The question of whether negawatts - energy conservation - could and should compete with megawatts (MW) of generating capacity was debated in the early 1990s with the overall result that subsidies required for negawatt (NW) programs did not produce sufficient benefits to justify the cost.(1) These demand side management programs (DSM) also produced Robin Hood in reverse – they taxed the poor and subsidized the rich.(2) The issue of NW competition is arising again as power pools, various states, and Canadian provinces attempt to maintain adequate resources to meet power needs at minimum cost and reduce peak prices. This article is based on a report distributed at the recent Ontario Power Summit and explains that a market based negawatt program can add significant economic value, but this value is highly sensitive to the market design.(3)

If NW were able to bid along side MW in the Ontario wholesale market four major benefits would result:
(1) average wholesale and retail prices would decline,
(2) critical peak prices would also decline,
(3) the wholesale market would become more stable, and
(4) locational market power would be reduced.

Ontario retail customers, and the regional economy, would obtain significant economic benefits. However, if NW were allowed to compete with suppliers in the Pennsylvania – New Jersey – Maryland (PJM) energy market, customers would not see these benefits. The critical distinction is that the energy market only in Ontario reveals efficient peak prices. In contrast, the separate energy and capacity markets in PJM, along with the installed capacity obligation in PJM, produces flat rate capacity pricing that subsidizes high cost peaking MW and discriminates against lower costs NW.

The critical characteristics of the negawatt program considered here are its dispatchability by the system operator, and that it produces measurable, reliable and verifiable results.(4) The system operator must be able to use NW to meet load with the same level of reliability and controlability as when dispatching MW to meet projected load. A negawatt program could curtail or interrupt power use; the program considered here curtails power. The program is market based and competes in the wholesale market without a subsidy.

Illustrating a Negawatt Program

Table 1 below is a simple and hypothetical illustration of the market effects of including 300 NW of supply alternative. Although the numbers are hypothetical and illustrative, the MW of capacity and supply of negawatts are roughly applicable to Ontario. We assume first that the system operator projects that 27,600 MW of capacity is required to meet projected demand. As in the Ontario auction market, the supply resources in Table 1 are stacked from the lowest price bid to the highest price bid. The lowest price bids of the first 27,600 MW of capacity will be accepted, with the marginal bid price determining the wholesale price received by all bidders.

Meeting projected peak demand requires a capacity level above 27,600 MW, which we illustrate by bids of capacity increments of 300 MW. This capacity increment is selected to correspond to a plausible increment in negawatts. The second column in Table 1 illustrates bid prices that define the supply curve where increasing levels of MW of capacity are required to meet peak demand. The third column depicts the larger price increments that characterize an increasingly inelastic supply curve. For instance, in this illustration, the increments in baseload capacity increase in bid price by 0.1, 0.2 and 0.3 cents. However, these price increments increase as installed capacity level is approached and the last two price increments are 1.0 cents and 2.0 cents respectively. The last bid of 300 MW of capacity increases the marginal bid price from 7.3¢/kWh to 9.3¢/kWh – an increment of 2.0¢/kWh. The market clears with 27,600 MW of capacity being supplied at a market spot price of 7.3¢/kWh. Wholesale customers pay 7.3¢/kWh for each kWh they purchase during this auction period.

The illustration thus far assumes that all market adjustments are supply side and in the form of adding MW of generation to meet demand. We now let 300 negawatts be economically viable at 5.8¢/kWh.(5) With 300 negawatts entering the bid order, the 300 MW power plant that bid 5.9 cents drops down one place in the order (col. 4, Table 1). All higher price bids also drop down one place in the stacked order. The negawatt response has the effect of moving down the bid order of all higher priced MW supplied. The last 300 MW of supply required previously to meet demand is no longer required; it is displaced by 300 negawatts of reduced megawatt use (col. 5). As depicted in Table 1, the market again clears with 27,600 MW of resources being used to meet projected demand, but this resource now consists of 27,300 MW of capacity at its margin bid of 6.3 cents and 300 negawatts of reduced demand, which enters the bid order at a lower price.

The first effect of increasing this supply alternative is to reduce the wholesale price to all customers. The market price is again determined by the marginal bid price, but with 300 negawatts of market based resources entering the bid order, the required resources are now brought on line at a reduced marginal cost. Table 1 illustrates that with the negawatt response, the spot market clears with 300 less MW of capacity, and at a reduced peak price of 6.3 ¢/kWh instead of 7.3 ¢/kWh.

Wholesale electricity markets, that use spot markets and produce real time prices, tend to produce a price duration curve that resembles an inverted hockey stick. Spot prices are relatively flat during much of the year, but increase during peak periods, and increase very sharply during the few hours of greatest peak demand. An important feature of the NW resource is that it displaces the marginal or critical peak supply resource that produces the critical peak prices. Although market based negawatts compete successfully well before a critical peak is reached, it is the marginal, high-cost, supply resource that customers no longer have to pay for. Negawatts therefore reduce peak prices and add price stability to the wholesale market.

