Sometimes the juxtaposition of two items highlights important themes. Today the Wall Street Journal published an article (sub. req.) describing some state efforts to curb retail electricity rate increases. Typically, these efforts take the form of lobbying for political and legislative action to “control” rates; no mention is made in the article of the more forward-looking idea of how active, empowered consumer demand can discipline producer prices, even in a period of high fuel and environmental protection costs.
I read this article this morning, after having spent Monday reading the Department of Energy’s recent report to Congress describing and quantifying the benefits of demand response in electric power. This report is in response to several requests for information and research stipulated in the Energy Policy Act of 2005. Unlike the business-as-usual political approaches described in the Wall Street Journal, this report highlights the most resilient, most flexible, and most effective way to “control” rates economically: harness the beneficial tension between demand and supply by removing existing barriers to the active expression of demand in wholesale and retail electricity markets.
Demand response is not a new concept. Many reports, analyses, and pilot projects have examined, demonstrated, or argued for more demand-side participation in both wholesale and retail electricity markets. This report boldly synthesizes these prior efforts and compares them in an apples-to-apples way, which makes it a substantial contribution to making active, empowered demand a more widespread reality.
The report lays out the variety of reasons why demand response is important, which I generally characterize as “demand response is another arrow in the quiver”. If you take a system balancing and reliability perspective, active demand gives you another set of tools, another resource on which you can call to enable system balancing to avoid triggering capacity constraints and involuntary interruptions. Furthermore, double-sided markets have important economic efficiency benefits as well as system reliability benefits; in the absence of active demand:
“This disconnect between short-term marginal electricity production costs and retail rates paid by consumers leads to an inefficient use of resources. Because customers don’t see the underlying short-term cost of supplying electricity, they have little or no incentive to adjust their demand to supply-side conditions. Thus, flat electricity prices encourage customers to over-consume — relative to an optimally efficient system in hours when electricity prices are higher than the average rates, and under-consume in hours when the cost of producing electricity is lower than average rates. As a result, electricity costs may be higher than they would otherwise be because high-cost generators must sometimes run to meet the non-price-responsive demands of consumers.” (p. 7)
The report points out that demand response can be a valuable aspect of market structure at all of the timescales relevant to electricity, from 10-year advance planning to 15-minute dispatch. More importantly, it points out the nuanced idea that the market structure and the form the transaction takes will vary depending on the timescale of the transaction, and that active demand will play diverse roles in these various market structures. Sections Three and Four analyze the costs and the benefits of implementing active demand in both wholesale and retail portions of the supply chain. The last section contains recommendations in these general categories:
- Fostering Price-Based Demand Response—by making available time-varying pricing plans that let customers take control of their electricity costs;
- Improving Incentive-Based Demand Response—to broaden the ways in which load management contributes to the reliable, efficient operation of electric systems;
- Strengthening Demand Response Analysis and Valuation—so that program designers, policymakers and customers can anticipate how demand response delivers benefits;
- Integrating Demand Response into Resource Planning—so that the full impacts of demand response are recognized, and the maximum level of resources benefits are realized;
- Adopting Enabling Technologies—to realize the full potential for managing usage on an ongoing basis; and
- Enhancing Federal Demand Response Actions—to take advantage of existing channels for disseminating information and forming public-private collaboratives.
This report does an admirable job of addressing the breadth and depth of the issues involved in demand response, and of doing so in a way that tackles difficult analytical questions. For example, on p. 71 they present a discussion of the distinction between increased economic benefits and wealth, or rent, transfers. The context of the discussion is how to interpret the effects of price reductions that arise from increased demand response: do they represent an increase in social welfare, or a transfer from producers to consumers? The discussion of this issue is good. It also provides in-depth analyses of different effects depending on the market structure of the region, whether a vertically-integrated utility or a competitive retail market.
Instead of looking backward to political processes to control electricity prices, this report on demand response points to a portfolio of ways to look forward, to engage the dispersed and distributed rivalry that consumers can provide to discipline the pricing behavior of producers. Political processes that promise to perpetuate the disconnect between electricity costs and retail rates are bad for reliability, bad for efficiency, and therefore bad for consumers. Active, empowered demand response is a better strategy for those states worried about how to “control” rates in the face of high fuel and environmental protection costs.