After the D.C. Circuit Court’s invalidation of FERC Order 745, how can we pay for demand response?

“Demand response” happens when electricity customers change consumption patterns in response to the needs of the power grid. Electricity customers can provide a substantial amount of demand response to grid operators without a noticeable effect on their electricity service — for example, by adjusting the set-point of an industrial freezer or a home hot water heater by a degree or two. Aggregate those adjustments over enough customers, and the total becomes a major resource that can be used to manage the grid’s variability in the short-term, to absorb renewable energy generation during times of high output and low load, and to avoid “overbuilding” the system in the longer-term by cutting down peak demand.

In 2011, in response to the clear value of demand response, FERC issued Order 745 to place it on par with generation in electric energy markets. FERC’s order stated that grid operators should compensate demand response resources that provide a “net benefit” at the “locational marginal price” of generation in the same area. This gave the electricity markets access to a new cost-effective resource and contributed to the development of demand response in capacity and ancillary services markets. Increased access to low-cost demand response proved extremely valuable; for example, when PJM qualified demand response to participate in its capacity market, prices dropped 85 percent in one year.

But this past May, a 2-1 majority on the D.C. Circuit Court vacated FERC Order 745, declaring that FERC lacks the jurisdiction to compensate retail customers for reducing consumption. While the Court did not dispute the benefits of demand response for electricity prices, nor its ability to provide the same type of service as generation, the Court found that Order 745’s compensation mechanism interfered with the “retail market” relationship that is exclusively under the purview of states. FERC petitioned for “en banc” review, aiming to get the case in front of the full 11-person panel of judges, but that petition was rejected in September. It is unclear whether the U.S. Supreme Court will review the case.

Leaving things somewhat ambiguous, the Court declined to explain which entities, if any, may continue to participate in a market for demand response. The ruling makes it clear that FERC itself may not circumvent state jurisdiction over retail markets by ordering ISOs/RTOs to directly pay customers for demand response; instead, only states can set compensation levels for customers who provide demand response. This finding is grounded on the Court’s holding that demand response is solely a “retail product,” an assertion the dissenting judge contested. The ruling also leaves open the question of whether ISOs/RTOs may voluntarily accommodate the sale of demand response on the wholesale market in the case that it is entirely outside the jurisdiction of FERC.

So, what can be done to enable demand response to continue to provide reliability, affordability, and environmental benefits to consumers? Scott Hempling, an attorney and expert on FERC jurisdiction, outlined several potential actions that states or ISOs/RTOs may be able to take now to support demand response despite the ruling:

1. States can call on utilities to become retail load managers without any resale into the wholesale market. (Note that this likely leaves substantial value on the table.)
2. States can call on utilities or third parties to act as aggregators of demand response and resell to the wholesale market. (The ruling is somewhat ambiguous on whether or not this is possible.)
3. With state approval, the wholesale market operator can independently open and operate a market for demand response outside of FERC jurisdiction. (This is not unprecedented, as Renewable Energy Credit markets are not FERC jurisdictional.)

Because of the lingering questions about the scope of the D.C. Circuit Court’s ruling, some of these suggestions are likely to be the subject of further litigation. However, they provide examples of proactive ways to keep paying demand response providers for the value they deliver. In addition to considering the proposed schemes outlined above, states can also initiate stakeholder discussions about how to address demand response in light of the Court’s ruling, bringing together the regional wholesale market operator with the utilities, demand response aggregators, customers, and regulators.

What have states and RTOs done to preserve demand response after the D.C. Circuit ruling?

New York’s Public Service Commission (NY PSC) and PJM have both taken proactive steps to preserve demand response in spite of the ruling. Here’s what they’ve done:

New York
New York’s “Reforming the Energy Vision” proceeding (described in a previous blog post) recognizes that distributed energy resource optimization is essential to ensuring just and reasonable rates. New York’s vision would transform utilities into “Distribution System Platform” (DSP) providers, encouraging them to look across all options — including demand response — to optimize the distribution system. With a DSP at the core, there are vast opportunities for demand response to meet local grid needs outside of FERC jurisdiction.