Demand Response: New Offers and Customer Acceptance

1
Demand Response New Offers andCustomer
Acceptance

• Prepared for the
• Peak Load Management Alliance (PLMA)
• Annapolis, MD
• By
• Daniel M. Violette, Ph.D.
• Summit Blue Consulting
• Boulder, Colorado Phone [phone] dvi
  olette_at_summitblue.com
• October 7, 2002

2
Background

• Recent Experience draws from two white papers
  co-authored for the Peak Load Management Alliance
  (www.peaklma.com).
• Demand Response Principles for Regulatory
  Guidance, February. 2002
• Demand Response Design Principles for Creating
  Customer and Market Value, October, 2002
• Recent work for utilities on demand bidding, DR
  valuation in wholesale markets, benefit-cost
  tests for DR, program design for ISOs.

3
Demand Response Defined

• Three Components
• 1. Load response called for by others --
  includes direct load control, partial or
  curtailable load reductions, load interruptions.
• 2. Price response -- includes real time pricing,
  dynamic pricing, fixed time-differentiated rates
  (e.g., time-of-use rates), and demand bidding at
  different prices.
• 3. Distributed generation -- includes backup
  generation and net on-site generation.
• All three represent some form of price
  response.

4
Whats Up in Retail Markets

• Regulators who are working on existing market
  design and planning post-transition market design
  are keenly aware of demand response.
• Several states are initiating pilots to address
  time-differentiated pricing (New York,
  Massachusetts, California, Pennsylvania)
• Others are following (e.g., New England Demand
  Response Initiative).
• NARUC meeting agendas show high regulator
  interest.
• FERC designated ISO NE as a test bed for DR
  offers.
• Customers are actively being brought into the
  discussions
• Increases awareness and helps put energy on
  customers agenda
• Develops better understanding of what they can
  bring to the table with demand response and
  pricing options.

5
Key Trends

• The value of demand response offers (pricing and
  load) is becoming more widely recognized
• As a risk management tool (past planning tools
  understated value)
• As a supplier of reliability and operational
  services to grid operators.
• Projections of modest wholesale electric prices
  for the next few years has interesting effects
• Creates more headroom for retailers in markets
  open to retail choice.
• Returns the willingness of regulators to
  experiment with pricing and demand response
  offers.
• Still, risk remains from unexpected events such
  as forced outages, and transmission bottlenecks.

6
Benefits of Demand Response

• Creates opportunities for risk management
• Enhances Market Efficiency
• Price reduction at the margin
• Enhances system reliability
• Potential environmental improvements
• Customer service and choice
• Market power mitigation

7
Key Factors

• Demand response is important to the continued
  development of wholesale and retail markets.
• Competitive markets are based on the interaction
  of supply and demand in response to price
  signals.
• However, the history is one of cost-based
  administered pricing in retail markets with
  average rates that ignore the fact that costs
  vary across hours, months and seasons.
• So, what are markets about?
• 1. Markets should be designed to to allocate
  resources efficiently.
• 2. This is done through price signals.
• 3. A promise of innovation and improved
  productivity -- this was a promise made by
  regulators as part of restructuring activities.

8
Bottom Line for Markets

• If we dont price whats scarce (e.g.,
  peak-period commodity), how do we incent
  innovation and enhance productivity.
• If we dont price whats scarce, how do we
  improve load factors in one of the countrys most
  capital-intensive industries.
• Issues
• Uncertainties from restructuring and bifurcation
  of incentives have discouraged investment in
  infrastructure to support demand response.
• While wholesale competition has been encouraged,
  it can be argued that price elasticity and demand
  response capabilities have actually decreased in
  recent years.
• This creates a disconnect between wholesale and
  retail markets.

9
Key Factors

• Opportunities for generators have increased with
  open access and market based rates -- this needs
  to be balanced with market incentives and access
  for demand response resources.
• Market designs need to provide support for this
  balance between supply-side and demand-response
  resources.
• This is a long term proposition -- markets that
  incorporate economic demand response capability
  will promote efficient resource investments over
  time.
• The appropriate transition path to markets with
  economic demand response may be uncertain and
  open to debate but markets are going to change.
• Where are the points of leverage and how will the
  retail business be affected?

