hedge against wholesale price spikes. While this ruling potentially affects DR in capacity and ancillary service markets, their exchange focuses on the future of DR in wholesale energy markets. 

ERIC GIMON: 

Vacating Order 745 delays progress toward a more efficient grid. But a pivot by utilities and regulators to real-time prices for consumers could mitigate damage and is ultimately a better solution for harnessing flexible demand. 

Upholding the D.C. Circuit Court ruling will not end the DR industry. Regardless of developments in deregulated markets, DR is making headway in regulated markets. Consider Nevada, where NV Energy’s mPowered DR and home energy management (HEM) program uses an internet-connected smart thermostat to interact with customer air conditioners. Today, mPowered includes over 50,000 devices, driving significant peak reductions over 100 megawatts with 3 kilowatts per home, while saving customers 10 percent to 15 percent on energy bills.

Unfortunately, when the local utility is the only arbiter of value, it may or may not accurately value flexible demand in its own territory. Considering how some are unable to share other resources like generation reserves, we can’t assume utilities will trade flexibility with neighboring utilities.

Because utilities poorly promote customer flexibility at scale, an alternate solution is required. DR participation in wholesale markets provides that alternative by allowing customers to largely sidestep utilities. However, real-time prices, updated at least every 30 minutes, can also provide the necessary utility conduit to develop and optimize flexible DR in regulated and restructured markets. This properly aligns financial reality with the material reality of customers connecting to the grid via their utilities. If customers can respond to rates coupled with wholesale prices, DR providers have financial incentive to provide market benefits similar to Order 745. 

With both wholesale DR and real-time pricing, participating loads need better visibility and control over their energy use and generation. Leading DR companies see the writing on the wall: an energy industry rich in data using software to maximize value, where DR providers branch into other services like energy management software -- consider EnerNOC’s new Energy Intelligence Software business. These activities prepare customers for a world with more transparent and granular pricing.    

MIKE O’BOYLE:

One reason behind FERC Order 745 was the lack of real-time pricing on the retail level, which inhibits DR markets. Since Order 745 was issued in 2011, little has changed.  

Real-time pricing remains a distant goal for residential and smaller consumers because consumers prefer stable retail prices. Moreover, according to one amicus brief to the U.S. Supreme Court, large industrial and commercial consumers often purchase power at a fixed price to hedge against price spikes, even in ISO markets where real-time pricing is available, reducing the effectiveness of real-time pricing programs and obscuring DR’s full value.

Uptake has also been underwhelming where customers are offered real-time pricing plans. For example in ComEd’s Illinois territory, residential real-time pricing (RRTP) enrollment has declined over 10 percent since 2010. In fact, more than 5 percent of customers left the RRTP program in 2014, expressing dissatisfaction with rate hikes during the polar vortex.

Few residential consumers take time to manually react to real-time or hour-ahead wholesale market prices, leaving savings and grid flexibility on the table. Automation technologies, like programmable communicating thermostats, are the only way grid operators and customers benefit from the flexibility and bill savings real-time pricing provides. 

Customers’ inability to respond to price spikes (as shown during the polar vortex) may reflect lack of adopted technologies to maximize real-time pricing benefits -- less than a quarter of ComEd RRTP customers surveyed had installed demand management technologies 10 years after the program began. 

By contrast, FERC Order 745 allows third parties to bypass utilities and provide flexibility where regulated retail markets have not delivered. Specialized third parties can pair technologies with innovative compensation structures to maximize customer satisfaction and price responsiveness, while sending a clear signal to utilities to explore demand-side management. Without DR participation in wholesale energy markets, customers lose a valuable alternative to underachieving utility DR programs.

GIMON: 

Actually, customers are just beginning to benefit from real-time markets, and many more might benefit if regulators made it possible. Customers who participate in wholesale DR markets already have strategies in place to modulate demand and take advantage of real-time prices. Regulators shouldn’t avoid exposing consumers to real-time prices, because they can manage risk and the technology exists to support them.  

Many companies -- Alarm.com, Tendril, Opower, Vivint, ADT, Nest, iControl and EcoFactor, to name a few -- each have over a million home energy management system devices that could easily adapt to real-time pricing. Other companies are using behind-the-meter resources like battery storage plus distributed solar PV to minimize bills. These represent a broad class of customers ready to dive into real-time pricing -- if utility regulators step up to the challenge of providing it.

