Demand response is as important as it is difficult to understand. And that’s why the Supreme Court’s majority opinion, written by Justice Elena Kagan, is a marvel. People should read it for something bordering on electrical literacy — a rarity these days, understandably but also unfortunately.
To understand demand response, you first need to grasp a key detail: You and I generally pay the same price for every kilowatt hour of electricity that we use at home, but that’s an artificial arrangement that protects us from shifts in electricity’s true price on wholesale markets. This price varies greatly based on the demand for it, and that demand fluctuates constantly — even if we tend to be individually insulated from these market shifts by our utility company, its regulators, and so on.
Here’s how wholesale electricity markets — operated by nonprofit entities like PJM Interconnection, which regulate sales between electricity generators and those who purchase power to deliver it to us, such as utilities — actually work, per the Supreme Court ruling:
…..suppose that at 9 a.m. on August 15 four plants serving Washington, D. C. can each produce some amount of electricity for, respectively, $10/unit, $20/unit, $30/unit, and $40/unit. And suppose that LSEs’ [load serving entities, aka utility companies] demand at that time and place is met after the operator accepts the three cheapest bids. The first three generators would then all receive $30/unit. That amount is (think back to Econ 101) the marginal cost—i.e., the added cost of meeting another unit of demand—which is the price an efficient market would produce. FERC calls that cost (in jargon that will soon become oddly familiar) the locational marginal price, or LMP.
Yes, you just read that right — all three low bidders get the highest of the three bids.
This system may sound odd, and has been the topic of much debate among economists, explains Susan Tierney, a former Energy Department assistant secretary who is now with the Analysis Group. But the idea is that without it, generators wouldn’t make the lowest bid that they can afford, and the final settled upon price would end up being much higher. “The consensus among economists is, a clearing price market really encourages people to offer as low as they can offer,” Tierney says.
But now, the Supreme Court majority continues, suppose that there’s an electricity demand spike:
As in any market, when wholesale buyers’ demand for electricity increases, the price they must pay rises correspondingly; and in those times of peak load, the grid’s reliability may also falter. Suppose that by 2 p.m. on August 15, it is 98 degrees in D. C. In every home, store, or office, people are turning the air conditioning up. To keep providing power to their customers, utilities and other LSEs [load serving entities] must ask their market operator for more electricity. To meet that spike in demand, the operator will have to accept more expensive bids from suppliers. The operator, that is, will have to agree to the $40 bid that it spurned before—and maybe, beyond that, to bids of $50 or $60 or $70. In such periods, operators often must call on extremely inefficient generators whose high costs of production cause them to sit idle most of the time….As that happens, LMP—the price paid by all LSEs to all suppliers—climbs ever higher. And meanwhile, the increased flow of electricity through the grid threatens to overload transmission lines…..As every consumer knows, it is just when the weather is hottest and the need for air conditioning most acute that blackouts, brownouts, and other service problems tend to occur.
So enter “demand response”:
But what if there were an alternative to that scenario? Consider what would happen if wholesale market operators could induce consumers to refrain from using (and so LSEs from buying) electricity during peak periods. Whenever doing that costs less than adding more power, an operator could bring electricity supply and demand into balance at a lower price. And simultaneously, the operator could ease pressure on the grid, thus protecting against system failures. That is the idea behind the practice at issue here: Wholesale demand response, as it is called, pays consumers for commitments to curtail their use of power, so as to curb wholesale rates and prevent grid breakdowns.
And that’s why the Federal Energy Regulatory Commission, or FERC, moved in 2011 to empower “demand response” and ensure its compensation in electricity markets — and thereby allow companies to sell the lack of electricity use. With demand response, such refraining from use itself becomes a bid on the market.
That’s right — our system is such that not using power when everybody else is demanding it is a very valuable thing. Especially if you’re a big company with a big electricity bill, demand response could save you a lot of money if you use it to shift around when you turn on certain key pieces of equipment or run certain operations.
The Supreme Court’s majority opinion thus not only rules that FERC was within its powers to empower demand response in these obscure but crucial markets. It also does a masterful job explaining how all of this works and why we should care about it.
We live in a time when so much about how we get electricity is changing. We’re witnessing the rapid spread of rooftop solar, the glint of a home battery market, smart thermostats that we monitor by smart phones, and much more. It’s also a moment in which more and more, utility companies are offering us the chance at “real time pricing” — electricity rate schemes in which individuals will will pay more (or — and here’s the big opportunity — considerably less) depending on how they behave during periods of peak demand.
All of this means that someday you and I, too, may be able to engage in a kind of demand response, saving money by turning stuff off and running on stored power at key times.
But that means we, too, will have to understand what’s actually happening here. Greening our grid and knowing our grid are intimately connected.
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