Gao’s New Study On Electric Power Demand Response And Retail Choice

Lynne Kiesling

An unusual and well-done study makes you think differently about something that you think about day and night. The recent General Accounting Office study entitled Electricity Markets: Customers Could Benefit from Demand Programs, but Challenges Remain did just that when I read it.

The GAO report is a very useful summary of the issues and the existing literature in the role of consumers, retail choice, and the demand side in the electric power industry. In analyzing existing demand response programs they broke them into two categories: market-based pricing (such as real-time pricing, time-of-use pricing, and bidding for demand reduction) and reliability programs (such as interruptible contracts, demand control contracts with the system operator, and compensation for voluntary demand reduction). By doing this, the report makes it crystal-clear that active demand participation in electric power markets is a crucial tool for enhancing the reliability of the network, as well as for improving the efficiency and effectiveness of electric power markets.

The report surveys the extensive literature on the costs and benefits of double-sided markets and an active demand side. For example, it highlights the $1.5 million in savings to consumers under the New York ISO’s demand bidding program in the summer of 2001 alone, as well as savings of $38-58 million to both customers and utilities in 2001 due to other NYISO demand-based reliability programs. It is also clear from the report that such calculations include benefits to customers who do not themselves participate in demand response programs, and those benefits are of two types: decreased prices because of the decreased cost of producing power, and increased reliability through decreased probabilities of outages. The report also provides a clear, concise summary of the conceptual and theoretical economic analyses of the crucial role that active demand can play in integrating electric power markets and making the network more relilable. In so doing this report should be of great value to policymakers and others looking to become better informed about demand-side issues in electric power.

But this report provides much more than that. It connects ideas in an innovative way, and makes some recommendations that are both novel and feasible. One particularly striking point that the report makes is that wholesale and retail markets are inextricably intertwined, even though their regulation is jurisdictionally separated. Thus regulatory inefficiencies and distortions present in one portion of the value chain affect other portions. The report cites widespread agreement among those interviewed that the lack of retail customer choice hampers the evolution of robust wholesale markets and contributes to higher and more volatile wholesale prices.

The report also points out that fixed retail rates create an environment in which end-use customers inadvertently harm both the efficient operation of markets and reliability of the network. We’ve all been discussing the concept for years, but thinking of the inadvertent overall harm that customers unknowingly produce because of the incentives facing us is a powerful way to communicate the inefficiencies and the unfairness of the existing regulatory environment.

The barriers to active demand and retail choice that the report recognizes – regulated fixed retail rates, metering technology installation, and customer awareness – are indeed the largest barriers to the integration of demand and supply in robust electric power markets. The report analyzes some real-world demand response programs as case studies that lend some insight into ways to overcome the barriers. Simply put: incentives through offering differing pricing options, creating/exploiting receptivity, awareness education, equipment, and ease of participation.

Some aspects of the issue are implicit in the GAO study. It does not ever explicitly state, but strongly suggests, that small reductions in demand in peak hours can have disproportionately large benefits in both price and network reliability. Small demand resources can have large impacts at the right time. Also, Figure 1 makes clear one thing that the report does not state – under a regime of flat retail rates, off-peak users subsidize peak users. That’s not just inefficient, it’s downright unfair, and must be recognized as such.

The GAO study is a valuable contribution to the electric policy debate. Their conclusion is on point:

It is clear that connecting wholesale and retail markets through demand response would help competitive electricity markets function better and enhance the reliability of the electric system, thus potentially delivering large benefits to consumers. Overcoming existing barriers will not be easy, however. Capturing these benefits will require leadership, collaboration, and action on the part of FERC, interested state regulatory commissions, and market participants in order to develop electricity markets that are truly competitive. Without these efforts to incorporate demand response in today’s markets, prices will be higher than they could be, the incidence of price spikes caused by either market conditions or by market manipulation will be greater, and industry will have less incentive for energy efficiency and other innovations, among other things.

2 thoughts on “Gao’s New Study On Electric Power Demand Response And Retail Choice

  1. From a policy advocacy standpoint, publications like this are priceless. While the consensus among scholars, especially economists, for an issue may be practically unanimous (say, congestion pricing for freeways), policymakers may still view the solution as either politically-motivated (they should know, right?) or just a plain old unworkable academic notion.

    However, for whatever reason, when it can be stamped with the imprimatur of a federal regulatory agency, department, or office like GAO, even if it’s essentially just a lit. review, it suddenly seems more “sensible,” less a “radical departure,” and no longer a “political” solution.

  2. Well said. That is precisely one of the dimensions upon which I hope this report contributes to meaningful regulatory policy change.

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