FERC Issues Final Rule on Demand Response Compensation

On March 15, 2011, the Federal Energy Regulatory Commission (FERC) issued a Final Rule on compensation for demand response resources participating in organized wholesale energy markets administered by a Regional Transmission Organization (RTO) or Independent System Operator (ISO).  The Final Rule requires that when dispatch of a demand response resource is cost-effective—as determined by a new “net benefits” test—the demand response resource must be compensated at the locational marginal price (LMP) for energy.  Each RTO or ISO must file a net benefits analysis, along with proposed tariff revisions necessary to comply with the Final Rule, by July 22, 2011.

Commissioner Moeller dissented from the Final Rule.

Overview of the Final Rule

The Final Rule requires that demand response resources in organized wholesale energy markets be compensated at the LMP if:  (1) the demand resource has the capability to provide service, i.e., the ability to displace a generation resource in a manner that allows an RTO or ISO to balance supply and demand; and (2) the payment of LMP to the demand response resource is cost-effective as determined by a “net benefits” test. 

The calculation of net benefits must account for the “billing unit effect,” i.e., the fact that dispatching demand response resources may result in an increased cost per unit to load as a result of the decreased amount of load paying the bill, depending on the change in LMP relative to the size of the energy market.  As a result of the net benefits test, FERC anticipates that LMP will be paid to demand response resources when small decreases in generation will result in price decreases sufficient to offset the billing unit effect. 

The net benefits analysis must identify, for each month and on the basis of historical data and the previous year’s supply curve, a price threshold estimate where customer net benefits would occur.  The threshold price corresponds to the point along the supply stack for each month beyond which the benefit to load from the reduced LMP, resulting from dispatching demand response resources, exceeds the increased cost to load associated with the billing unit effect. 

The filings must include the data, analytical methods, and the actual supply curves used to determine the monthly threshold prices for the last 12 months to demonstrate how the RTO or ISO would calculate its supply curves.  When the net benefits test becomes effective, the supply curve analysis for the historic month that corresponds to the effective month must be updated for current fuel prices, unit availabilities, and any other significant changes to the historic supply curve.  As part of their compliance filings, ISOs and RTOs must explain how applicable protocols will continue to ensure that demand response resources are accurately measured and verified.  FERC has invited each RTO and ISO to propose any changes to their respective protocols to adequately capture the performance (or non-performance) of each participating demand response market participant.

Additionally, the Final Rule requires each RTO or ISO to conduct a study examining the requirements for, and impacts of, incorporating the billing unit effect into RTO and ISO dispatch algorithms in order to more accurately integrate demand resources on a dynamic basis.  The results of these studies must be filed with FERC for informational purposes on or before September 21, 2012.

The Final Rule also mandates that the cost of compensation for demand response resources be allocated to all entities that purchase energy at the times and locations in which the demand response resources that reduced the LMP were committed or dispatched. 

Commissioner Moeller’s Dissent

In his dissent, Commissioner Moeller objects to FERC’s imposition of a standardized approach to demand response compensation across organized markets.  Moeller argues that RTOs and ISOs should be allowed to continue to work with market participants to develop compensation rules that are tailored to the specific needs of individual energy markets. 

Commissioner Moeller also took issue with the establishment of a net benefits test on the basis that it discriminates against demand response resources.  Moeller noted that “[i]n no other circumstance is a resource required to show that its participation will depress the market price in order to receive comparable compensation for a comparable service.” 

Finally, Commissioner Moeller asserts that the Final Rule will overcompensate demand response resources, because resources will receive the LMP plus save an amount that would otherwise be paid for purchasing generation (G) at the retail rate (e.g., LMP + G).  Commissioner Moeller concluded his dissent by stating “if I were to now support any standardization of demand response compensation, it would be the LMP - G approach, which in my opinion, is the only economically efficient outcome for the markets.”

Ongoing Issues

Implementation of the Final Rule will, in large measure, be a function of the net benefits test established by each RTO and ISO.  Market participants are likely to have widely differing views on key analytical issues.  Future RTO and ISO efforts to modify dispatch algorithms to integrate the dispatch of demand resources on a dynamic basis will likely engender additional debate.  Given the level of stakeholder interest in this issue, the diverging views of stakeholders, and Commissioner Moeller’s dissent, the Final Rule likely will be subject to a number of rehearing requests and, ultimately, judicial review.