Enabling Price Responsive Demand

Distributed energy resources (DER) have the potential to transform electricity markets, making them more reliable, competitive, and affordable, while providing a cornerstone for zero-net-CO2 energy systems. But enabling DER to play a larger and more dynamic role will require rethinking how the supply and demand sides of the market interact.

Electricity has always resisted the strictures of textbook microeconomics. Electricity consumers have historically had limited ability or desire to respond to prices that can vary considerably over time. Even where consumers have access to time-varying wholesale prices, system operators often limit their role in price formation due to concerns over system reliability.

Before the creation of organized markets in the late 1990s and early 2000s, consumers participated in day-to-day electricity economics through utility DSM programs and demand charges. Organized markets provided an alternative and more direct route to market for consumers via third-party providers, enabling significant growth in demand response and an expansion of price responsive demand via market-based wholesale pricing.

Over the 2010s, ISOs expanded opportunities for demand-side participation in organized markets, creating new demand response products and business models for DER aggregators. Utilities began to explore new program and retail rate designs, enabled by AMI and emerging DER technologies.

But even as opportunities for consumer participation have expanded and evolved, they remain rooted in a traditional demand response paradigm that compensates consumers for reducing demand relative to a baseline.

This traditional paradigm is at odds with a future in which there is significantly more battery or thermal storage embedded in distribution systems. Storage enables automated price response, rendering consumption baselines less meaningful (and more open to gaming) and bringing electricity closer into the orbit of orthodox microeconomics by allowing consumers to have bona fide demand curves. Ubiquitous distribution-level storage — paired with energy management systems and, in some cases, on-site generation — would have profound implications for the electricity industry.

However, the transition to DER-enabled price responsive demand is not simply a matter of inexorable technological progress. Enabling price responsive demand requires tackling two overarching institutional questions: (1) who should own and operate distribution-level storage and for whose benefit, and (2) how can ISOs better integrate price responsive demand into their market processes and price formation.

These questions involve thorny, complex issues that have multiple options and avenues and will take time to work through. The first (1) requires resolving federal-state jurisdictional issues, unbundling and modernizing distribution system operations, better aligning utility and customer incentives for DER through rates and incentives, and modernizing distribution planning. The second (2) likely requires new intraday products (e.g., 30-minute markets) that clear using market participant demand curves, a step change in information and communication technologies, and a rethinking of capacity markets.

The fact that these issues are challenging does not imply that we should shy away from them. On the contrary, tackling them head on now will provide the lead time needed for what will likely be a circuitous transition

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