10
RTO and ISO Issues

• A liquidity point is needed for DR, i.e.,
  customers able to respond to price need to
  benefit from taking these actions.
• RTOs and ISOs can provide price signals and
  settlements
• ONE VIEW Any market in which generation
  competes should be open to DR resources
  including
• Energy resource markets (day-ahead, hour-ahead,
  and real time)
• Ancillary services markets (as appropriate)
• Replacement reserves
• Emergency demand response
• Capacity markets
• In these markets, demand response resources
  should be treated on an equal footing with
  generation.

11
What is the Impact on Your Business?

• Do you believe that the retail industry is facing
  change?
• Think about the regulatory initiatives going on
  across the country.
• Think about the FERC SMD NOPR and White Paper
• Demand response is essential in competitive
  markets to assure the efficient interaction of
  supply and demand.
• Demand response options should be available so
  that end users can respond to price signals.
• What are the implications of this attention to
  demand response?
• Are customers willing to discuss innovative
  pricing for electricity?

12
Distribution Company

• Distribution companies are likely to continue to
  have a major supply responsibility.
• Regulatory rules on rates (pricing) and cost
  recovery will be critical.
• Factors that impact the financials of LSEs may
  also impact the distribution company,
  specifically the role of risk management.
• In states with retail choice, what happens after
  the transition period?
• Up till now, demand response has not been on the
  regulators agenda -- Does that matter for the
  future?

13
Key Regulatory Issues

• Who benefits from and pays for demand response
• If a customer is served by an unregulated energy
  services provider?
• If a distribution company acts as a standard
  offer provider or provider of last resort?
• If DR is provided by a specialist curtailment
  services provider (CSP)?
• Regulators need to develop rules that keep
  distribution companies from taking on additional
  risks without equal opportunity for reward.

14
Market Challenges

• How should DISCOs be expected to manage the large
  fixed-price MWh obligations as markets continue
  to transition?
• How to align retail offerings with products from
  wholesale markets?
• What types of regulatory and market rules will
  allow for, and even encourage, the development of
  tools to address these issues?

15
Key Trends

• Three trends can be expected as retail markets
  expand
• 1. Increased recognition of the value of
  flexibility across both price and quantity
  dimensions (regulators and retailers).
• 2. A drive to develop innovative price and
  related demand response offerings that meet
  strategic and financial objectives.
• 3. There will be a re-integration of retail and
  wholesale activities.
• Physical hedges will complement financial hedges
• A portfolio play that manages risk will be needed
  to maintain margins

16
Pricing Options

• Innovation in pricing is already occurring
• quantity limits
• two-tiered fixed/spot contracts
• variable TOU rates where the peak and off-peak
  periods are tailored to or defined by the
  customer
• hour-ahead and day-ahead quantity adjustments in
  contracts and demands
• bidding contracted quantities back into supply by
  customers
• standby and buy-through contracts
• retailer serving as a broker for portions of
  customer load on peak days
• Customer load control through on-site or
  proximate generation options

17
Success Factors

• Dont follow. Instead, seek to create new markets
  with appropriately priced product offerings
• Develop sales tools and techniques that engage
  customers in the process of procuring energy.
• Sales discipline -- negotiating specific pricing
  schemes requires setting limits and creating
  enabling sales tools.
• Analytics are developed to value the negotiated
  offer
• A contract confers future rights to buyers which
  can be represented by a strip of options.
• Setting prices that appropriately reflect the
  value of these options to the seller and buyer is
  a challenge.
• Can this be done by DISCOs in a tariff
  environment?

18
Appropriate Regulatory and Market Rules

• Many distribution companies will continue to be
  in the supply business.
• Regulators need to set incentives that encourage
  economic demand response.
• DISCOs may already have sizeable incentives to
  seek out demand response that are not fully
  recognized.
• DISCO benefits depend on nature of the contracts
  for default, standard-offer or basic service
  obligations.
• Is there a regulatory hedge against price
  volatility, i.e., fuel-clause pass through?
• Are there inadvertent penalties for load
  reductions?
• What happens after the transition period?
• Outsourcing standard-offer/default service may
  alleviate some concerns.

19
Conclusion

• Customer differentiation matters.
• Different product and pricing options can be
  marketed.
• Attain what ever flexibility is available.
• Identify opportunities by engaging customers in
  the sales process.
• Risk management is a necessary and a critical
  success factor.
• Demand response can be one of the most
  cost-effective methods of managing risk, and
  providing operational reserves.
• Customers will become increasingly sophisticated.
• Time-differentiated pricing will increase the
  market for energy services by rewarding
  technology that manages energy use.
• A period of modest wholesale electric prices may
  promote experimentation by regulators.