Demand Response: A Window to Market Transparency

Ross Malme | Dec 18, 2002

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Responding to a negative newspaper editorial, Abraham Lincoln quipped, “I may be a slow walker, but I never walk backward.”

Perhaps the same thing can be said about the last few years of deregulating the energy market. There have been mistakes and there has been progress. It may have been slow, but it’s not likely to step backwards. And why? Because the new, open and competitive energy marketplace is much needed, and we now have the technology to make it work.

Previously, energy was considered a fundamental commodity. But, as we move to more open and competitive markets, “energy” becomes an asset, something that can be owned, traded, valued, saved, purchased, leveraged and managed. And it’s this idea of regarding energy as an asset that is the groundwork for energy conservation and effective energy management.

To realize the full potential of the energy asset requires a vigorous and healthy open market structure, one that allows full and timely two-way participation, and one that ensures market transparency. Market transparency is often used to mean open and visible systems that allow all interested parties to observe how the market is functioning, what deals are being made. This also implies several things, from merely allowing end users to view real time price signals and their energy usage up to strict monitoring of all trades and the respective positions of all market players and counter parties.

“Market Transparency” is also a term that has grown popular in the energy marketplace partly due to the creation of FERC’s Standard Market Design (SMD), the consequences of the Enron collapse, and increased questioning of trading practices throughout the industry. There is, as yet, no clear-cut definition of “market transparency,” but much discussion is taking place in the marketplace of ideas. What is clear, however, is that the concept is considered an essential and necessary component of an open market or deregulated market system.

Jeff Brown, General Manager of Regulatory Affairs for Shell Trading Gas & Power Company, said, “Transparency is a fundamental element of well functioning electric power markets. Without quality information that the market can trust, buyers and sellers are forced to transact with an unnecessarily high-risk premium…. Establishing day ahead and real time energy markets using tools such as locational marginal pricing would clearly provide an effective means for customers who are willing to reduce their consumption to receive the reward for their actions. Otherwise, customers are relegated to seeing a single price for the entire region, with no consideration for transmission constraints or power availability.”

To succeed, deregulated markets require a functional and efficient means of ensuring market transparency and liquidity. One proven means of doing this is to bring Demand Response Resources (DRR) to the wholesale and retail energy marketplace. On a practical level, a common software-based system is required to provide a vehicle to create market transparency through the active management of DRR assets for energy, capacity, reserves, and transmission congestion applications.

Empowering the management of these DRR assets is the Internet and online trading, both of which have brought “market transparency” to the forefront in the energy industry. Online energy trading is attractive to end-users because of its speed and efficiency. The increased use of these online trading systems allows for more liquidity and price transparency and provides energy companies the ability for improved real-time risk management. The Internet gives end-use customers the ability to view real-time price signals and their respective energy usage and to compare energy resources, services and markets. This makes consumers more sensitive to perceived differences in the mix of variables and allows them to make more informed operational decisions and manage their energy costs. It also intensifies competition between energy supplies, making deregulation work as envisioned. On the contrary, in a non-transparent market, market participants can profit from customer ignorance, create artificial confinement, and stifle price competition.

A parallel can be drawn from the financial services industry. As technology and the Internet mature, people are able to access the financial markets easier, faster, and less expensively. The average person can log on to one of several Internet portals such as Yahoo or MSN to see how the market is moving throughout the day. Before the Internet and Financial News Channels, investors needed a direct link to the market via a Quoteron machine or an open phone line to their broker.

A recent study on the impacts that technology advances have had on the financial industry said the following:

To those who trade in market securities, information and communications technologies have always been viewed as critical to the health and efficiency of secondary markets. Indeed, the disclosure and dissemination of timely and accurate information are crucial elements of promoting fair, orderly and efficient markets. It is therefore not surprising that the financial industry has moved more quickly than most to make use of new techniques for integrating information processing and analysis with the management and manipulation of large databases. In the last decade, technology developments such as innovations in data storage and management, networking capabilities, more powerful computer processing and increasingly sophisticated software have been developed and adopted in the securities industry. These recent advances in information and communications technology have resulted in markets that are more transparent and better able to handle increasing trading volume….

