SMART GRID: Battle over 'negawatt' pricing heads to court
July 2, 2012
By Hannah Northey and Gabriel Nelson, E&E reporters
Having failed to convince the Federal Energy Regulatory Commission that new "demand response" policies would skew electricity markets across the country, powerful utility industry groups are now demanding a response from the courts.
The American Public Power Association, Electric Power Supply Association and Edison Electric Institute have all asked a federal appeals court to throw out a new nationwide policy that pays the same amount for demand response -- which are usually agreements with electricity customers to reduce power use at times of heavy demand -- as it pays utilities to send more megawatts onto the grid.
Speaking for the owners of power plants, the trade associations say FERC made a mistake last March when it came out with the rule. In a filing earlier this month with the U.S. Court of Appeals for the District of Columbia Circuit, they claim that offering the same payouts will lead to perverse incentives, such as shuttering factories so as not to use electricity.
The policy only makes sense if "one can get far enough through the looking glass to accept that a retail customer's decision not to consume electricity is a form of supply," they said.
Deciding how to compensate demand-response companies has been a top-line issue for FERC Chairman Jon Wellinghoff, a Democrat who has aimed to support energy efficiency and the integration of renewable power onto the grid.
When the rule came out last March, the commission said it was carrying out its duties under the Energy Policy Act of 2005 by removing barriers in front of demand response. The rule was described as a way to encourage efficiency in the wholesale power markets and in the process avoid the cost of building more power plants for the few hours a year when electricity use soars.
A new breed of energy services companies have already risen to the challenge, putting in bids across the country for "negawatts" and, increasingly, beating their power-generating counterparts. That has now sparked a debate over the way to put a price on electricity, a commodity that by its rare nature must always be made and consumed in equal measure.
Under the new FERC rules, the upstarts have shown they can offset demand more cheaply than utilities can meet it.
More than 14,000 megawatts of demand response made the cut when the grid operator for much of the eastern United States, called PJM Interconnection, took bids on new resources for 2014 and 2015. That amount, equivalent to a few dozen midsized coal or natural gas power plants, was far more than all other new sources of generating capacity combined: new power stations, upgrades to existing ones and around-the-clock energy efficiency.
The incumbents in the energy markets have naturally pushed back, said Blake Young, president and CEO of Georgia-based demand-response company Comverge Inc., during a conference Wednesday in Washington, D.C.
In the past, rather than building new capacity to bid into these auctions, power companies have "taken advantage of those market structures and leveraged their baseload generation to create more margin, more profit," Young said at the event, held by the Association for Demand Response and Smart Grid.
In other words, the utilities were taking advantage of scarcity. When there is less capacity available at times of high demand, a grid authority has to pay a higher price to avoid risking power outages.
"The moral of the story is: If you don't build it, we will," Young said.
A split on FERC
Nationwide, there are now about 40,000 megawatts of demand-response resources available to the U.S. power grid, double what existed about five years ago.
The rapid rise came in response to the surges in electricity prices at times of peak demand, which most economists will describe as the result of decades of irrational -- if understandable -- policy.
The retail rates that customers pay are flat for months at a time, mostly because of old meter technology. Wholesale rates, which power generators charge, can fluctuate wildly based on supply and demand, which must always be met instantaneously, either with new electricity or energy that has been stored in a battery, a flywheel or a pumped-water system.
If people were charged based on supply and demand at any given time and could see the real cost of energy, they could shift their behavior and their businesses to get a better price. But they cannot do that. So utilities bid up the price of electricity, making sure they have enough to avoid outages on hot summer afternoons and other times of strain.
FERC was told to clear the way for demand response when a decrease in supply is preferable to an increase in demand. But the method chosen by the commission was a source of disagreement, with Commissioner Philip Moeller, a Republican, calling it a "misguided" swing toward reductions in supply.
Moeller cast the lone dissenting vote against the rule, saying that it showed preference to demand-response companies without explaining what barriers they face. In so doing, it conflicted with FERC's efforts to promote competition and ensure that prices are just and reasonable, he said.
The rule "actually results in overcompensation that is economically inefficient, preferential to demand resources, and unduly discriminatory towards other market resources," Moeller said.
The angry utilities had their argument seconded in court when a group of economists -- professors from Harvard University; the University of California, Berkeley; and the Massachusetts Institute of Technology -- filed a friend-of-the-court brief that said FERC's rule should be tossed. They say demand-response companies should get paid less than power generators under a formula called "LMP minus-G," which stands for the market rate at any given moment minus the price at which a customer would have bought electricity.
Otherwise, they say, a customer will stop using power just to take advantage of the payments, passing on the cost of the demand-response services to other electricity customers.
"Simply put, the customer must be treated as if it had first purchased the power it wishes to resell to the market," the economists wrote. "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."
They say it is a "subsidy" that relies on the faulty assumption that "more demand response is always better, regardless of the effect it has on other market participants."
But in the eyes of demand-response companies, the utilities are mischaracterizing the service they provide. It is not the same thing as reselling electricity, they say, but rather shifting electricity use away from the most expensive times, thereby making it cheaper for everyone.
Audrey Zibelman, founder and CEO of the Philadelphia-area Viridity Energy Inc., said the growing demand-response industry isn't looking for subsidies or handouts, but utilities are fighting FERC's order because it could reduce their profits when demand is high and electricity rates spike.
FERC's order pays any party equally, including utilities, to use its resources to help manage the grid, she added.
"The economists are missing the boat," she said. "Managing the grid happens on both sides of the equation -- increasing output or decreasing consumption."
Viridity has taken FERC's side in the court case, seeing it as one of the key drivers of the industry's quick growth.
"The case is a critical watershed to opening up the capital to transform the industry in a positive way," Zibelman said. "I think demand response would not falter but would not excel without it."