Supplier Compensation: European Commission and US FERC See Eye to Eye


Energy suppliers are lobbying against a proposal from the European Commission to remove barriers to demand response schemes, writes Philip Baker. According to Baker, the Commission should stick with its proposal. Demand response, he argues, will bring great savings to energy consumers. What is more, the Federal Energy Regulatory Commission (FERC) in the United States has introduced similar measures, indirectly supporting the position of the European Commission.

Demand response is a vital source of flexibility in the cost-efficient transition to a decarbonised electricity system. A flexible demand side will ease the integration of intermittent wind and solar generation, while reducing or delaying the need for network investment to electrify the heat and transport sectors. Explicit demand response, where third-party “aggregators” pay domestic and smaller commercial customers to flex their demand, will play an important role in the development of a flexible demand side, providing a low risk and automated path to market participation that avoids exposure to variable energy prices.

Demand Response will Reduce Customers’ Electricity Bills

In addition to smoothing the transition to a low-carbon future, explicit demand response and demand flexibility can deliver an immediate and beneficial impact on customer’s electricity bills. Analysis commissioned by RAP demonstrates that even the modest application of demand response across the German/Austrian, Nordic, and French electricity markets will bring savings exceeding €1.6 billion annually, with proportionately greater savings seen across Europe as a whole. Suppliers will initially see these savings in the form of reduced energy costs, but, in a competitive market, they can pass the savings through to customers in the form of lower electricity bills.

Proposed Electricity Directive Eliminates Barriers to Demand Response

Despite the obvious need to encourage customer participation in the electricity market in the interests of decarbonisation and lower energy bills, significant barriers to the successful development of explicit demand response persist. In many Member States, aggregators must obtain permission from the customer’s supplier to operate on the customer’s load or compensate the supplier for lost income. These requirements threaten the development of a flexible demand side. The European Commission, in Article 17 of the proposed Electricity Directive, removes these barriers. We encourage widespread support for this proposal.

Energy is Not Transferred

Not unexpectedly, incumbent generators and suppliers strongly oppose these proposed changes. The savings in customer’s electricity bills come at the expense of wholesale market revenues seen by generators, and suppliers cannot bill for the energy not consumed by customers providing “downward” demand response. In making the case for compensation, suppliers contend that energy bought by them is transferred via aggregation to others for profit.

In reality, however, energy is not transferred. Downward demand response simply reduces the amount of energy that needs to be generated; the saved energy is neither generated nor consumed by anyone. These self-interested objections should therefore be resisted by the Commission, who should persist with their sensible objective of removing unjustified and damaging barriers to the growth in demand side flexibility.

US Compensates Demand Response at the Full Wholesale Market Price

A very similar debate in the United States supports the Commission’s position. It centered around the Federal Energy Regulatory Commission’s (FERC) Order 745, which requires market operators to pay the same wholesale price to providers of demand response as is paid to generators—essentially the same situation as exists in European markets today. The Order was adopted in preference to an alternative compensation scheme proposed by the Electricity Power Supply Association (EPSA) that would have subtracted from the wholesale price the savings made by customers in not consuming energy. The EPSA remedy was similar to, if not the same as, the incumbent’s supplier compensation proposal in Europe in that a third-party aggregator would retain the wholesale price minus the retail price of the unused energy. In Europe, suppliers are asking the Commission to require the aggregator to continue compensating the supplier for energy costs that cannot be recovered from customers who have chosen not to consume that energy.

The Supreme Court of the United States eventually reviewed Order 745 and concluded that deciding the terms on which demand response should be remunerated was a matter for FERC and not for them. As a result, the situation in the United States and Europe (based on the wording of Article 17 of the proposed Directive) is essentially the same—demand response will be rewarded at the wholesale market clearing price with no discount or compensation applied.

Although the Supreme Court did not express an opinion on the technical merits of the remuneration provided in Order 745, it is instructive to note the arguments deployed by FERC to justify its position. Firstly, FERC considered that, as the acceptance of a demand response and the equivalent generation offer have same impact on the wholesale market price, they should both receive the same value from the market. Secondly, although they did not inquire into the costs incurred by a market participant when making an offer to the market, FERC noted that the cost structure of different providers could be very different. While a generator needs to recover the cost of fuel, a demand response provider may need to recover significant up-front hardware costs.

The Commission can take comfort that an expert electricity regulator of FERC’s stature has reached a similar conclusion—the value of demand response is the full wholesale market price and no discount is warranted.

A version of this article originally appeared on Energy Post.