FERC and Demand Response

by Bruce Huber — Tuesday, Feb. 17, 2015

I’ve been exploring a few issues in energy regulation that Congress is likely to take up this term. Up today: FERC’s efforts to promote demand response in wholesale electricity markets.

What is “demand response”? It’s the umbrella term for programs that urge customers to turn off the lights when demand for electricity is extremely high. Because electricity cannot easily be stored, there must be enough electric generating units out there to satisfy the highest peaks of demand—even if those so-called “peaking” power plants are only needed for a few hours out of the year. Peaking plants tend to be expensive, inefficient, and relatively dirty from an emissions standpoint. Demand response programs offer an alternative to firing up these plants: find people who are willing to reduce their power consumption at those times when other customers are using lots.

In a very general sense, utilities have long relied on demand response in that they have used various pricing models to shape the behavior of users of electricity. Sam Insull, a protégé of Thomas Edison who became a Chicago-area electric tycoon around the turn of the 20th century, recognized early on that a critical feature of the electricity sector was erratic demand. It was exceedingly inefficient, Insull realized, to build expensive power plants that were only necessary for brief moments of very high demand. So Insull developed pricing plans designed to flatten out demand for electricity. He sought to induce customers to orient their operations around the emerging economic realities of the grid. Lower prices could be had, for example, by buying power at night when residential customers were asleep.

Some of today’s demand response programs are similar in that they use pricing schemes to shape customer behavior. But the more controversial (and arguably more robust) programs work in a different way: they actually pay customers for a commitment in advance to reduce their consumption at times of peak demand. These programs are an important tool in the grid operator’s arsenal because they offer demand reductions that can be dispatched on short notice if the need arises. Programs that rely on pricing, by contrast, are not as dependable; customers can always choose to leave the power on and pay the going rate.

So far, so good. But there is another important rationale behind demand response programs, and it’s one that is often overlooked. Demand response offers grid operators an antidote to the market power of electricity producers.

In the old days—that is, before energy markets were restructured in the 1980s and 90s—utilities were regulated monopolies. They earned a regulated rate of return; they couldn’t exploit times of peak demand because their rates were established in advance by FERC or a state utility commission. But by the late 1990s, FERC had created wholesale energy markets in which rates for electricity were determined by market forces. When demand peaked, the price went up—and sometimes, way up. As in, California electricity crisis UP. At the very highest peaks of demand, producers with any remaining available generation capacity had enormous market power and could charge almost any amount for power. Worse, the California crisis demonstrated that firms could sometimes manufacture power shortages in order to drive up market rates.

One of FERC’s biggest challenges in the years since the California crisis has been finding a way to limit the market power of big power producers at times of market strain. It should be obvious now why demand response programs are an important tool in this regard: they offer a competing resource, a competing way of satisfying the grid’s demand rather than simply switching on the last remaining peaking plant at some exorbitant rate. And it comes from a source completely separate from, and indeed at odds with, the club of power producers.

So why might this be an issue for Congress? The reason is that the D.C. Circuit in 2014 struck downFERC’s demand response program. A split panel ruled that the program transgressed the jurisdictional lines established for FERC in the Federal Power Act. Just last month, the Solicitor General petitioned the Supreme Court for cert on behalf of FERC. Depending on the Court’s decision, reviving FERC’s program may well require Congressional action. It’s clear that some in Congress regard this as an important concern. In the confirmation hearings for FERC Commissioner Collette Honorable (who was confirmed in December of 2014), a number of questioners pressed Honorable for her views on demand response generally and FERC’s embattled program in particular.

The fate of wholesale demand response programs, then, remains uncertain. But if the Supremes deny cert or otherwise uphold the D.C. Circuit’s opinion, it could well be up to Congress to sustain this import bulwark against the monopolistic tendencies of power producers.

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