HOW DR PROGRAMS CAN DELIVER BIG SAVINGS

There has been significant discussion about the cost effectiveness of demand-response (DR) programs in wholesale markets when capacity is in short supply. Major savings accrue when DR programs can substitute for expensive peaking power — or rolling blackouts, which are even more expensive. But, is there empirical evidence to support this?

The most impressive empirical evidence was provided during an extensive heat wave in the United States that affected major portions of the Midwest and the East Coast during the summer of 2006, breaking historical peak loads and setting record prices for peak power.

During the August 2006 heat wave, PJM Interconnection reported cost savings totaling US$650 million attributed to its DR programs. On just one day alone, Aug. 2, 2006, when PJM set a new peak load record of 144,796 MW, it reported DR savings of $230 million. These savings were based on incentives paid to DR program participants versus the cost of acquiring peaking generation, as determined by the market-clearing prices on that day. These (DR) voluntary curtailments reduced wholesale energy prices by more than $300/MWh during the highest usage hours.

In the case of PJM, where there are a number of markets for DR, participating customers or curtailment service providers can effectively bid load reduction into the wholesale market to be used during a peak demand episodes. These resources can be invoked when their price is less than buying peaking capacity or ancillary services during a heat wave or some other system emergency. The savings reported by PJM and others for reliance on DR are real and substantial.

ECON 101 APPLIED TO DEMAND RESPONSE

The significance of price elasticity can be seen in the graph shown here. In most markets, demand exhibits some elasticity, represented by the downward sloping line D1, on the left side of the graph. If demand shifts from D1 to D2, for example because of a heat wave, the market-clearing price increases from P1 to P2.

Contrast this with the steeply rising supply curve on the right side of the graph, and the inelastic demand curve represented by vertical line D1. In this case, a slight shift in demand, from D1 to D2, would result in a significant price spike. When there is little or no demand elasticity, relatively small changes in demand can cause a very large spike in prices.

In practice, the aggregate supply offer curve in an organized market during a peak demand episode resembles the shape of the curve on the right side, with a near vertical tail. Making matters worse, the aggregate demand curve, in the absence of DR, tends to be highly inelastic, represented by the vertical lines. This is why demand-response programs are so effective in reducing price volatility when supply is constrained.

Andy Ott (ott@pjm.com) is senior vice president of markets for PJM, LLC. Following 13 years in transmission planning and operations at GPU Inc., Ott joined PJM and is responsible for executive oversight of its Market Operations, Market Strategy, Member Training, State Relations, Customer Relations and Performance Compliance divisions. He was responsible for implementation of PJM's wholesale electricity markets, including the PJM locational marginal pricing, financial transmission rights day-ahead energy market and capacity market systems. He has extensive experience in energy market restructuring, including electricity market design and implementation issues, and in power-system engineering applications. Ott is the U.S. representative and working group chair for CIGRÉ Study Committee C5 on Electricity Markets and Regulation.