If other customers aren’t ready or prefer not to capitalize on the opportunities offered by real-time pricing, they can use insurance-type products as insulation against price fluctuation. For example, customers could opt out of real-time pricing for flat or time-of-use rates offered by their utilities. Similar transactions are quite common in financial markets. Here the utility takes on variable pricing risk in return for a fixed monthly rate.  

Alternatively, a customer might take out insurance against peak rates or bills reaching a certain threshold, like in those severe weather events, just as they might buy insurance against potentially high medical bills. Customers could negotiate with a third party to cover the cost of installing on-site equipment to manage demand, pay real-time rates, and charge a fixed rate in return, much like energy service contracts or solar power-purchase agreements.

The key is creating real competition in this risk management space so utilities are just a convenient provider of last resort and can’t use their monopoly position to take advantage of customers not yet ready for real-time prices.   

O’BOYLE: 

Compared to the current DR structure, that financial overlay sounds unnecessarily complicated for customers. Instead of a state-by-state mish-mash, Order 745 created uniform interstate standards for DR compensation at the wholesale level, easing regulatory burdens and improving consumer access. Mandatory real-time pricing coupled with insurance-like products to hedge against volatility would vary in states with different policy objectives for the electricity sector and could further handicap the DR market.

Even the D.C. Circuit Court ruling agreed “demand response payments will lower the wholesale price [and] increase system reliability.” In PJM, electricity-use reductions during a 2006 heat wave saved customers over $650 million in one week. 

In Texas, a study from the South-Central Partnership for Energy Efficiency as a Resource found modest DR participation would have saved customers $200 million in five days during 2012-2013. With these benefits already flowing to consumers and wide participation by DR providers, it’s hard to see how real-time pricing could be better for consumers and DR’s development.  

Additionally, DR benefits have been even greater in capacity markets than in energy markets. Utility DR programs can limit capacity needs, but that value can only be captured locally. Were DR unable to participate in either, real-time pricing would leave potential DR capacity value on the table in states with wholesale capacity markets.

GIMON: 

Despite an inability to efficiently function in capacity markets, real-time pricing does offer some advantages over aggregated DR. Namely, wholesale DR depends on establishing a counterfactual baseline to measure against DR.

Establishing the right baseline is challenging, and can lead to perverse outcomes, as Severin Borenstein points out in his column. I especially like his example of the Baltimore Orioles baseball stadium turning on stadium lights during electricity shortages to be paid for shutting them off.

I agree that regions with a wholesale capacity market face an unfair handicap, as real-time pricing cannot compensate flexible loads equitably for capacity (capacity markets blunt the wholesale price signal), losing a great deal of DR’s economic value.

Ideally, power prices at the customer meter should fluctuate without market manipulation or regulatory constructs such as price ceilings, capacity markets, and resource-adequacy requirements. Competitive insurance policies or other financial risk management mechanisms are a better way to handle price spikes prudently. Real-time pricing as a strategy for harnessing load flexibility will work much better in energy-only markets like ERCOT which embrace this philosophy.

In summary, regulators in regulated and restructured markets should set rates and create markets truly valuing the minute-by-minute cost of consuming electricity even if the Supreme Court upholds Order 745.

Social goals can still be maintained by setting similar real-time rates for broad customer classes, or through explicit support for low-income or underprivileged customers. People preferring flat rates or block rates can be served by insurance, derivatives and other risk-management tools. Customers are then positioned to capture the total value of demand response for themselves or via an aggregator.  

O'BOYLE:

Even with accurate real-time price signals, utilities may lack motivation to promote DR, which naturally reduces peak demand, correlating with less need for traditional transmission and distribution infrastructure. In almost all jurisdictions, increased capital investments create higher shareholder returns, increasing the value of publicly-owned distribution utilities. 

Therefore, public utility regulators must ensure utilities are promoting DR. New regulatory models like the recent Track Two proposal under New York’s Reforming the Energy Vision proceeding provide examples for regulators to better align utility incentives with customer value.

If Order 745 is history, regulators should focus on aligning utility incentives with cost-effective DR to reduce peak energy consumption and provide distribution and bulk-system benefits. Where there are capacity markets, these same utilities should ensure the benefit of reduced reserves requirements are passed along to DR providers via additional compensation, and regulators should allow third parties to compete to provide DR services to utilities and customers.

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Eric Gimon and Mike O’Boyle represent America's Power Plan. Thank you to John Moore and Sonia Aggarwal for their input on this piece. The authors are responsible for its final content.