For Demand Response, Second Best Isn’t Good Enough

A major cost to the power grid is handling peak load—making sure that there is enough power available when it’s needed most. In the PJM region, more than 20 percent of the cost of electricity is used for this. For decades, utilities have reduced those costs through “peak-shaving” demand response programs, such as paying customers to turn down their air conditioners when the grid is under stress. But grid operator PJM has refused to acknowledge these peak-shaving programs. It’s now changing course, but its recent proposal to re-integrate them into the grid would leave demand response serving as a second-class resource.

This is a lost opportunity to replace old, unneeded power plants with a cheaper, cleaner alternative. PJM should allow demand response to be used when it’s the cheapest resource available. Instead, it asks ratepayers to pay hundreds of millions of dollars every year for a more expensive, dirtier solution. Thankfully, federal regulators still have an opportunity to reject PJM’s misguided plan.

When consumers use less electricity, it’s much like having a power plant produce more power. Because of this, demand response is treated by power markets as a resource in its own right. Groups of customers who commit to curtailing their power usage compete head-to-head with power plants. Since demand for electricity is highest in the summer, seasonal programs like air conditioner cycling keep the grid reliable at much lower cost than “peaker” power plants that sit idly for most of the year. This approach has worked phenomenally well: from 2007 through 2015, more new demand response was created in PJM than new power plants built, saving consumers billions of dollars.

Demand Response and Consumers Pay for Power Plants’ Failure

An astonishing number of PJM’s coal and gas power plants failed during the cold snap of January 2014, bringing the grid uncomfortably close to blackout. In response, new rules were put in place requiring most power plants to be available year-round. Perversely, this was extended to throw out peak-shaving demand response. PJM argued that it could only require generators to deliver power during the winter if demand response was required to reduce power during the winter. Since air conditioner cycling programs aren’t much use during the winter, those programs were thrown out of the market.

This effectively stranded (i.e., devalued) the investments that states had made in demand response programs, with PJM refusing to acknowledge their value or make use of them. As a result, ratepayers have had to pay hundreds of millions of dollars keeping generators on call year-round to make up for the rejected demand response, even though the need is only in the summer. This has exposed PJM to considerable pressure to reincorporate seasonal demand response into its markets. In December, PJM filed their proposed rules to do this.

Proposed Peak Shaving Rules Are a Step Backwards

Sadly, the proposal is so flawed that NRDC had no choice but to oppose it. PJM has fixated on the idea that demand response should not be able to participate in wholesale markets. Instead, PJM argues, demand response should happen outside of markets, and only indirectly compete with power plants. Following this logic, the proposal limits peak-shaving to a subset of utility programs, and only acknowledges their benefits by reducing forecasts for future electricity demand.

This approach suffers from numerous flaws. To name the top four:

• Peak-shaving programs would curtail based on weather, rather than being controlled by grid operators. Since system emergencies don’t perfectly track the weather, this means they might not be used when needed. We looked at one successful utility program and found that under the proposed rules, it would have curtailed less than half of the times it was needed in the last ten years. This is simply throwing away the value of demand response programs.
• On the other hand, on many hot days the grid is doing just fine. The proposed new rules would have demand response curtail on those days anyway, even when much cheaper sources of power are available. We found that to qualify under the new rules, demand response programs would have to curtail dozens of unnecessary hours every year. The customer incentive payments for those curtailments are enough to make some programs uneconomic.
• Demand response doesn’t get paid. Instead, demand response programs are expected to justify their costs by the savings to ratepayers. If nothing else, this means that non-utility demand response providers—who, at last report, provided 83 percent of the demand response in PJM—will have no way to see the benefits of their demand response. Limiting demand response to state-sponsored utility programs goes against the principles of a competitive market, and stifles innovation in one of the more dynamic sectors of the power industry.
• The grid uses a variety of reliability services—technical products that meet specific needs like balancing supply and demand in real time, responding to surprise outages, and so on. These services will become even more important as more renewables come online. Demand response is an effective, low-cost provider of these services. However, because these services don’t directly show up in ratepayers’ bills, they don’t fit into PJM’s preferred model. PJM’s proposed solution is draconian: demand resources that elect to use the proposed peak-shaving option are banned from providing other grid reliability services.

Better Solutions Already Exist

What makes these flaws fatal is that we already know how to avoid them. The model of “demand response as supply” that’s been used successfully for more than a decade has none of these problems. When demand response is treated as a controllable resource, it is as flexible as a power plant: it can be used when needed, not used when lower cost options are available, and provide all the services needed by competitive power markets.

The electric industry knows how to do demand response, and how to do it well. PJM offers a solution that is less efficient, less cost-effective, and less flexible than what came before.  We remain puzzled why PJM seems to have dug in its position against seasonal demand response, or the motivation for its quest to push demand response out of wholesale markets. Regardless, they have asked the Federal Energy Regulatory Commission (FERC) to choose between a tried-and-true solution and an inferior substitute. The correct choice for FERC is clear: PJM should be ordered to reinstate seasonal resources into its markets.