Knowledge Problem

Michael Giberson

Does the Federal Energy Regulatory Commission (FERC) really want to go down this path? Do they really think that faking a consumer cartel will help make wholesale power markets work more efficiently?

Consumers come to any market in pretty direct competition with each other. Suppliers are offering their goods and I would like to buy as cheaply as possible, and so would you, and our competition will drive the price to a level higher than either one of us would prefer.  It is obvious to me and my neighbors that it would be easier for us to buy cheaply if you and your neighbors stayed home. In fact, me and my neighbors might save enough from you and your neighbors staying home that we could pay you enough to stay home.  And with a little formal coordination, we would be on our way to creating a buyers’ cartel.

A well organized buyers’ cartel could, for any given set of supply offers and demand levels, figure out the quantity of consumption that maximizes the economic surplus received by consumers in any period. The cartel would have to make side payments to consumers who have their consumption reduced, but by definition their are enough consumers benefiting from the cartel that the side payments could make everyone better off than before (or rather, all consumers better off).  Sound good?

Of course effective cartels lead to inefficient outcomes; they waste resources. The cartel’s problem is that allowing willing consumers and suppliers to pursue all of the otherwise-wasted opportunities will drive prices back up for everyone. But if buyers can be roped into participation and a sufficient scheme of side-payments is enforced, buyers could be winners (at least in the short run).

To my mind, FERC seems to be pursuing a kind of ad hoc and partial cartelization of buyers with its current ideas for encouraging “demand response” participation in markets (FERC Docket RM10-17-000, Demand Response Compensation in Organized Wholesale Energy Markets, see the Supplemental NOPR for the latest and Technical Conference materials here). FERC has proposed that qualified “demand response” resources be able to bid a demand reduction into day-ahead RTO markets, have it treated sort of like a supply offer, and be paid the market price for energy for any demand reduction accepted by the market.

FERC also invited comments on whether a “net benefits test” of some sort is needed – to make sure that a particular demand reduction actually results in benefits for other consumers – and if so, how should the net benefits be calculated. In addition, the issue of cost allocation arises. Ultimately some set of consumers somewhere will be paying the demand response resource for its service of dropping out of the market, and FERC wants a rule that doesn’t accidentally end up making some consumers worse off in any obvious way.

Read enough about these demand response compensation plans and it begins to sound like a set of instructions for turning an energy market into a Rube Goldberg machine.  In one corner of the machine a cap naps too soundly (these are energy consumers), allowing mice (these are the energy suppliers) to get too much cheese. Now comes FERC to assess the situation, and they suggest if we attach a broom handle to the rocking chair which is tied by a string to a teeter-totter that the bowling ball falls onto, then the broom handle can prod that cat at the right moment and the cat will stop mice from getting too much cheese. Clever, maybe, but no way to run an energy market.

Look, Lynne and I are both big advocates for an active and engaged demand side of the market. We’ve said so several times here in the past and occasionally highlighted research that explains the great value that could be created. We believe!

But jury-rigging the market to goose a few consumers into action isn’t the same thing as enabling an active and engaged demand side of the market.

AFTERWORD: This tirade, written late and in haste, surely requires more time and thought. Admittedly, FERC is in a tight spot. Efficient wholesale power markets really do need an engaged demand side, but the demand side is heavily encased in state-jurisdictional retail rate policies, and technically speaking outside of FERC’s reach. FERC is, in essence, trying to overlay some super-incentives for wholesale-level-hence-FERC-jurisdictional  ”demand response” to make up for the bad incentives (inadvertently, but nonetheless) created by most state retail rate policies.  It is these state policies which keep the cats napping, hence the Rube Goldberg attempt at a work-around.  The trouble is that FERC will end up creating perverse incentives, and we will end up with “Demand Response machines” every bit as stupid and wasteful as the the PURPA machines incentivized by an earlier mix of state and federal energy policies.

On a more constructive note, scanning some of the comments presented for the recent Technical Conference, I’d urge FERC carefully consider the comments of Paul Centolella of the PUC of Ohio. Centolella seems spot on in his analysis.