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How demand response cuts wholesale power costs

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In the late 1990’s, U.S. energy regulators began to recognize how the demand side affects wholesale power markets by effectively creating new power resources at far lower costs than building either traditional or renewable generation. Following several years of development, demand response has now started transforming wholesale markets — and reducing costs for ratepayers.

Demand response programs compensate customers for agreeing to reduce their electricity usage for a few hours, usually on summer afternoons. These programs also can include energy efficiency — that is reducing energy use throughout the year, usually by replacing equipment or appliances with more efficient models.

In May PJM (the wholesale market operator for 13 states and the District of Columbia) announced its May capacity auction results. PJM noted price reductions of up to 85 percent — driven largely by demand response resources.

In PJM, as in many wholesale markets, retail energy suppliers (utilities) pay for power supply in two ways:

  • Capacity: These purchases ensure that sufficient power resources are available to meet the annual peak demand of utility customers. This can be considered a reservation payment: a retailer with a million customers would reserve, say, a 2,000 MW power plant to serve their customers on the peak day of that year.
  • Energy: Retailers also must pay for the actual energy (kWh) consumed by their customers every day.

This is rather like paying for a car. Your monthly car payment (say, $500) ensures that you have a car available to use. But you also pay separately for all the gasoline you use to drive around. Your monthly payment is “capacity,” the gasoline is “energy.”

In wholesale power markets around the world, capacity typically costs $50-100 per kilowatt-year — which means for that price an energy retailer can reserve one kilowatt’s worth of generation capacity at a power plant. (Remember, 1MW = 1,000 kW). So if a utility needs to reserve 2,000 MW of capacity for a year, that will cost $100-200 million per year.

Back to PJM — which happens to be the world’s largest electricity wholesale market. For 2011/2012, most of PJM’s capacity cost was $40.15 per kW-yr — a little low, but not unusual. However, for 2012/13, that cost plummeted 85 percent to just $6 per kW-yr!

What changed? One reason for market prices to drop is an increase in supply. In this case, the supply of demand response resources bid into the market skyrocketed from 1,597 MW to 10,167 MW. That’s the equivalent of adding eight large coal plants or four major nuclear plants — in a single year! And with no greenhouse gas emissions or nuclear waste involved.

Consequently, our example utility which needs 2,000 MW of capacity would pay only $12 million per year, rather than spending $100-200 million. And these savings can be passed on to ratepayers.

I should point out that this especially low price, while highlighting the importance of demand response, is very unusual. Even with demand response, PJM’s capacity prices are projected to climb back up to $45.98/kW-yr by 2014/15.

But that’s still less than half the cost to build new power plants.

This article originally appeared on eMeter’s Smart Grid Watch blog. Chris King is the Chief Regulatory Officer for eMeter. He is a nationally recognized authority on energy regulation and competitive energy markets, and is widely recruited by regulators and legislators to consult on technology issues in electric restructuring and grid management.

One Response to “How demand response cuts wholesale power costs”

  1. This is clearly a win win situation, but tell me: What happens to the electiricty buying companies on those summer afternoons. What do they do? Shut down their factories? I don’t understand I am afraid. Thanks.