Reaping What You Sow: How Generators’ Push to Kill Demand Response Is Backfiring
August 25,2014
The New York PSC Staff's straw proposal concerning Track One of the Reforming the Energy Vision proceeding may make generators wish they never appealed FERC Order 745, which established compensation for demand response participation in the energy market.
A Court of Appeals found that FERC exceeded its authority in requiring RTOs to compensate certain demand resources at the full LMP under Order 745, on the basis that such compensation amounted to a retail rate, and therefore was beyond FERC's jurisdiction.
Generators reacted with glee to the apparent win, and quickly sought to apply the Court's logic to all FERC-regulated demand response (e.g., arguing that FERC cannot set capacity payments for demand response on the same "retail rate" basis).
However, this exercise may turn out to be an entirely short-sighted folly for the generators, as it only emboldens states to establish compensation for demand response -- and state regulators aren't going to care how it affects LMP or the wholesale market.
We have seen the first steps of this in New York, with the Staff straw proposal in the REV proceeding. Given the questions regarding the continued legal viability of RTO demand response programs, Staff proposes that each utility institute tariffed demand response programs, with presumably (at least initially) administratively determined pricing.
From Staff's straw proposal:
"[T]he Commission should direct a process in which stakeholders work with distribution utilities, Staff and the NYISO to immediately develop programs that allow demand response providers, interfacing with the distribution utilities, to respond to bulk power system needs currently addressed by the NYISO’s Special Case Resource (SCR) and Emergency Demand Response Programs. Staff intends to immediately convene discussion with utilities and stakeholders to begin the development of the programs.
Toward the goal of developing mature DER markets, distribution utilities should further be directed to revise reliability-oriented DR programs, as needed, to use DR as an economic system resource and provide a platform on which DSPs can ultimately utilize DER as a component of their supply portfolio along with purchases from the bulk power system.
...Staff recommends statewide expansion of existing utility-offered demand response programs in the near term in order to give customers more opportunities to benefit from participation in programs that offer reservation and performance incentives for load reductions. These programs have the added benefit to DER providers through identification of opportunities for near-term DER investment on the distribution system.
While the immediate goal of the utility DR programs is to stand in the place of NYISO Special Case Resource programs if necessary, in the longer term utility DR programs should be expanded to take advantage of economic opportunities, and the terms of the programs should be carefully constructed to maximize economic participation by customers. As part of this expansion, staff recommends that utilities file a proposal to inform customers of these new DR programs, using state-of-the-art marketing tools and methods designed to increase DR adoption."
Although pricing is not discussed in the straw proposal, it is very to easy to see how demand response offered in response to a state-regulated utility tariff will exceed the compensation provided under FERC Order 745. Aside from avoided energy costs, the state regulator may administratively decide to value demand response at a higher price to reflect distribution-system benefits as well as environmental benefits (or avoided costs) and other externalities.
This could well result in faster and quicker penetration of demand response than if FERC Order 745 remained intact. With state regulators baking-in additional value to demand response aside from the wholesale energy or capacity value, many more megawatts of demand response could be procured versus the standard set by FERC Order 745.
Furthermore, now that this demand response is out of the wholesale market, it will no longer set scarcity prices. Instead, it will simply crater any LMPs whenever upward pressure begins showing. Indeed, if the New York utilities actively manage a portfolio of demand response and other distributed resources, which seems to be the end-state vision of New York, the utilities could effectively prevent any price formation in the RTOs by calling on demand resources proactively, keeping this load out of the wholesale market.
It would appear that the generators made a grave error in kicking a dog out of the manger. Yes, FERC Order 745 provided subsidized compensation to demand resources, and by no means did we support the policy. But it was LSEs, not generators, who were most hurt by it. While the order arguably unfairly favored demand response, it did not pay demand response beyond the LMP also paid to generators, and at least it kept demand response in the market, which should help aid price formation.
Rather than foolhardy arguments concerning FERC's jurisdiction, generators concerned with price formation should have focused on ensuring that demand response under Order 745 led to efficient scarcity pricing and accurately set clearing prices. Sure, it would mean giving some candy to demand resources, but it's not as if the FERC-run markets are bastions of free enterprise (witness administratively-established capacity demand). Generators should have kept their eyes on the prize -- scarcity pricing -- and simply accepted Order 745 as a cost of getting a much more important goal.
Now, however, generators risk any scarcity pricing in the RTOs, if more states follow New York's lead in developing utility-run and compensated demand response. We can't say we're shedding a tear