Robert Borlick writes in Public Utilities Fortnightly that FERC Order 745 is “one of the worst orders FERC has ever produced” – “a time bomb for electricity consumers”. Whoa! I better sharpen my axes. That is a more lethal statement than I would even write, and it isn’t even in the opinion section. It’s a featured article.
Let’s take this a step at a time. The Federal Energy Regulatory Commission (FERC) is adorned with the authority to regulate “the sale of electric energy at wholesale in interstate commerce”. As noted in DC Smackdown of FERC, regulation of interstate commerce is a universal power of the federal government created to prevent trade wars among the states.
Per regulations (presumably, FERC’s), demand response can be split into two bins – reduction of electric consumption compared to business as usual due to:
- A response to an increase in the price of electricity, or
- Incentive payments designed to induce lower consumption
FERC 745 is about #2.
When I think of the demand response programs we have in the upper Midwest and elsewhere, these are lousy definitions. Most demand response (DR) consists of interruptible rates, time of use rates, and direct load control.
- Interruptible rates vary in how they are structured, but one way or another, large energy users pay lower demand charges in exchange for curtailing load when asked. If they do not curtail load, they are severely punished with penalties. It’s fair and square.
- Time of use rates include higher rates during peak hours, typically 9:00 AM to 9:00 PM, weekday, non-holidays. These exist mainly for larger users but also for residential customers. For more, read here.
- Direct load control cycles the larger loads for small users including small business and residential. The loads are typically summer space cooling equipment and water heaters.
However, I notice that FERC Order 745 applies to “day-ahead and real-time energy markets”, which we do not yet have in the Midwest.
FERC 745 directs the non-profit ISOs and RTOs, which balance and control the flow of power over multi-state regions, to compensate those DR participants by paying them the locational marginal price (LMP, or lump as I call it) for their curtailment. In other words, participants are compensated for two times the cost of energy by not using energy. For simplicity, if the lump is 30 cents per kWh and a customer shuts down a 100 kW load for three hours, she doesn’t pay the $90 she would have used, plus she gets compensated $90 for not using it.
I am tempted and would like to write about the legal hair splitting, which is not unlike the Clean Power Plan’s labyrinthine justification, but that would take the rest of the post. Please, egg me on to do so, and I will do it.
Four Flaws of 745
Borlick says there are four flaws with FERC Order 745. It:
- Overcompensates demand response
- Discriminates against wholesale suppliers
- Sanctions and enforces exercise of market power
- Will increase prices
Starting with overcompensation, he says precisely what I did above – that DR participants are paid twice the lump for each unit of energy not used. The overcompensation equals the lump. The proceeds are shared by the customer, the aggregator of DR, and the load serving entity (utility). Who pays for it? The incentive is paid by non-participants and suppliers lose revenue.
I read recently that DR markets are still dominated by commercial and industrial customers. Economic theory, which happens to be correct, is that when profit-driven enterprises are overcompensated for curtailing production there is a net economic loss. It reminds me when I was a kid on the farm. Farmers were paid by the government to idle 10-20% of their land to support commodity prices. I thought, what a racket! Who else gets paid to do nothing? Taxpayers pay farmers to curtail, and they pay again in the form of higher food prices at the store. As Gorlick says, what’s not to like?
Discrimination against wholesale suppliers is essentially a subset of overcompensation. Under 745, the ISO pays twice the cost for DR resources as compared to purchasing from a wholesale supplier. Look at it this way: if someone is double compensated, somebody else is double paying.
More clearly, the discrimination makes it far more likely / cost effective to run generators behind the meter. Some may think this is competition. If paying one side twice the cost of saved electricity with others’ money, sure.
This argument is essentially the flip side of the farm program noted above. In that case it is the customers / tax payers who pay to reduce output and then pay again at the grocery store. Order 745 inserts an incentive that cuts out/down suppliers in competitive markets where it applies.
Although 745 reduces consumer prices near term, over the longer term, prices will rise as investors build suppressed pricing into their projections. This essentially means they will wait until demand is high enough to produce prices high enough when accounting for 745, to be profitable.
I made a similar argument in our internal blog, Michaels Energy Daily – that you can’t intervene in a competitive market without substantial consequences because it raises risk and therefore cost for new suppliers, and ultimately higher prices for customers.
Does this mean DR is bad? Absolutely not. I will save that for another day.