Setback for Demand Response in Organized Markets

June 2014

On May 23, 2014, demand response (DR) resources received a significant setback when the U.S. Court of Appeals for the D.C. Circuit Court issued a decision vacating and remanding the Federal Energy Regulatory Commission’s (FERC) Order No. 745. The order, which was issued in 2012, expanded the role of DR in energy markets controlled by Regional Transmission Organizations (RTOs) and Independent System Operators (ISOs). The premise of the order was to establish a framework to compensate DR when called upon to replace more expensive generation.

Although many questions remain unanswered as a result of this decision, it is clear that DR will continue to play an important role in how electricity is produced, delivered, and consumed. Additional background on the order, the court’s decision, and implications for DR in the future are summarized below.

Key Details

DR resources are essentially retail customers, often aggregated by third parties, who are able to reduce their consumption of grid-provided electricity at specific times when called upon to offset the need for additional generation to meet demand. This may be by reducing load (e.g., turning off equipment) or by self-generating (if they have on-site generation). In return for reducing consumption during critical times, retail customers are compensated for their actions. To increase the penetration of DR in organized markets and provide alternatives to expensive generation sources, FERC issued Order No. 745. The order as originally issued stated that:

  • DR is an important resource and can play a role in improving the efficiency of organized markets.
  • Calling on DR resources during peak periods would reduce demand and therefore reduce the amount of generation required to meet demand.
  • Demand reductions through DR could reduce locational marginal pricing (LMP), as DR would replace more expensive generation in the bid stack.
  • DR customers would be compensated for taking the action to reduce demand.
  • Customers would be paid the full LMP when called upon by the ISO or RTO.

When issued, Order 745 had many supporters and detractors. Those opposed to the Order included Commissioner Moeller, who dissented from the order arguing that standardized compensation for demand resources would undermine existing markets. He also held that the rule would overcompensate DR resources relative to traditional generation resources. His rationale was that DR resources would benefit from both the savings of the avoided cost of purchased power and full LMP payment.

Subsequent litigation paralleled Commissioner Moeller’s arguments. In the end, the ruling by the D.C. Circuit Court to vacate Order No. 745 in its entirety was based on a different set of arguments. In its ruling, the court held that:

  • FERC overstepped its statutory authority as FERC’s jurisdiction under the Federal Power Act (FPA) is limited to “the sale of electric energy at wholesale in interstate commerce.”
  • Order No. 745 was determined to be direct regulation of the retail market, thus outside FERC’s jurisdiction under the FPA.
  • Because DR is part of the retail market, it falls within the states’ jurisdiction to regulate.
  • The decision to require payment of full LMP was arbitrary, capricious, and would result in overcompensation of DR resources.

Implications

The ultimate effect of the court’s majority decision on DR resources is not likely to be known for some time. As expected, FERC has taken action and on June 11, 2014, indicated their intention to seek a rehearing of the court’s decision. Regardless of the outcome, the door has not shut completely on DR.

Some interesting points to consider:

  • PJM, the country’s largest energy market, already has a large DR presence with much of these resources in the capacity market.
  • Economic DR, which is covered under Order 745, makes up only 2% of EnerNOC’s revenue (EnerNOC is the largest DR provider in the United States).
  • The decision does not impact non-jurisdictional markets, including ERCOT and most of the western United States.
  • The primary beneficiaries of economic DR have been large industrial and commercial customers savvy enough to play in this market.

If the court’s decision stands, the most significant outcome could force state regulators to address DR and recognize its importance as a part of the energy mix. Similarly, if Order 745 is struck down, it will not preclude RTOs and ISOs from establishing their own compensation structures for economic DR, outside of FERC’s oversight. However, parties such as the Advanced Energy Management Alliance contend that the outcome of the decision will lead to significantly higher energy costs for consumers.

More Information

FERC Order 745: http://www.ferc.gov/EventCalendar/Files/20110315105757-RM10-17-000.pdf

SNL News Article: http://www.snl.com/interactivex/article.aspx?id=28203434&KPLT=2

This report is part of the Regulatory Minute series. To view all featured Minutes, please click here.

view more

Contributing Authors

Dave Adams Director

Welcome to ScottMadden!

Sussex Economic Advisors is now part of ScottMadden. We invite you to learn more about our expanded firm. Please use the Contact Us form to request additional information.