Source: “ERCOT Investment Incentives and Resource Adequacy.” Brattle Group. June 1, 2012.
In January, we discussed the benefits of demand response (DR) and how Texas is not taking full advantage of it. Not only is DR a low cost, zero water source for providing capacity through conservation, but it can also actually directly benefit consumers financially. Furthermore, since residential and small customers account for “more than 70 percent of peak load” it is paramount that we tap into this resource.
The 13 Percent Reserve Margin
Fast forward to this summer, where a few factors have encouraged the situation as Texas’ energy crunch comes to light. In May, the 13.75 percent reserve margin became the center of discussion about how to proceed. Set in 2010 by the Electric Reliability Council of Texas (ERCOT) board, the 13.75 percent target planning reserve margin is to ensure enough power is available for contingencies such as extreme weather and unplanned power plant outages. However, a newly revised Capacity, Demand and Reserves (CDR) report shows that in 2014 we may be only at 9.8 percent and by 2015 this could drop to 6.9 percent, numbers that are very far away from the original goal. A failure to meet this reserve creates instability, not only for the ERCOT market as a whole, but that uncertainty ripples through the state for all businesses and households.
In June, the peak energy forecast for this summer was surpassed. ERCOT had predicted a 66,195 megawatt (MW) peak demand for the whole summer, but we surpassed that with 66,583 MW in June, well before the string of 100+ degree days we have seen recently.
The 15 Percent Potential From Demand Response
In June the Brattle Report came out reiterating FERC’s studies, which demonstrated that the potential for achievable participation in DR is 15 percent of capacity in Texas. This means that “dynamic pricing and load control technologies are deployed on an opt-out basis, with roughly 75 percent of customers participating.”
So if Texas met this DR goal of 15 percent it would be enough to cover our reserve margin of 13.75 percent and then some. Without new power plants. Without any new generation capacity at all. While in actuality we would rely on other demand side resources as well – such as distributed generation and storage – it is very important to point out the link between the 13/15 ratio, and how much potential demand response provides us.
Even better is that unlike other mechanisms that do not benefit consumers financially such as the price cap increase, DR and other demand side resources can provide large gains for consumers. Not only do they encourage reductions in energy consumption and thus energy bills, but because there is an added value in providing that “negawatt” capacity back into the system, customers are compensated. As we noted in an earlier blog, in the PJM market, $20 million of the payments went to residential customers!”
While there are still only a few of these initiatives around the country, the momentum is alive. Last year, FERC Rule 745 was established that “requires wholesale energy market operators to pay DR participants the market price for energy when those resources are able to balance supply and demand as an alternative to additional generation, and when DR dispatch is cost-effective.” This lays the foundation for how consumers will be compensated. FERC Chairman Jon Wellinghoff put it well, “[this] final rule is about bringing benefits to consumers. The approach to compensating demand response resources as we require here will help to provide more resource options for efficient and reliable system operation, encourage new entry and innovation in energy markets, and spur the deployment of new technologies. All of this contributes to just and reasonable rates.”
On June 26, ERCOT moved in the right direction by approving a DR pilot project that “will allow eligible participants a half hour to respond to ERCOT requests to reduce their electric use. The program is open to electric users — either as individual customers or as part of an aggregated group of consumers — who can reduce demand on the ERCOT grid by at least 100 kilowatts, which is the amount 20 homes use during peak demand.”
This follows a rule change adopted by the PUC in May that “authorizes ERCOT to conduct pilot projects to ‘evaluate resources, technologies, services, and processes that demonstrate the potential to advance the operational and market functions of the ERCOT system.’ This is the first pilot project approved under the new rule.” EDF commented on these rule changes and we are pleased to see ERCOT moving forward with these pilots. While many more deployments need to begin, we are headed down the right path and finally waking up the innovations needed in the energy market.
