EBF 483
Introduction to Electricity Markets

12.1 Demand Response in Electricity Markets


By now, you have heard (or read) dozens of times that electricity supply and demand must balance in real-time, every second of every day. The reason for this is that electricity cannot be stored in large batteries at reasonable cost. While Tesla may be looking to change this with large-scale battery production, the simple fact at the present time is that while battery energy storage is really cool, it’s not economically viable. This is not to say that there is no such thing as energy storage in the power grid. There is some, it just doesn’t come in the form of batteries. Here are a couple of examples.

  • Pumped storage hydroelectricity uses mechanical pumps to move water up a hill to a storage facility. When conditions are right, the water is released to flow downhill through a turbine, generating electricity. The water is then pumped back uphill and the cycle starts over again. This effectively “stores” electricity by using cheap power from the grid to pump water uphill at night when overall demand is low and then releasing the water to generate electricity during peak times of the day.
  • Many conventional hydroelectric dams have large reservoirs that are used to store water for release at a later date. Instead of storing electricity per se, the “fuel” is stored and used when needed.
  • Electric energy can be stored as thermal energy. The hot water heater in your home, for example, can be programmed to heat water when the grid has excess electricity. This hot water is stored in the hot water tank for use at some future time, rather than producing hot water on demand. France has used controllable hot water heaters extensively to absorb excess power from nuclear power stations.

Note that all of these “storage” technologies effectively balance the grid by either increasing supply when demand goes up, or increasing demand during times when supply is high. Another increasingly popular way to balance supply and demand on the grid, particularly during times of very high electricity demand, is by reducing demand rather than increasing supply. This practice is known as “demand response.”

In RTO electricity markets, demand response can compete against power plants to balance supply and demand. Often times demand response is cheaper than running a peaking power plant (and often pollutes less as well). Here’s a simple example of how demand response works. Suppose that there are only two power plants in the electricity market. Plant A has 100 MW of capacity and a marginal cost of $5/MWh. Plant B is a peaking plant with a capacity of 10 MW and a marginal cost of $50/MWh. If demand is 101 MWh during some hour, then Plant A will be dispatched fully and plant B will be dispatched at 1 MWh. The system marginal price will be $50/MWh. Demand response solves this problem by reducing demand rather than increasing supply. Suppose that there was a large commercial building that was willing to turn off the air conditioners during this particular hour, reducing overall system electricity demand by 2 MW. The building owner asks to get paid $20 per MWh of electricity reduced. In order to balance supply and demand, the RTO would save money by dispatching the demand response rather than the peaking Plant B. The RTO would order the building owner to reduce demand, so the final level of demand would be 99 MWh and the system marginal price would be $20/MWh.

Demand response can also participate in capacity markets as well, and get paid for a commitment to be able to reduce demand at some point in the future, just as power plants get paid for a commitment to be operational and increase supply at some point in the future. Energy conservation investments, such as low-energy buildings, can also be eligible for capacity payments since they measurably reduce overall electricity demand.

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Figure 12.1: Demand response market revenue in PJM: ancillary services (brown), energy (orange and blue) and capacity markets (green).
Source: Monitoring Analytics

The figure above shows the distribution of market revenues for demand response in PJM (which has the most active demand response market in the United States) over the last several years. Not only is the market opportunity for demand response growing, but the biggest source of revenue for demand response is (and basically always has been) the capacity market.