Last year the Federal Energy Regulatory Commission ruled that RTO and ISO markets should pay retail consumers an amount equal to the market’s real-time marginal price when consumers reduce consumption at peak periods. Economically speaking, it is the wrong price.
Parties opposed to FERC’s action have taken the issue to court. A group of “leading economists and educators” have filed an amicus brief in the case (and somehow I got invited to be part of this group). Here is the introduction:
Amici curiae (listed in Addendum A) are leading economists and educators who have designed, studied, taught, and written about the electricity markets affected by the Federal Energy Regulatory Commission Final Rule under review here, Demand Response Compensation in Organized Wholesale Energy Markets, Order No. 745, 76 Fed. Reg. 16,658 (Mar. 24, 2011), FERC Stats. & Regs. ¶31,322 (2011), reh’g denied, Order No. 745-A, 137 FERC ¶61,215 (Dec. 15, 2011). That Rule establishes the rate wholesale market participants must pay retail customers for reducing purchases of electric energy during peak-demand periods. In particular, FERC now requires market participants to pay the full “locational marginal price” (“LMP”) for electricity that is not consumed, treating non-consumption of energy as the equivalent of costlessly producing energy. See Pet. Br. 45-61.
Although the views of amici may diverge on market-design issues in other contexts, they all agree that FERC’s Rule creates a counterproductive demand response mechanism that produces economically undesirable behavior and wasteful outcomes that will injure consumers and society in the long run. Although FERC invokes economics to justify its course, the Final Rule is economically irrational. Retail customers that reduce their consumption should not be paid as if they generated the electricity they merely declined to buy. Instead, retail customers should be compensated as if they had entered into a long-term contract to purchase electricity at their retail rate but instead, during a peak demand period, resold the electricity to others at the market rate (LMP). In other words, they should be paid “LMP-minus-G,” where G is the rate at which the retail customer would have purchased the electricity. Simply put, the customer must be treated as if it had first purchased the power it wishes to resell to the market.
FERC never adequately explains its decision to adopt its contrary approach. Nor could it. By overcompensating reductions in retail purchases, the Final Rule encourages retail customers to reduce demand even when society would be better off if they continued purchasing electricity needed to engage in productive activity. It encourages inefficient self-supply of electricity. And it leaves market participants paying for the delivered electricity more than once—first to the generator that created it and then to the user who provided the demand reduction. That overpayment harms both suppliers and non-demand-response consumers, to whom the cost of the subsidy ultimately will be passed on.
So far as I can tell, the case Electric Power Supply Association v. Federal Energy Regulatory Commission hasn’t been heard yet at the U.S. District Court of Appeals. The full name of the brief is: “Brief of Robert L. Borlick, Joseph Bowring, James Bushnell, and 18 other leading economists as Amici Curiae in support of petitioners.”