FERC Order 745 and the Future of Demand Response

FERC Order 745
Jesse Remillard for Zondits, December 17, 2015. Image credit: Sweetaholic

The Federal Energy Regulatory Commission (FERC) Order 745, which was passed in 2012, required utility operators to pay the same amount for demand reduction as for generational capacity. This permitted demand response to be sold on wholesale markets. On May 23, 2014, the US court of appeals ruled against FERC order 745, as result of a case brought by the Electric Power Supply Association claiming that FERC does not have jurisdiction over demand response. FERC immediately sought an appeal of the decision, for which oral arguments took place on October 14, 2015. As of December 16, 2015, a decision had still not been made but is likely imminent.

The case is significant because it addresses a fundamental shortcoming of the current electric market, which is that retail consumers usually pay a fixed rate determined in advance while the wholesale market reflects minute-to-minute fluctuations in cost due to demand and supply. This creates a barrier to the proper balance of supply and demand in the retail markets, and prevents natural curtailing of usage due to increased prices during periods of high demand leading to inefficient use of electricity generation and wholesale price volatility. This shortcoming has become an increasingly important issue due to declining reserve margins and transmission congestion in certain areas.

Markets were originally set up this way to ensure that all customers had access to electricity supply. Electricity is considered a fundamental right, and if costs were allowed to fluctuate in natural markets, small retail consumers could be pushed out of the market during times of high demand and limited supply.

FERC Order 745 was a groundbreaking rule in that, for the first time, utilities were required to pay retail customers for reducing the amount of electricity they purchased during peak demand periods. This would allow retail customers to profit by choosing to reduce their electric loads during those peak demand periods. The concept is that utilities should compensate customers who reduce their demand and therefore help the utility avoid peak demand costs. This would also have strong emissions reductions because peak demands are often met with inefficient, high pollution-emitting sources and would create a link between retail and wholesale markets. Proponents of FERC Order 745 advocate that it would create uniform standards for demand response across the country, thus greatly increasing accessibility for customers and support for the emerging software technologies that make demand response possible.

Electricity generators oppose the Order because it requires them to compete against retail customers negotiating energy reduction during peak demand periods, but also because of believed fundamental shortcomings in the Order. According to the Electric Power Supply Association, Order 745 should not require electricity generators to pay full wholesale price for electricity reduction during peak periods, but rather the difference between the wholesale price and the retail price the customer is currently under. The argument is that the cost of avoided energy use is not the same as the cost of electricity. In an example in the linked appeal, the argument is made that if a customer is buying a car for $20,000 and another customer offers $30,000 for the car, you do not offer $30,000 to the first customer for not buying the car, but you could offer $10,000 to the first customer and sell the car to the second customer for $30,000. This fundamental issue resulted in FERC reissuing the order with restrictions on when customers can bid energy or demand reduction into the wholesale market, to periods only when it is cost-effective to the rate payer, or when electricity costs are particularly high. The Electric Power Supply Association claims that the restrictions are cumbersome and unclear as to how they should be implemented.