One Comment
EDF is correct is concluding that residential and small customer demand response (DR) is the answer to ERCOTs’ looming reliability problems. My comments submitted to the PUCT in Project 40480 contained the same observation. However, Marita Mirzatuny’s blog of August 13 contains a number of misleading statements that deserve clarification.
The first statement relates the FERC study claiming that demand response has the potential for achieving a 15 percent reduction in peak demand in Texas. While this claim is true, it is no necessarily economically efficient to do. The methodology employed in the FERC study assumes that every customer is subjected to critical peak pricing (CPP) that increases electricity prices sevenfold on high demand (“event”) days. The study erroneously states that CPP is a good surrogate for real-time pricing (RTP) – it is not. The CPP price is only deployed a few times per year and when deployed the price is either too high or too low. It is equivalent to hitting the customer over the head with a sledgehammer even when a light tap on the wrist with a ruler would bring forth the needed amount of DR. Yet under really bad conditions even a sledgehammer blow might be too little. The advantage of RTP is that it quantitatively applies just the right incentive to curtail load all of the time. Unfortunately numbers in the FERC study is often cited and taken at face value. One has to wonder whether anyone bothered to actually read the report and understand its methodology.
If the FERC study had been based on RTP it would have had to account for the interaction between the high prices produced during scarcity conditions and the incentive for generators to build new plant. This is because the high prices charged to customers would also be paid to the generators. When that interaction is accounted for it places an upper limit on how much DR can be brought forth before new generation enters to market and stabilizes the scarcity prices. A preliminary study that I did for the MAAC region of PJM indicated that this upper limit is in the range of 15 to 18 percent of peak demand. Of course the results for ERCOT may be different, depending on a number of factors such as the “peakiness” of the load duration curve and the relative cost to build new peaking plants. Interestingly, the numerical results produced by the FERC study are reasonable despite its simplistic methodology.
The second misleading statement is that customers’ bills are appropriate measures of their economic welfare. If that were true ERCOT could maximize everyone’s welfare by simply shutting down all of the generators. Everyone’s bills would then be zero. Clearly that would not make customers better off. The appropriate measure of customers’ economic well being is their consumers’ surplus derived from electricity usage. It is easy to show that RTP maximizes that surplus even though it also exposes customers to very high prices during times of scarcity. The bottom line is that increasing the price cap will benefit customers if it keeps the lights on, whereas poorly designed DR programs (like CPP) could actually make customers worse off. Finally, the fact that PJM paid some residential customers $20 million does not mean that the total population of customers were collectively better off.
Marita’s reference to FERC Order 745 implies that this is a good thing. It is not. The order erroneously overcompensates customers providing demand response during times when energy supply is adequate by compensating them twice for the same “negawatt-hour” of energy – once through payment of the wholesale market price of energy and again by allowing the customer to keep the bill saving that results from not buying the energy from its supplier. The economically efficient price to pay for such demand response is the wholesale market price less the energy rate in the customer’s retail tariff (i.e., “LMP – G”). Order 745 encourages customers to shut down they usage when the value of the products and services that the electricity could have produced is worth more than the cost of the producing and delivering the electricity foregone. In an economy already suffering from unemployment an idle productive capacity the inefficient curtailment of industrial output is not what we need.
But wait, the story is even worse. Order 745 also imposes a “cost-benefit” test that promotes the exercise of market power on the demand side. In effect the ISOs are ordered to encourage customers to reduce their loads in order to deliberately manipulate market prices such that generators are disenfranchised of legitimate profits as long as all customers enjoy cheaper electricity. This is the basis of a lawsuit against FERC, which is now before the DC Court of Appeals. Hopefully, Order 745 will be overturned soon before it does any more damage to the US economy. Fortunately, ERCOT is not regulated by the FERC, thus Texas has escaped the folly of Order 745.
In summary, there is little doubt that demand response is the economically efficient answer to ERCOT reliability problems. However, the amount needed is not going to naturally develop by 2014. It will take heroic action on the part of the PUCT to keep the lights on and in the interim some less efficient temporary measures may be called for.