focus on demand response to ensure adequate capacity

Demand response already accounts for many thousands of megawatts of capacity but that contribution is poised to burgeon if properly encouraged.

The confluence of higher electricity prices throughout much of the nation, concerns over the adequacy of installed and accessible generating capacity to provide reliable service in a number of regions, and a directive in the recently enacted Energy Policy Act of 2005 (EPAct 2005) should open the door to a new era of demand responsiveness, supported by real-time or interval metering technology.

demand must be part of the solution

One of the vexatious issues confronting the power industry is ensuring that reliable service is backed by adequate generating capacity. Recent debate on this issue has focused on setting capacity prices high enough to ensure that existing generation is maintained and new capacity is brought on-line to replace retired units and satisfy growing demand. Whether this should be accomplished by setting prices in relation to an administratively determined demand curve, as in New York and proposed for PJM and New England, or instead be determined through energy market forces, as in MISO, is a debate that should play out thoughtfully, grounded in experimentation.


Load reduction agreements could credit large consumers for reduced levels of consumption that reduce a utility’s capacity obligation.
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Supply considerations alone, however, must not drive the industry’s efforts to ensure adequate and reliable power supplies. Demand-in particular, the price elasticity of demand – must also be part of the solution.

This should be obvious. Reserve requirements seek to meet coincident peak demand within acceptable loss-of-load parameters, particularly in load pockets with limited import capability. Within the historical industry model, this could be achieved through regulatory fiats requiring vertically integrated utilities to carry an installed reserve goal (e.g., 115 percent of peak demand) in exchange for a cost-based capacity payment. But in competitive wholesale markets with decontrolled pricing this approach produces an unsatisfactory dynamic. Although scarcity in such a market should produce very high marginal prices that induce new investment, politics ordinarily intervene to cap prices below levels required to maintain and invest in marginal units. At the same time, the target reserve percentage produces a vertical demand curve that falls to zero once the required reserve percentage is achieved.

The solution to this unsatisfactory state of affairs, of course, will require determining what capacity is available where and pricing it adequately to maintain existing units and induce new entry. But it should also include enabling consumers, both large and not so large, to change their power demands in response to transparent prices or dispatch instructions. The economics of demand response are self-evident. According to California Energy Commission projections, it costs $600 per kilowatt to build new peaking capacity while demand response costs only $100 per kilowatt or less, a cost that drops as the cost of smart meters continues to plummet and demand response programs become better coordinated and achieve greater scale.

Notwithstanding the already significant contribution that demand response makes, too often this side of the equation has not received the attention it deserves in ongoing deliberations on how to ensure adequate capacity. Given sufficient participation, supported by real-time or interval consumption meters, demand responsiveness could shave peaks considerably, lessening the need for capacity reserves. That could ultimately obviate (in whole or in part) the need for capacity markets separate from energy markets.

it’s policy now

Congress recognized the potential contribution of demand response supported by real-time or interval metering in amendments that EPAct 2005 makes to section 111 of the Public Utility Regulatory Policies Act of 1978. As amended, section 111 announces that it is the policy of the United States to encourage states to provide reliable and affordable demand response services. It goes on to direct each state regulator, with respect to the retail electric service providers that it regulates, and each nonregulated electric utility to consider and determine whether to implement a standard that would require some form of time-based rate schedule implementation by April 8, 2007, such as:

Time-of-Use Pricing where prices are set seasonally for future time periods

Critical-Peak Pricing where time-of-use pricing is supplemented with customer discounts for reducing consumption during certain periods of peak demand

Real-Time Pricing where prices can change as frequently as hourly in relation to production or purchase-power costs

Load reduction agreements that credit large consumers for reduced levels of consumption that reduce a utility’s capacity obligation.

For states and nonregulated utilities adopting it, this standard would further require the electric utility to provide to each of its customers that requests a time-based pricing scheme, a time-based meter capable of enabling the utility to offer and the customer to receive service at time-differentiated prices.

The amendment envisions a process where each state and nonregulated utility would begin by Oct. 8, 2006, and conclude within one year, its consideration of adopting the time-based pricing and metering standard. Combining this consideration with present or future investigations into how to ensure capacity adequacy would be propitious and would likely result in more efficient solutions to problems of capacity adequacy than would consideration of capacity supply issues in isolation.

DR must receive more attention this time around

The history of PURPA standards, however, is not particularly encouraging. Other standards from this same section of PURPA that pre-date EPAct 2005, including the use of “time-of-day” rates, generally did not receive from the states or nonregulated utilities the attention that they deserved and were poorly implemented, if at all.

But there are reasons to hope that the time-based pricing and metering standard of EPAct 2005 will receive more thoughtful consideration than did these earlier PURPA standards. The industry and its regulators are already focused on the capacity adequacy issue and demand response will be the most economical solution to capacity shortages in many regions, particularly fast-growing coastal regions where supply-side solutions, technologically or politically, are infeasible.

In the new amendment, the secretary of energy is charged with providing technical assistance to states and regional organizations in implementing the time-based pricing and metering standard to address capacity adequacy as well as other issues such as transmission and distribution constraints. Unfortunately, but predictably, the administration’s proposed budget provides no funding for this technical assistance. Utilities and regulators should demand that Congress appropriate sufficient funding for the secretary to provide the technical assistance needed to induce states and nonregulated utilities to adopt the demand response programs that will be made possible through time-based pricing and metering.

Dan Watkiss is a partner with Bracewell & Giuliani in Washington, D.C. Focusing on litigation and arbitration, his clients include utilities, banks and other lenders and energy project developers. You can contact Dan at Dan.Watkiss@bracewellgiuliani.com.

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