…Technology continues to be the driving force behind the securities industry, in several aspects. First and foremost, technology is allowing the everyday investor to become part of the world's financial markets in an unprecedented way through the Internet.

The same thing can now be said about the changes in our energy industry. The Internet enables market participants to regularly obtain price information from various pricing sources. The ultimate beneficiaries of price transparency are, in effect, the end use customers. Customers ultimately have a higher confidence level in their decisions on energy management if they are able to view price signals and their own energy usage. In turn, this confidence translates into increased efficiencies in the marketplace as a whole.

Market Transparency thus allows each participant in the energy market (i.e. ISOs/RTOs to Energy Providers, to the end users) to gather basic market information. In a healthy market this works to decrease market power unfairly exerted by any one source, and allows market participants to be active in more markets. All participants have access to market information such as price signals, reliability information, transmission status, congestion constraints, capacity credits and emission credits. Recently we witnessed an example of an unhealthy market in the Western U.S. during times of tight energy reserve margins when certain companies have been accused of holding back their extra generation to drive up energy prices. This kind of abuse makes it very hard for new entrants to enter the market and also offsets many of the benefits of deregulation in the electricity market.

Through the use of transparent DRR and the automated tools that enable consistent operation of these resources, this problem, as well as market power, are mitigated. In addition, DRR solutions allow end user customers the option of reducing load or turning on distributed generation to respond to the market reality at hand.

Demand Response

An essential factor behind the argument for Demand Response is a finding by the Edison Electric Institute that a 5 percent of demand reduction can reduce market prices by 50 percent. Before deregulation, information on prices and usage was not readily accessible in most cases. Customers were typically not able to see how much they were paying for energy until they received the bill the next month. With market transparency, the demand side of the market is able to take part in this market. Customers now have the opportunity to get paid as much as an energy company would get paid for selling generation into the market. This allows the customers choices and helps create greater market efficiency.

During emergency conditions, Demand Response Resources (DRR) and market transparency both play an important role. Each NERC region is required to keep a 15 percent reserve margin of electricity in case of an emergency. When energy reserves are short, utilities go out into the market to purchase power. EPRI has estimated that, “Power interruptions and inadequate power quality” already cause economic losses to the nation estimated at more than $100 billion a year.” With market transparency, if customers are able to receive the information that reserves are tight, they can respond to the need for power. This process increases system reliability by delivering the customers’ reductions to the market during emergency conditions and allowing those with onsite generation to market their excess asset.

In regions with transmission congestion demand response plays another important role in better managing capacity. In those areas where there is adequate generation and reserve capacity but energy providers are unable to export power due to transmission capacity constraints, demand response is proving itself a valuable tool. Used properly, demand response can help to increase the utilization of existing generation and encourages sounder conservation habits. Demand Response can also improve economic efficiency, improve system reliability, and manage congestion.

Standard Market Design (SMD)

FERC is currently working to restructure the design of the wholesale energy power markets to create a Standard Market Design (SMD). The Commission has outlined a plan in the “Working Paper on Standardized Transmission Service and Wholesale Electric Market Design.”

The SMD objective is to establish a common market framework that promotes economic efficiency and lower energy prices, maintains system reliability, mitigates market power and increases the choices offered to wholesale market participants. To this end a standardization of market design is being attempted that will use common business practices and market rules.

The SMD directly addresses demand response as a necessity that needs to be included in the creation of regional markets. The following three concepts are spelled out specifically in FERC’s SMD:

  1. Energy and transmission markets must accommodate and expand customer choices. Buyers and sellers should have options that include self-supply, long-term and short-term energy and transmission acquisitions, financial hedging opportunities, and supply or demand options.

