Worried About Too Much Demand Elasticity in Electric Power Markets

Michael Giberson

Will electric power consumers facing smart-grid enabled real time prices have the potential to accidentally destabilize the power grid and cause a blackout?  A paper presented at a recent IEEE conference says it is a possibility. The surprising culprit? Too much price elasticity in the market demand function.

It is a surprising culprit because consumer demand for electricity is currently notoriously inelastic (that is to say, not responsive to changing prices) in the short run, in part due to the way standard regulatory rate structures end up with consumers being presented with relatively unchanging prices reflecting a longer-term average cost of production. Prices don’t change much, so consumers don’t watch prices much. But this price inelasticity of demand doesn’t mean the quantity of electricity consumers want to consume is unchanging – consumers want more or less electricity throughout the day in response to ordinary household schedules and in response to outside temperatures and building heating and cooling demands. Consumer demand for power responds to a lot of things, but rarely to changes in the price of power itself.

Because of the way the current grid is designed, the quantity of energy supplied and demanded must be balanced continuously. Therefore, the grid is typically operated to take the quantity of power demanded as a given and make whatever adjustments in the quantity supplied to maintain system balance. (In brief, because prices can’t do much work coordinating supply and demand in the short-run, all of the coordination must be done by adjusting quantities. Grid operators can typically control suppliers but not consumers, so quantity-based supply side adjustment does most of the work of keeping the market balanced.)

The authors, three engineers at MIT, worry that if too many consumers facing real time prices pick similar high price points at which to cycle off appliances (or low prices as which to charge electric vehicles), that the market demand function will acquire highly price elastic segments in which quantity demanded will suddenly drop off (or spike up) at rates faster than the supply side can safely accommodate. Therefore, a blackout risk. To counter this possible risk, the authors suggest diversifying price signals sent to consumers, or employing hourly instead of 5-minute price signals, or using rolling-average prices to consumers rather than location-specific current marginal price. They admit their safeguards would hamper the efficiency of market results, the efficiency loss essentially the price paid to mitigate the possibility of a price-responsive demand shock to the system.

In my view, the idea of having so many real-time price-aware consumers responding in the market remains so far-fetched that I’m not willing to worry about that so many of them will coordinate their home energy management systems on the same price points and unwittingly bring down the system.

And well before this possibility of too-much consumer responsiveness comes about, I suspect most RTOs will be paying suppliers for ramping capability and charging consumers for using it in ways that will enable sufficient short-run system responsiveness. So I’m not ready to worry now about this problem, and don’t think that I’ll need to worry about it later, either.

(See MIT media relations summary here, HT to Scientific American via Economist’s View.)

4 thoughts on “Worried About Too Much Demand Elasticity in Electric Power Markets

  1. Mike,

    What a wonderful opportunity for a long duration, real time pricing, smart grid demonstration program.

    Management in the natural gas industry used to worry about too many customers using night setback during the winter, with automatic thermostat setup at ~ 6am. The problem never materialized. Of course, without grid storage, the electric grid does not have the advantage of “line pack” available in the natural gas transmission and distribution system.

    Vernon Smith could probably have fun with this “problem”.

  2. If true, then this problem can be smoothed by adding noise to consumer-specified prices, so that demand is more curvy and less steppy…

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  4. Ed, only if everyone bought the same home energy management system, left it on the default price settings, and had similar appliances, home characteristics, personal schedules, and outside temperatures, and faced the same locational marginal prices, THEN maybe they all stack on the demand curve at the same prices and trigger at the same time. It just seems far-fetched, and yet I can imagine someone at a state PUC or state energy office saying we’d better only give consumers hourly prices because otherwise they might crash the system.

    David, one of their suggestions was similar. I think ordinary consumer diversity will tend to keep the problem from arising.

    Of course, I don’t want to neglect the policy that a state PUC will mandate that everyone use the same standard piece of certified-by-the-state/accepted-by-the-local-utility piece of hardware. Maybe the manufacturers add noise to the default settings so that when 90 percent of consumers push the on button and walk away, there is already some diversity built in?

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