EBF 483
Introduction to Electricity Markets

12.2 What Is the Price of a Negawatt?


12.2 What Is the Price of a Negawatt?

There is no question that demand response could have huge benefits both to the grid and to market participants who are able to provide demand response. The grid gets to avoid using high-cost peaking power plants, which saves everyone money because the market price goes down. The consumer providing demand response gets paid not to use electricity. Everyone wins, right?

Yes, but the details of how demand response gets paid have been very controversial. Whether “negawatts” (a cute term referring to demand response) should get paid on the same basis as “megawatts” (our term for power generation supply) was the subject of a hotly-contested rule from the Federal Energy Regulatory Commission in 2015 that was fought all the way to the US Supreme Court.

To get an idea of what the fuss was about, read these two short articles about the Supreme Court case.

As you are reading the articles, remember the two sides of the issue:

  • One side argued that demand response should get paid whatever the prevailing LMP happened to be, just like power plants do. The argument here is that the service being provided to the grid (balancing supply and demand) is exactly the same whether that service is provided by the supply side or the demand side. Therefore, exactly the same price should apply. At the margin, the grid should not value the demand side any less than it values the supply side. This was FERC’s position in an obscure order (called “Order 745”) that was challenged at the Supreme Court.
  • The other side argued that for demand response to get paid the LMP for each unit of electricity not consumed amounts to a huge subsidy. To understand why, let’s go back to our original example. In that example, the building owner reduces demand by 2 MWh and is paid the market price ($20/MWh) for doing so. But the benefit to the building owner is already huge – if the building owner had done nothing, then the market price would have been $50/MWh. So the benefit to the building owner of demand response is already $30 per MWh of demand reduced. Demand response does not involve any obvious costs in the same way that running a power plant involves obvious costs (fuel, labor, and so forth), so what exactly is the $20/MWh payment compensating anyway?

In the end, the Supreme Court sided with FERC and decided that demand response could get paid the market price just like power plants get paid the market price.

Another troubling aspect to demand response is that it is possible to manipulate the electricity market through demand response just as it is possible to manipulate the electricity market by strategic economic or physical withholding of power plants. The problem with demand response, in particular, is that it can be very hard to tell when demand response is being used to manipulate the electricity market. A typical strategy for manipulating demand response is to inflate electricity usage just prior to being called upon to reduce demand, to make the measured demand reduction look larger. Another manipulative strategy includes offering to provide demand response during a period when demand would be low anyway. For example, a factory planning to halt production on a certain day might offer demand response for that day, even though the factory was planning to reduce electricity usage anyway, even if offering demand response to the market was not an option.

A real-life example of demand response market manipulation occurred in 2010 with the Camden Yards baseball facility, home of the Baltimore Orioles baseball team. The facility normally carries an electric power demand of around 2 MW when the Orioles aren’t playing. The facility was told that it would need to reduce electricity demand during a certain period and would get paid by PJM to do so. The facility owners were told that the total demand response compensation would be based on the difference in demand between the hour when the demand reduction was needed and the previous hour. So during the hour before the baseball park was supposed to reduce demand, the facility managers turned on two large generators, increasing metered electricity usage to more than 4 MW. During the hour when the demand response was needed, they turned off the generators and reduced demand to 1.8 MW. The baseball stadium was then paid for a total demand reduction of 2.2 MW, most of which was basically fake since usage had been artificially inflated just before the demand response hour.