  • Market rules must be technology and fuel-neutral. They must not unduly bias the choice between demand or supply sources, nor provide competitive advantages or disadvantages to large or small demand or supply sources. Demand resources and intermittent supply resources should be able to participate fully in energy, ancillary services and capacity markets.
  • Demand response is essential in competitive markets to assure the efficient interaction of supply and demand, as a check on supplier and locational market power, and as an opportunity for choice by wholesale and end-use customers.
  • Clearly, FERC has acknowledged the importance of demand response as a legitimate alternative tool to enable market structures to operate more reliably and efficiently.

    Regional Negawatt Hub (RNH)

    The Regional Negawatt Hub (RNH) concept is directly related to providing a functional and efficient means of ensuring market transparency and providing liquidity by bringing DRR to the wholesale and retail energy marketplace. A hub provides a vehicle to create market transparency through the management of DRR for energy, capacity, reserves, and transmission congestion through economic price signals and regional demand response information. The RNH is a central data exchange with security and user privileges to make sure only authorized individuals view the accessible information.

    This Hub technology enables market participants to contribute to market transparency and include DRR into the complete capacity portfolio of a region. The hub will be owned and operated by a third party that is an outside, neutral participant. Likely, the operator would also create an open standard data exchange that operates the flow of information to market participants. Once a secure, inexpensive data exchange is available to market participants, competition will be created for resources in the market as well as a diversity of products that would also add to the total customer benefit of the availability of the Regional Hub.

    As an example, the RETX Regional Negawatt Hub solution, such as the RETX RNH implementation at ISO New England, is targeted to deliver a functional and efficient means of ensuring market transparency and providing liquidity by bringing DRR to the wholesale and retail energy marketplace. The RETX RNH provides a vehicle to create market transparency through the use of DRR for energy, capacity, reserve, and transmission congestion applications. RETX RNH is an Internet-based solution that manages each market participant’s access to usage and market information so that Demand Response Resources can be activated, tracked, managed and analyzed in specific market programs.

    Conclusion

    New energy markets will not be successfully opened unless participants have access to critical market information that enables them to make good business decisions regarding their total portfolio of supply and demand commitments. New markets will also fail if some level of transparency is not maintained. At a minimum, pricing and energy usage information must be available so that end-user customers can view their situation and respond to trusted market signals regarding their active participation and behavior in the midst of these volatile pricing events.

    With the extensive implementation of Internet-based tools such as pricing exchanges and energy usage applications, it is not such a big step to envision the implementation of a Regional Negawatt Hub. Such a Hub can collect, maintain and manage how and when end-users participate in demand response events as resources alongside traditional generation and transmission assets. The implementation of such a Hub will contribute to the stabilization of markets during volatile pricing events, therefore contributing to market transparency and the health of a deregulated market.

    So, just as Internet-based tools have transformed the financial services industry and brought the end use customers to the front row of involvement, similar Internet-based tools like the Regional Negawatt Hub can bring a higher confidence level in the end-use customer’s decisions on energy management. With the ability to view price signals, see their usage and actively participate in the market as a resource by bringing demand-side strategies to bear, customers now become an alternative solution to the generation and congestion problems prevalent in our energy system today.

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    Comments

    This is a fairly visionary essay, which is both good and less-good. The strategy espoused is highly encouraging, and this type of thing needs to be more widely publicized (popularized?) in order that our country keeps an attitude of optimism about electric industry deregulation. I am all for it, but one can sense the national mood is about to capitulate to reactionary interests.

    In the end, the form of deregulation is going to have to be successfully explained to state legislators so they can vote for it without their constituents opposing. Federal agencies are not likely to be able to do it either, without the support of state governments.

    Excellent article. While I hope that internet-based tools will do away with any need for a "Negawatt hub" (by allowing anyone to create a virtual hub anywhere), it was good for illustration purposes.

    Until the small user gets paid the same for foregoing firm demand as the large supplier gets for providing, there will be capitulation to "reactionary" interests, especially when demand is only as "firm" as is convenient for the control area that can drop "firm" load for free anytime it wants while it pays big bucks to Big Business to switch "nonfirm" load to "firm" busses.

    Reregulation that stacks the cards in favor of Big Business over Joe Sixpack should be opposed. True deregulation, including access to demand response payments, should be tried sometime, as the author urges.