From the perspective of the system operator, the negawatt program looks like a typical MW supply resource, not a demand side response. In fact, the impact of negawatts on the system is barely distinguishable from using an additional conventional MW technology to meet perceived load. The main effect of adding a negawatt program to MW supplied is to reduce average prices and peak prices. The same price effect would occur from adding a conventional generating plant to the mix of supply resources. A negawatt program is like a supply side resource, except that it meets projected load by reducing the use of low value electricity instead of producing more high cost electricity. The market effects on average prices and price spikes can be identical to an incremental supply resource; customers see no difference, and the system operator sees little difference.

Local markets in Ontario experience price spikes when power demanded at one location exceeds that provided by available generators. Generating stations come in large discrete increments that do not always match locational power needs. Negawatts are available in tiny increments, and are widely dispersed across a market area. Given the dispatchability requirement of megawatts and negawatts, a system operator would be able to dispatch negawatts in locations experiencing high locational marginal costs. The diversification between negawatts and megawatts thereby reduces locational price spikes.

The PJM Market

The Pennsylvania-New Jersey-Maryland (PJM) wholesale market is significantly restructured from that of traditional regulation. This market includes auction markets for energy, capacity, and others for various ancillary services. These markets produce real time and day ahead spot prices. Floating prices are essential to achieve price-demand response. Although PJM wholesale market prices float, these prices do not reflect the actual marginal cost of supplying peak electricity demand.

According to the PJM market rules, an installed capacity margin (ICAP) is set to meet peak demand requirements.(6) In the PJM model, this installed capacity level must also be maintained throughout the year. The cost of peaking units is thereby averaged throughout the year, just as in the traditional rate of return regulatory model. Capacity market prices vary randomly around an annual average price regardless of capacity utilization. In the absence of peak prices that reflect real peak costs, price-demand responses, including market based negawatts, are not feasible.(7) Just as in traditional regulation, in the PJM market, the high cost peaking units tends to crowd out lower cost negawatts, because these high costs are shifted to non-peak users.

With relatively flat retail rates, there is little incentive for retail customers to reduce their low value peak power in exchange for negawatts. With relatively flat wholesale prices there is limited opportunity for negawatts to reduce peak demand or peak prices.

The Ontario Market

The Ontario electricity market is an energy market only (no separate capacity market) that includes an “energy reserve” of roughly 1400 MW above actual consumption.(8) Wholesale prices are determined in a real time auction market. The Independent Electricity System Operator (IESO) issues forecasts of needed energy the following day. Generators and importers submit offers to supply electricity and the offers are stacked until the highest priced offer just provides the needed power. As stated by the IESO “All suppliers are paid the same price – the market clearing price. This is based on the last offer accepted”(9) with real time prices.

Ultimate customers are divided into low volume and large volume customers, where large volume customers are those who consume more than 250,000 kWh a year. Large volume customers pay the wholesale price of electricity, which is a floating price determined in the auction market. Residential and small business customers pay an administered price, which is currently 5.0¢/kWh for the first 750 kWh and 5.8 cents for the additional electricity consumed during the month.

Stable and flat rate retail prices discourage price-demand response in this market. At present there is demand response in the wholesale market from the largest customers, but little price-demand response from residential and small business customers. A market-based negawatt program is highly feasible in the Ontario market. The program provides a supply side resource, in the form of demand reduction that contributes to meet projected load at a lower cost than a MW only resource. It does so by reducing the use of low value energy when market prices indicate that such energy is expensive to produce.

References

(1). Paul Joskow and Donald Maron, “What Does a Negawatt Really Cost? Evidence From Utility Conservation Programs” The Energy Journal, Vol. 13, No. 4, pp. 41-74.
 

(2). Ronald J. Sutherland, “Income Distribution Effects of Electric Utility Programs” The Energy Journal, Vol. 15, No. 4, pp. 103-118.
 

(3). The report is “The Economic implications of Negawatt-Megawatt Competition in and Electricity Market”, and is available from the Electric City Corporation. See www.eleccorp.com
 

(4). Most conservation programs do not have these characterstics, but the “Virtual Negawatt Power Plan” of Electric City Corporation has these properties.
 

(5). The assumption of 5.8 cents is arbitrary. The only necessary assumption is that market-based negawatts enter the bid order before the last or marginal supply resource.
 

(6). PJM Market Monitoring Unit, 2002 State of the Market Report, March 5, 2003, p. 68.
 

(7). Ronald J. Sutherland and Nat Treadway, Resource Adequacy and the Cost of Reliability: The Impact of Alternative Policy Approaches on Customers and Electric Market Participants, Center for the Avancement of Energy Markets and Distributed Energy Financial Group, January 2005, see www.defg.com
 

(8). Information in this paragraph was obtained from the Ontario Independent System Operator site, www.ieso.ca.
 

(9). Quoted from the IESO site, www.ieso.ca, “How the Wholesale Price is Determined”

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